Since its appearance blockchain has gradually been changing the financial world. Now we’re witnessing two blockchain-based concepts – NFT and DeFi – merging together to transform the way we manage finances.
Decentralized Finance (DeFi) has taken the lead in managing crypto transactions, with TVL (total value locked) now as much as $210 billion.
Since traditional centralized systems are prone to fraudulent activity, DeFi is a perfect alternative, as the absence of any intermediaries makes transactions transparent and secure.
Alongside, boomed in 2021, NFTs have been greatly contributing to a number of spheres: art, gaming, and even real estate. As of February 2022, NFT market capitalization is estimated at $20 billion.
Non-fungible tokens are now actively entering the DeFi world, bringing new insights into how to make traditional processes more effective, and offering new concepts and ideas.
In this article we will find out what aspects of DeFi are most susceptible to the NFT revolution and explore the most prominent use cases of non-fungible tokens in DeFi solutions.
Overview of DeFi
DeFi is a blockchain-based system of finance management. Decentralized finance allows conducting financial operations such as payments, lending, borrowing, saving, margin trading, yield aggregation, and currency trading fast and securely on a P2P (peer to peer) model, thus excluding any third parties (e.g. banks or other financial institutions).
DeFi services are made possible by decentralized applications (dApps), the majority of which run on the Ethereum platform.
Decentralized finance attracts a great deal of attention from leaders in the blockchain sphere and form investors, with both parties fully aware of the significant opportunities offered by the technology:
“I’m very excited about the potential that DeFi offers in principle. The idea that anyone anywhere in the world can have access and choose their financial exposure is a very powerful thing.” — Vitalik Buterin, founder of the Ethereum blockchain
What are the benefits of DeFi?
DeFi can boast a number of tangible advantages:
- no centralized authority meaning that no one has the power to tamper with the data or suddenly change the rules.
- transparency and immutability – all information concerning transactions is kept on the ledger and is open to everyone, yet no changes can be made to it.
- accessibility – DeFi applications are cross-platform and have no territorial limits meaning that any person with a stable internet connection can perform DeFi operations.
- no need for permission – fast access to a full range of financial services and transactions is made possible without the need to wait for requests to be verified.
- interoperability – DeFi solutions are highly flexible and can be tailored precisely to the users’ needs. Besides, it is possible to build dApps on existing protocols and attach third-party applications.
In this video, Daria Khritonenkova, a blockchain consultant, dives even deeper into the DeFi phenomenon. She talks about all the pros and cons of this concept, explains how CeFi and DeFi differ, and introduces notable DeFi use cases.
A quick look at NFTs
Let’s get back to NFTs. NFT stands for non-fungible token and represents real-life items recorded on the blockchain as unique digital assets. Examples of an NFT can take multiple forms – from images and videos to tickets and real estate. Unlike fungible tokens such as Bitcoin, NFTs are one of a kind and possess distinct characteristics.
NFTs caused lots of fuss in the art community as creators are now able to make a profit on their works without relying on middlemen like galleries or auction houses.
Gamers have also appreciated the perks stemming from incorporating non-fungible tokens into the gaming experience: it’s now possible to trade in-game assets legally and engage in P2E (play to earn) games, the very goal of which is to generate revenue while playing.
“NFTs are unstoppable and the opportunities in NFTs are endless.”― Anuj Jasani, CEO at JustBrandable & BudgetOK
What are the benefits of NFTs?
The key features making NFT such a sought-after technology are:
- proof of ownership – the information about the author is permanently stored on the token’s metadata and no matter how many hands an NFT passes through, the creator saves all authorship rights and receives royalties in total sum.
- uniqueness – as implied in its name, a non-fungible token is one-off, with no duplicates possible.
- transparency – NFTs’ metadata is open to anyone so it is easy to check on the authenticity of the token you are interested in as well as viewing its previous owners and price history
- investment potential – NFTs have a tendency to suddenly become very expensive overnight so there is a chance of you buying a token very cheaply to later find out that its price has more than doubled.
How can NFTs benefit DeFi?
It’s clear that NFTs can make quite a difference in a number of traditional operations, but what can they bring to the sphere of finance?
Traditional centralized finance has always been controlled by governing authorities that supervise transactions, investments, and trade contracts, judging them to be trustworthy and accountable. Yet this approach has its disadvantages – going through verification and approval can be a very long process resulting not only in physical delays but also requiring tangible expenses. Not to mention that the chances of fraud or error are greater when too many people are involved.
However, decentralized finance comes as a solution to these issues, offering a transparent and efficient means of handling finances while not compromising on privacy and security.
Sounds good, right? Wait until NFT comes on the scene.
Many DeFi projects are now adopting NFT for its ability to store value and serve as an immutable proof of ownership. In its turn, DeFi helps to unlock this value and perform all kinds of operations with tokenized assets. These two technologies are mutually beneficial and open new possibilities in the financial domain.
We recommend you to watch the video above, where we discuss the role of NFTs in the DeFi market and how they can be applied in decentralized finance. We also briefly discuss popular DeFi projects that use NFTs.
The most prominent use cases of NFTs in DeFi
There are a number of DeFi aspects that can significantly benefit from the adoption of NFTs: loan collateralization, fractional ownership, insurance, and debt management.
In the traditional system it is the bank that determines the collateralization amount, but what about letting the lenders decide? This is exactly how it happens with DeFi.
NFTs facilitate the process of securing collateralized loans, as the borrower can present a token to mitigate the lender’s risks in case the loan can’t be returned. The lender can examine the NFT’s current price, secondary market tendencies and demand for that particular type of asset to make a calculated decision.
This has resulted in NFT lending being the most popular segment of decentralized finance, with TVL reaching $49 billion in 2021.
There are multiple platforms where NFT owners can place loan requests including Arcade, Genesis, NFTfi, PawnFi, and TrustNFT.
Let’s take a closer look at Arcade. The platform is built on Ethereum and allows for P2P lending and borrowing. Arcade utilizes the Pawn protocol that combines decentralized finance and NFTs. Any ERC20 token (including wETH, USDC, and DAI) can be used as collateral.
When applying for a loan, borrowers need to specify the desired amount of money, the currency, the payout amount, and the loan term. Interest rates vary depending on the type of NFT, loan to value ratio, and the duration of the loan. Usually the average interest rate is about 20%.
Some non-fungible tokens happen to be extremely expensive and, thus, may wait a while before a potential customer shows up. But if the token is fractionalized, the price can be divided between a number of buyers, making the asset much more liquid.
For example, the Fractional platform makes it possible to split NFTs and generate ERC20-compliant fractions. Apart from increasing liquidity, the platform helps people become fractional owners of collectibles they could never afford otherwise.
DeFi and NFT are also set to make changes in the insurance sector, covering both crypto-related assets and traditional insurance products. Insurance policies are converted into NFTs and can be transferred, bought or sold.
As non-fungible tokens don’t have an expiry date, you don’t have to repeatedly renew documents and go through a tedious process of collecting all the relevant papers and meeting with bank officers for verification.
CoverCompared is one of the projects which combine NFT and DeFi for effective insurance management. The goal of the solution is to lower the price of insurance policies as well as transactional and administrative costs.
All products by CoverCompared can be bought with a host of cryptocurrencies on a native marketplace. The platform is working on granting access to multinational insurance providers for all global insurance products including crypto-related protection, health, life, and travel policies be easily available.
Another area of finance that can see considerable improvements with the adoption of NFT DeFi is debt management. The bigger the company is, the more people it needs to keep track of its finances, including debt issues.
Utilizing smart contracts for recurrent operations like approvals and various calculations helps significantly minimize time spent and prevent human error. In addition, as decentralized finance runs on blockchain, all data stays on the ledger so you can check the details any time.
And, if the debt someone owes you has an NFT as its collateral, you don’t have to worry if the borrower can’t repay you. In such a situation you automatically get the NFT and no court action is needed.
Top DeFi projects leveraging NFTs
With such a breadth of potential applications, many developers are taking the opportunity to unleash the potential of the NFT DeFi combination: Uniswap3, Solv Protocol, Charged Particles, NFTfi, Burnt Finance, WiVX, Pods, and Just Liquidity, to name a few.
Let’s take a closer look at these solutions:
Uniswap is a DeFi protocol for cryptocurrency exchange and automated liquidity provision.
Uniswap3 took the issue of impermanent loss (common in the Curve protocol) into account and introduced non-fungible liquidity pools, thereby creating a brand new application for NFTs.
Now liquidity providers don’t have to spread all prices in the pool, but can allocate their capital in a specific price range. This means that liquidity providers achieve higher exposure to desired assets while reducing the downside risks.
Solv Protocol is a DeFi platform allowing minting and trading of specific financial non-fungible tokens called Solv Vouchers. These vouchers are a form of derivative representing vesting assets, i.e. tokens. At the time of writing the total value locked in these vouchers is $75 million.
The assets are locked up and then released periodically. Such a system ensures long-term commitment from investors and team members, resulting in reinforcement of the project’s growth and prosperity.
Usually, locked assets are illiquid, and all that is left to do is passively wait for the vesting period to end to claim the assets. With Solv Vouchers owners of locked assets can now exercise active control, including buying and selling, splitting, or merging the vouchers into bigger entities.
Solv Protocol issues financial NFTs with a new token standard ERC-3525 to simplify the implementation and programming of advanced financial products.
Charged Particles is a protocol that lets any token (e.g. ERC-20, ERC-721) be deposited into NFTs. With this, non-fungible tokens become a kind of virtual basket carrying various digital assets.
For example, if you deposit Aave tokens that then get converted to aTokens by the protocol into an NFT, you will generate yield-bearing assets. The interest generated is programmable, which means that you have full control and can send it to any wallet.
Such tokens can also be used for virtual geocaching, entertainment NFTs, establishing NFT-based savings accounts, and charity art sales.
NFTfi is a liquidity protocol for non-fungible tokens. The solution enables NFT lending and borrowing on a peer-to-peer and completely trustless basis. NFT liquidity providers use NFTfi to earn attractive yields or – in the case of loan defaults – to obtain valuable NFTs.
Currently NFTfi runs on the Ethereum blockchain only, but will soon be available on Flow as well.
Burnt Finance is a decentralized NFT auction protocol running on the Solana blockchain. The platform holds digital asset auctions and fundraising campaigns, and allows for the creation of unique NFT collections.
Burnt Finance can boast high processing speeds (400 millisecond processing time) and low transaction costs – $0.01.
The project is going to expand and build an NFT marketplace with full DeFi functionality including lending, liquidity mining with staking incentives, fractionalization, and GameFi.
WiVX is a decentralized reserve token protocol. WiVX was introduced as an extension of WiV Technology’s blockchain-based wine investment platform.
Each WiV token represents a case of wine. Owning a token means real-life wine is your property. All wine cases are securely stored either in a professional warehouse in the owner’s custody or within WiVX’s merchant network. When requested, the wine will be delivered to the owner.
The tokens can be used for building a collection, trading, or as loan collateral.
Pods is a decentralized non-custodial options protocol that provides an easy means of hedging cryptocurrency in the NFT DeFi domain. In October 2021, Pods joined the Galaxy ecosystem and launched their NFT reward program. According to this program rewards will be distributed to the first adopters and the most avid participants of the community.
The Awakening was the first season of the reward program, and consisted of three NFT groups. In the future, Pods NFT holders will be able to vote on governance proposals, take certain positions in the community, and access early testing and research groups.
Just Liquidity is a financial system aiming to create a fully decentralized experience with global fiat applications such as Visa and Mastercard Debit Card. Nowadays, the system offers an NFT staking model.
The user can stake their tokens in a pool for a specified period of time and obtain an NFT to gain access to the next pool. The NFT becomes a kind of an entry ticket to a new pool, and expires when the user finally enters it.
JustLiquidity’s NFT staking model creates a secondary market for these NFTs based on the access provided.
Even though still in its early stage, the technology of non-fungible tokens is making quite a difference in the DeFi world, entering the very core of its operations. NFT and DeFi merged together now seem like serious game-changers in all aspects connected with finance management, and we keep an eye on the future development of these cutting-edge solutions with great interest and anticipation.
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