- As cryptocurrencies are mired in bearish sentiment, NFTs are bucking the trend amid broad adoption.
- NFT-backed loans, which allow holders to use their NFTs as collateral, have become more popular too.
- Arcade’s Gabe Frank shares the steps for borrowing against your NFTs and how traders use the loans.
After a recent slump in performance, cryptocurrencies are shrouded by a mist of bearish sentiment and uncertainty. Some investors are predicting further sharp drawdowns, while others eye a $100,000 bitcoin price target again.
But non-fungible tokens, which were once called a digital fad, have continued to gain momentum on the back of rising sales volume and mainstream adoption. In 2021, the market size of NFTs ballooned to $41 billion in value, compared with about $50 billion in sales in the traditional art market in 2020.
The breakneck growth of NFTs has seen no signs of slowing in 2022. OpenSea, the largest NFT marketplace, this week raised $300 million in a Series C funding round that drove its valuation up 800% to $13.3 billion from $1.5 billion in July 2021. Electronics giant Samsung said it will integrate an NFT platform into its smart TVs later this year. Most recently, the Wall Street Journal reported that GameStop is launching an NFT unit and has hired 20 people for it.
Meanwhile, prices for some of the so-called rare or blue-chip NFTs continue to soar, with a recent Mega Mutant Serum NFT being sold for $5.8 million.
As the boom in digital collectibles continues, some investors and entrepreneurs have found a new way to extract the maximum value out of their NFT holdings — by using them as collateral for loans.
NFT-backed loans solve the problem that most digital collectibles are illiquid despite their rapid appreciation in value, according to Gabe Frank, the co-founder of decentralized NFT lending marketplace Arcade.
“We’ve always seen NFTs as a new asset class,” he said in an interview. “And to be a new asset class, you need to have credit markets.”
How to take out loans against your NFTs
Crypto users take out NFT-backed loans for various reasons. Some use the money to scoop up more undervalued NFTs, others engage in a decentralized finance strategy called yield farming, which could generate potentially higher returns than the interests on the loans, according to Frank.
To get started on Arcade, users need a Web3 wallet where their NFT holdings are held. After connecting to the decentralized application via their wallet and giving the firm their token IDs, Arcade’s institutional OTC desk will appraise the assets based on metrics including recent sales and recent transaction activities. Then, lenders and borrowers will be presented with the appraisal report.
“It helps them come to terms on the loan. And basically, the blockchain is the term sheet for the loan,” he explained. “Once those numbers are figured out in terms of duration, funding currency, and funding amount, then they can just log on to the site. A few clicks and the loan gets settled.”
These loans are mostly funded in the stablecoin USD coin (USDC) and ethereum (ETH). They are non-recourse term loans, which means if the borrower defaults on the loan, the lender can claim the asset. For instance, The Block reported last year that an NFT owner used one of their NFTs as collateral to take out a 3.5 ETH loan but couldn’t repay the loan at the end of the term. As a result, their NFT, which had surged to $340,000 during the duration of the loan, was taken by the lender.
Meanwhile, if the NFT suddenly plunges in value and the borrower can’t repay, the lender will be stuck with the asset too.
Frank said that the institutional lenders that his firm works with generally charge anywhere from 15% to 20% annual percentage rate on these NFT-backed loans. For example, a Golden Bored Ape fetched a borrower an $850,000 three-month term loan at around a 15% APR on the platform, he added.
How to pick high-quality projects
To be sure, Arcade is far from the only player in the NFT-backed loan market.
Similarly, crypto lender Nexo partnered with hedge fund Three Arrows Capital to allow customers to borrow stablecoins and other digital currencies by using NFTs as collateral. Crypto exchange Kraken is also working on a marketplace where customers can take out loans backed by their NFTs.
Yet as the financialization of NFT keeps up, scams and frauds could also follow as bad actors jump into the space. As a result, the ability to separate the wheat from the chafe could be more important than ever.
“Probably 95% to 98% of the NFTs are not valuable,” Frank said. “So it is hard to look at it as a speculative investment because most of it will go to zero.”
Instead of getting caught up in picking NFTs as investments, Frank follows a simple axiom that he also applies to buying physical art — “buy what you like.”
In addition, he tracks metrics such as the artist’s social media following, the collection’s supply-and-demand dynamics, and whether the project continuously provides value to its NFT holders. His favorite digital artists include Beeple, Pak, and FEWOCiOUS.