NFT-Backed Loan

Artists and decentralized autonomous organizations use their NFT collections or treasury assets as collateral. A creator can take a loan against the future royalties of their collection to fund new work. A DAO can leverage a blue-chip NFT in its treasury (like a Bored Ape) to raise operational capital without conducting a token sale, preserving governance control. This turns illiquid prestige assets into functional balance sheet items.

The primary risk is the extreme price volatility of the underlying NFT. If the NFT's market value falls below the loan's liquidation threshold, the collateral can be automatically seized and sold by the protocol or lender. This can result in a total loss of the asset for the borrower. Example: A CryptoPunk used as collateral could drop 40% in value during a market downturn, triggering a liquidation event.

Loan protocols rely on price oracles to determine the real-time value of NFT collateral. Risks include:

• Oracle failure: Outdated or incorrect price feeds.
• Manipulation: Coordinated "wash trading" on a marketplace to artificially inflate an NFT's price to secure a larger loan.
• Illiquidity: For rare NFTs, establishing a true market price is difficult, making oracle data less reliable.

The entire loan agreement is governed by smart contracts. Vulnerabilities in this code can lead to catastrophic loss. Key considerations:

• Audits: Has the lending protocol undergone rigorous, independent security audits?
• Upgradability: Can the contract be upgraded, and by whom? This introduces centralization and change risk.
• Integration Risk: Bugs in dependent contracts (e.g., oracle, NFT marketplace) can compromise the loan.

Understanding who holds the NFT during the loan term is critical.

• Peer-to-Peer (P2P): The NFT is typically held in a dual-signature escrow contract, reducing but not eliminating trust.
• Peer-to-Pool (P2P): The NFT is transferred to the protocol's vault contract. Risk shifts to the protocol's security and solvency.
• Default Risk: The lender (in P2P) or liquidity providers (in P2P) bear the risk if the NFT's post-liquidation sale doesn't cover the loan + fees.

Loan-to-Value (LTV) ratios are typically conservative (often 20-50%) due to volatility. Key implications:

• High LTV loans are far more susceptible to liquidation from minor price swings.
• Illiquid collateral (e.g., a 1/1 art piece) may have a much lower maximum LTV or be ineligible.
• Liquidation penalties can be steep (e.g., 10-15% of the loan value), adding to the borrower's loss.

Operational and legal uncertainties pose systemic risks.

• Platform Insolvency: A lending platform could become insolvent or be hacked.
• Regulatory Action: Evolving regulations could deem certain NFT loans as securities or impose restrictions, affecting protocol operation and asset recovery.
• NFT Provenance & Legitimacy: Lending a forged or stolen NFT can invalidate the contract and lead to legal disputes.

The collateralization ratio (CR) is the value of the pledged NFT relative to the loan amount, expressed as a percentage. It is a critical risk parameter.

• A high CR (e.g., 150%) provides a larger safety buffer for the lender against price volatility.
• If the NFT's value drops, triggering a liquidation, the CR may fall below a protocol's liquidation threshold.
• Borrowers often seek the maximum loan-to-value (LTV) ratio, which is the inverse of the minimum CR required.

Liquidation is the process of automatically seizing and selling a borrower's collateralized NFT when its value falls below a predefined threshold, protecting the lender from loss.

• Triggered by oracle-reported prices or missed payments.
• Often involves liquidation penalties and may use Dutch auctions or direct sales to liquidators.
• Protocols like BendDAO and JPEG'd have specific liquidation engines that define how NFTs are sold to cover the debt.

The floor price is the lowest listed sale price for an NFT within a specific collection (e.g., Bored Ape Yacht Club). It is a foundational metric for valuation in NFT lending.

• Most lending protocols use the floor price, often via a price oracle like Chainlink, to determine collateral value for common NFTs.
• Loans against floor NFTs are considered less risky than those against rare, high-value traits, leading to higher LTV ratios.
• Trait-based pricing models are emerging to provide more granular valuation beyond the floor.

Peer-to-Pool is the dominant model for NFT-backed loans, where lenders deposit funds into a shared liquidity pool that is used to issue loans, rather than negotiating directly with individual borrowers.

• Lenders earn interest from all loans in the pool.
• Borrowers can instantly draw funds from the pool if they meet collateral requirements.
• This model, used by BendDAO and NFTfi, improves capital efficiency and loan accessibility compared to peer-to-peer models.

Debt refinancing in NFT lending involves taking out a new loan to pay off an existing one, often to secure better terms such as a lower interest rate, a higher loan amount, or to avoid liquidation.

• Borrowers may refinance by moving their collateral to a different protocol offering better LTV.
• This activity is a key indicator of a competitive and healthy lending market.
• It requires the NFT to be re-locked as collateral with the new lender.