NFT Short Selling

A method where an NFT is locked in a vault and fractionalized into many fungible ERC-20 tokens (e.g., shards or index tokens). Shorting is achieved by:

1. Borrowing the fractional tokens.
2. Selling them on a DEX.
3. Aiming to repurchase them later at a lower price. This provides indirect short exposure to the NFT's value. Protocols like Fractional.art (now Tessera) and index providers like NFTX (through its vault tokens) enable this structure.

A derivatives approach granting the buyer the right, but not the obligation, to sell an NFT at a predetermined (strike) price before a set expiry. A trader anticipating a price drop can buy a put option.

• Writer: The counterparty who sells the option, collecting a premium and taking on the obligation to buy.
• Intrinsic Value: The profit realized if the NFT's market price falls below the strike price.
• Example: While less common, protocols exploring NFT options markets provide this direct short-like exposure.

Short selling NFTs introduces unique risks managed by protocol mechanics:

• Oracle Risk: All pricing for loans and liquidations depends on external oracles (e.g., Floor Price feeds), which can be manipulated or lag.
• Liquidation Risk: A rising floor price can trigger a liquidation, forcing the short seller to lose their collateral.
• Illiquidity Risk: The inability to buy back the exact NFT or fractional tokens at a predictable price can erode profits.
• Counterparty Risk: Mitigated in peer-to-pool models but present in pure P2P systems.

The primary financial risk is forced liquidation. If the NFT's price rises instead of falls, the value of the borrowed NFT increases, requiring the borrower to post more collateral. Failure to do so triggers an automatic liquidation by the protocol, potentially at an unfavorable price, resulting in a total loss of the posted collateral. This risk is amplified by NFT market volatility and slippage during liquidations.

Protocols rely on price oracles (e.g., Chainlink, floor price indexes) to determine NFT values for loans and liquidations. These feeds are critical attack vectors:

• Oracle delay/latency: Stale prices can cause incorrect liquidation or prevent necessary ones.
• Manipulation: An attacker could artificially inflate an NFT's price on a marketplace to trigger unjust liquidations or deflate it to borrow more than allowed.
• Floor price reliance: Using a collection's floor price exposes borrowers to volatility from rare, low-quality listings or wash trading.

Users are exposed to the security of the underlying smart contracts. Vulnerabilities such as reentrancy, logic errors, or admin key compromises can lead to loss of funds. Additional protocol-specific risks include:

• Collateral custody: The safety of locked collateral in the protocol's vaults.
• Governance attacks: Malicious governance proposals could alter risk parameters.
• Integration risk: Failures in integrated platforms (e.g., lending markets, NFT marketplaces) can cascade.

Unlike decentralized perpetual swaps, NFT shorting often involves a direct counterparty (the NFT lender). Risks include:

• Loan recall: The lender may have the right to recall the NFT before the short position is closed, forcing an early exit.
• Collateral asset depeg: If using a stablecoin like USDC as collateral, a depeg event could trigger liquidations unrelated to the NFT trade.
• NFT-specific risks: The borrowed NFT could have its metadata frozen, be flagged, or become untransferable, complicating the return of the asset.

NFT markets are inherently illiquid, creating execution risks:

• Borrowing/covering slippage: Finding a specific NFT to borrow or buying it back to close a position can be difficult, leading to high slippage and failed transactions.
• Collection divergence: A short position on a collection's floor price may not hedge against a rise in the value of the specific, rarer NFT that was borrowed.
• Platform liquidity: The lending pool for the desired NFT may be shallow, limiting position size or making entry/exit costly.

The legal status of NFT short selling is unclear in most jurisdictions. Potential regulatory risks include:

• Securities classification: If certain NFTs are deemed securities, shorting them may fall under traditional securities lending regulations.
• Tax treatment: The tax implications of borrowing, selling, and repaying NFTs (often treated as property) are complex and untested.
• Platform compliance: Regulatory action against a lending protocol could freeze assets or invalidate positions.

The lowest listed price for an NFT within a specific collection. It is the critical benchmark for NFT short selling and lending. Lending protocols use it to calculate collateral ratios, and short sellers target it as the most liquid price point to sell. Strategies often involve:

• Shorting the floor: Betting the lowest-priced asset will decrease.
• Floor sweeping: Buying multiple floor NFTs to raise the price and trigger liquidations against short positions.

A risk metric representing the value of collateral posted versus the value of the borrowed asset. In NFT short selling, a user borrows an NFT worth 100 ETH and might post 150 ETH in stablecoins as collateral, resulting in a 150% collateralization ratio. If the NFT's value increases, this ratio falls. If it drops below a protocol's liquidation threshold (e.g., 110%), the position is automatically liquidated to repay the loan, realizing the short seller's loss.

The practice of buying and selling an asset to create misleading market activity. In NFT markets, it can artificially inflate volume and price data, which poses a significant risk to short sellers and lending protocols that rely on accurate price oracles. A manipulated price spike can trigger unnecessary liquidations. Distinguishing organic demand from wash trading is a major challenge for risk models in NFT finance.