Author: 0x长安, @RealResearchDAO

First, Existing Controversy of NFT

NFT, one of the hottest tracks this year has grown about 210 times from a market cap of $82 million in 20 years to a market cap of $21 billion in 21 years. Just recently, the total trading volume of NFT has exceeded $5 billion, and the single-day trading volume of Opensea's Etherchain has broken the all-time high of $476 million.

NFT is the most accepted track by Web2 users in Web3, and one of the track with a lower threshold. Moreover, with many stars "leading the way", NFT has frequently come out of the circle and influenced a large number of Web2 users, so that more people outside the circle can learn about the crypto world.

However, NFT is a well-known problem: poor liquidity. NFT is a peer-to-peer trading, unlike FT, which can establish a liquidity pool to facilitate transactions between buyers and sellers. With the presence of market makers, FT transactions, and the resulting transactions can not be closed. In contrast, NFT, the user can only NFT pending on the platform, and if no one buys, the user's NFT will always be pending on the platform. And, the user's NFT can not be split, only a whole intact NFT for sale.

So, when a user holds an extremely bullish NFT and the user needs money urgently, a conflict arises. The conflict becomes more and more acute as the market value of the NFT rises. Because as the price of a particular NFT gets higher and higher, the fewer people are able to buy it. So how to release the locked-in value and solve the problem of poor NFT liquidity is the question we need to explore.

Second, Liquidity Solution

We can find solutions to poor liquidity in the real world. For example, the property market is a good example. People lock most of their wealth in their houses. If they suddenly need money urgently, or need big money for investment, people can't actually get it. However, when they are bullish on the property market/need to live in it and don't want to sell/can't sell, people usually rent out the house in their name and mortgage.

1. When the head of the household is short of money and urgently needs money for investment. Usually they will mortgage the house to the bank to get the money.
2. Rent out the house and collect rent in the form of monthly payments.

From the experience that can be learned from the real world, there are two mainstream ways to solve the NFT illiquidity solution in the market

1. NFT Lease
2. NFT Lending

In this article, we will discuss the issue of NFT liquidity from the perspective of NFT lending.

There are currently two products on the market: BendDAO and JPEG, although both belong to NFT lending products, but from the underlying logic, there are different points. bendDAO is similar to AAVE, Compound, belongs to the over-collateralized lending TOKEN class. And JPEG is similar to MakerDAO, which belongs to the over-collateralized minting stable coin category.

Third, BendDAO

BendDAO is a decentralized peer-to-peer pool-based NFT liquidity protocol. Depositors provide ETH liquidity to the loan pool to earn interest, while borrowers can use NFT as collateral to immediately borrow ETH through the loan pool.

Agreement Revenue: The interest rate paid by the borrower minus the bonus given to the depositor by the agreement is the agreement revenue, for example, as shown in the figure below: 15.44% for the borrower and 4.78% for the depositor, 15.44% - 4.78% = 10.66%, 10.66% x the amount of ETH borrowed from the pool is the agreement revenue.

Interest rate: BendDAO implements a dynamic interest rate, which is related to the funds in the pool. When the pool is full of ETH, the interest rate will decrease. Conversely, when borrowers all borrow the ETH in the pool, the interest rate will increase, prompting borrowers to return the ETH. BendDAO uses this operation to flexibly and dynamically adjust the utilization rate of ETH in the pool, so that ETH is kept as sufficient as possible.

Prophecy Machine: The value of NFT is difficult to measure, so BendDAO uses Opensea, LooksRare's NFT floor price as the price feed data for NFT collateral, and all NFTs will be valued at the floor price.

But since the protocol measures value in terms of floor price, could someone intentionally be evil and deliberately peg the price so low that the protocol detects a drop in the floor price, causing users to collectively blow up? The answer is no. BendDAO offers a solution, and after six months of backtesting by BendDAO, the floor price and average transaction price of the prophecy machine is consistent with the TWAP price.

1. The operation mechanism of the Bend oracle is that the off-chain nodes get the original floor price of NFT from Opensea
2. Filter the original floor price data, such as unreasonable deviations from the recent average price
3. Use the time-weighted average price algorithm (TWAP) to weight the floor price to ensure that the price is reasonable

On-chain Time-Weighted Average Price (TWAP), which is a traditional algorithmic trading strategy that allows transactions to have a reduced impact on the market while providing a lower average transaction price.

Clearing mechanism: As the price volatility of NFT is very high, the NFT lending clearing mechanism must not be consistent with FT lending. Otherwise, it will lead to a collective explosion of users. For example, if the azuki project party ''self-destructs'', resulting in a major price explosion of azuki, borrowers will not use the agreement to borrow if there is no reasonable mechanism.

When the health factor of an NFT loan falls below 1, liquidation will be triggered. That is, when (floor price * liquidation threshold)/interest bearing debt < 1, the NFT will suffer liquidation. For example, suppose the current value of BAYC is 100ETH and the BAYC holder lends NFT the top amount of 40ETH. when the price of BAYC falls to 44ETH, (44 * 90%) / (40 + interest) < 1, NFT will then enter the liquidation mechanism.

BendDAO adopts 48 hours strong leveling guarantee mechanism, so the user has the right to return the loan and interest within 48 hours, and the NFT pledged by the user will not be liquidated. If the user does not return the loan and interest within 48 hours, BendDAO will start an auction, and the auctioneer will be able to participate in the auction at a price 5% below the floor price, BendDAO adopts this mechanism to encourage users to participate in the auction. Careful friends can notice that within the 48-hour strong leveling guarantee mechanism, if the price of NFT continues to fall below the amount of the user's borrowing, what can be done? The user can actually not return the loan because the price of the NFT is lower than the amount borrowed. How does BendDAO solve this problem?

1. Because the amount lent by users is valued according to the floor price. But in fact, NFT has rarity, the more rare NFT is more expensive, so even if it falls below the floor price, there will still be users redeeming their NFTs.
2. When the price of NFT falls through the floor price, users do not want it and NFT is still very common, BendDAO will use the funds in the pool (agreement revenue) to fill the hole.
3. The first bidder will get a penalty, and users are encouraged to bid first.

Fourth, JPEG

JPEG'd is a decentralized lending protocol on the ethereum blockchain that enables holders of NFT blue chips to open collateralized debt positions (CDP) using their NFT as collateral. Users mint PUSd - the protocol's native stablecoin - enabling users to effectively use their funds more efficiently.

JPEG uses a lending approach similar to MakerDAO, where the project owner groups a pool of PUSD on curve and users pledge their NFTs to the platform where they can mint stablecoins PUSD. Users get PUSD and can go to curve to exchange it for stablecoins such as usdt and usdc.

Currently, this project has not long started, the pool of PUSd is also just formed. You can only exchange on curve for other stable coins outside. PUSd has no more application scenarios, and the depth of the pool is not high. It is easy to see off-anchor phenomenon.

• Protocol revenue: The revenue of the protocol is diverse and complex, because JPEG's model is different from BendDAO, so the revenue of the protocol includes:

1. Interest on user borrowing, 2%/12 months x the amount of money borrowed by the user
2. User withdrawal fee, related to the amount of money lent by the user. 0.5% x the amount of money lent by the user
3. Insurance fee, when the user is worried about NFT being liquidated, the insurance fee paid before borrowing. The size of the amount lent × 5%

• Interest Rate: JPEG uses a fixed interest rate of 2% per annum on all loans, with interest accruing on each block. And users also pay a 0.5% deposit fee. For example, if a user borrows 1,0000 PUSd in JPEG, he will actually receive only 9,950 PUSd, while the user's loan amount is still based on 10,000.
• Insurance: This is a special mechanism in JPEG where you can purchase an insurance policy if you do not want your collateralized NFT to be liquidated. The insurance fee is 5% of the amount lent by the user, i.e. when lending 10,000 PUSd, you need to pay not only 0.5% of the withdrawal fee, but also 500 PUSD. the final amount you get in hand is: 9,450 PUSd.
• Liquidation: JPEG allows users to borrow 32% PUSd of the value of NFT's collateral assets and will be liquidated if the debt/collateral ratio is 33% or higher. In case of liquidation, you will need to return the funds to the agreement within 48 hours and will need to repay 25% of the liquidation fee. Otherwise, your NFT will be liquidated and the ownership will revert to DAO.
• Locking mechanism: If the user is not satisfied with the borrowed amount, JPEG also gives the proposal and empowers the $JPEG token with it. When the user seeks a higher limit, the user can create a proposal, e.g. the user wants his crypto punk to lend $1,000,000. If the proposal is approved, the user will need to lock the $82,500 worth of JPEG for 1 year. [$1,000,000 (collateral value) 33% (maximum loan amount) 25% = $82,500]

Fifth, BendDAO vs JPEG

Both BendDAO and JEPG give a very good liquidity solution, but the two protocols have different product implementation logic because of the difference in the underlying logic. Below I will compare the two NFT lending protocols in several ways.

• Number of NFTs supported for lending: As of today (2022/5/23), BendDAO supports seven NFT blue chip projects, namely: BoredApeYachtClub, CRYPTOPUNKS, MutantApeYachtClub, CloneX, Azuki, Space Doodles , Doodles. And JPEG currently supports only two NFT blue-chip projects, CRYPTOPUNKS, EtherRocks. In terms of supported NFT blue-chip projects, BendDAO is more dominant. The more blue-chip projects the protocol supports, the more users will flock to the protocol. And BendDAO supports NFT lending of NFT more pro-people, JPEG support for lending NFT blue-chip project threshold is too high, it leads to come to the agreement to lend money to fewer potential users.
• Interest: Comparing the two sides in terms of interest rates, there is no doubt that JPEG's interest rate is more user-friendly.BendDAO's dynamic interest rate will force users to keep an eye on the interest rate from time to time, and the high interest rate will result in changing the timing of the user's borrowing and altering the user's plans, resulting in a less friendly borrowing experience. In contrast, JPEG's fixed interest rate is relatively calculable.
• Clearing mechanism: Since the price of NFT is very volatile, the clearing mechanism is also a priority factor for users. I think BendDAO's clearing mechanism will be more reasonable than JPEG. JPEG's insurance mechanism costs a greater proportion, and if you do not buy insurance, for NFT pledgers, which is undoubtedly taking their NFT to risk, NFT itself comes with a high risk. Now that it is coupled with lending, it will lead to users afraid to enter the agreement to borrow. And due to the purchase of insurance, if users suffered, they also need to pay an additional 25% of the liquidation fee. The high cost will discourage the user.
• From lending TOKEN: BendDAO lends token is ETH, while JPEG gets PUSd stablecoin. For most users, direct lending ETH is more in line with users' wishes. Users can directly use ETH to make investments on the ethereal chain, defi mining, buying more NFT, etc., while JPEG lends PUSd, and In defi, JPEG has less application scenarios, not many transaction pairs, and users who want to make more on-chain investments need to exchange PUSd for other stable coins in the pool of curve, which is a more cumbersome step. The high threshold leads to fewer users. And the small amount of users leads to few stable coins in the pool, which will cause the risk of PUSd de-anchoring if panic selling.

Sixth, Summary

Both BendDAO and JPEG provide a good solution for the liquidity of NFT. With the development of NFTFI, the liquidity of high net worth NFT assets will be released. And the development of NFTFI will be correlated with the heat of the NFT market, and the development of NFT will drive the fire of NFTFI. And the development of NFTFI will also release more liquidity of NFT and provide users with more efficient use of funds, thus increasing the heat of the NFT market.

With the development of NFTFI, I believe that NFTFI will become the catalyst for NFT to make the greatest contribution to the blooming of a more beautiful petal for NFT.

References:

BendDAO Whitepaper：https://docs.benddao.xyz/portal/

JPEG Whitepaper：https://docs.jpegd.io/

Vic TALK:https://www.youtube.com/watch?v=0Tys9auU2o8&t=377s

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