While many people consider valuation to be the most challenging aspect of NFT lending, the real issue is liquidity. When taking an NFT as collateral for a loan it would be a recipe for disaster to think it can be sold easily at all points in the market cycle.
During 2021 NFTs experienced a huge uptake in their popularity. Some said this surge in demand was the cause of increased gas fees on the Ethereum network. However, in between the two peaks of this surge, there was a terrifying liquidity crunch where people saw the values of their NFTs plummet.
The story for NFTs was similar to the story for crypto adoption. After the first wave of FOMO came the inevitable pullback along with the narrative that it was all going to zero. What made it worse was the difficulty in disposing of your NFTs in a market with very low liquidity.
As Deniz, our CEO describes, “Liquidity is the ‘straw in the camels back’ for NFTs. It is a point of pain and also a gap in the market that other entrepreneurs will come in to solve. We believe liquidity with time, and with more use cases for NFTs, will drastically improve.”
Now that the initial hysteria around NFTs has subsided it’s given room for more interesting conversations around the real-world applications of the technology. As more of the business world moves into the digital realm it’s imperative that there’s a counterfeit-proof way of digitizing physical assets.
Deniz continues, “2023 seems like it will be a good year for NFTs and tokenized assets, i.e. physical goods/assets as NFTs. With such a growth in adoption, I believe systems like Paribus will become much more fluid and collateral friendly than it is now.”
Just as everyone is a genius in a bull market, so too every NFT valuation is safe when demand is surging. The problem is how to future-proof the security and stability of the protocol when market sentiment changes.
One way we’ve sought to shield Paribus against such risks is to whitelist specific projects with a proven track record and sustained demand. This has been a huge benefit to building in a bear market as we can see which types of projects still maintain demand during significant downturns.
In addition, we’ve also had to take some hard decisions about the size of loans we offer on NFTs as Wilson, our COO explains, “Given the current situation of liquidity crunch in the NFT market overall, it has undoubtedly forced our hand to take harsh but necessary decisions to protect the protocol and our users from an implosion of bad debt.”
Adding, “For example, although we have huge confidence in our appraisals and liquidation mechanism we still had to keep LTV at a cap of 60%. This is quite low, admittedly, however absolutely necessary for the sustainability of the protocol.”
Simon, our CTO describes the particular challenges NFT liquidations present, “Volatility is not the issue for us, it is by nature that NFTs and cryptocurrencies are volatile. However, the key difference between the two is liquidity and depth of order books.”
He continues, “You can liquidate millions in loans using cryptocurrencies as collateral, however, it is very difficult to liquidate anything above $150k in NFTs simply due to the lack of depth in the order book. With such a restriction, the LTVs on collaterals have to be reduced and given a lower percentage than a typical crypto loan would give.”
It’s because of the additional complexities surrounding NFTs that many lenders have chosen to focus exclusively on cryptocurrencies. While that works in the short term it leaves a huge gap in the market, especially when considering the likely increase in NFT popularity next year will bring.
As Deniz says, “We believe Paribus will lead the way in innovation and making NFTs a lot more liquid. We continue to review the market, looking for effective solutions for better LTVs, and where possible under-collateralized loans, subject to KYC/AML.”