NFT Collaterals are Now Apparently a Thing – Here’s How it Works…

Halloween is over but we’ve got news from the non-fungible scene that could turn traditional financial experts grey. NFT collaterals are growing in popularity. That means borrowers taking out loans backed by tokenised assets. The lender then claims the asset if there is a default.

The idea is nothing new. People have been borrowing money against fixed assets for years. The difference this time is that NFTs aren’t really fixed assets. There is still much speculation about the long-term value of tokens. Not to mention short-term stability. So from a lender’s perspective, NFT as collateral is a relatively high-risk move.

But organisations are engaged with the idea. The biggest loan issued so far was $1.4million. Agreed and paid out on 28th October, the collateral is Autoglyph 488. A Type 10 — the rarest in that generative art collection — currently the floor price for these is 299 ETH. Or $1.3million. In this case, the borrower was crypto boffin KrypToniK. Payment was made by MetaStreet DAO in DAI stablecoin.

What’s the Problem with NFT Collaterals?

Using non-fungible tokens as collateral for loans seems understandable. Checks and balances are clearly being done to ascertain current and projected market value of any token being used in this way. As such, there is a degree of protection for the lender.

In many ways, it may prove more lucrative than traditional loan collateral. One financier apparently lent 3.5 ETH, or $7,350 at the time. Repayments failed and an ‘Elevated Deconstructions’ NFT was seized as collateral. The value of that was $340,000. Not a bad profit.

However, it’s vital to remember we are talking about a very new type of asset being used to guarantee a loan in established currency. Cryptocurrencies might be a recent addition to the financial landscape, but they still have linked value to traditional fiat money.

Even if cryptocurrencies are stable, NFTs have yet to prove they are. 2021 has seen a boom in non-fungibles. Yet this is often cited as part of the ‘new technology cycle’. Tech is launched, there is significant early adoption and wild speculation of value. Activity then subsides, plateaus or — worst case — flatlines. Market value falls, and in some cases this has led to real term losses.

While we are skeptical about the idea of an impending, huge, NFT bubble burst, we’re also cautious in our optimism. History has shown assumption is the mother of all mess-ups. And, when it comes to economics, the future is hard to predict.

NFT Collateral and Unregistered Securities

Another huge issue relating to the NFT collateral is unregistered securities. Our article on controversy surrounding NBA Top Shot marketplace offers a useful case study. Dapper Labs, the firm behind NBA Top Shot, was sued by a user who believed a reasonable expectation of profit was created by the marketplace. Hype around NFTs, and the potential to make money from them, was the key reason for their investment.

From this view, NFTs should be considered a form of securities, and therefore subject to specific financial rules. Many NFT platforms are not registered to trade in securities, but you could now argue a compelling case that if NFTs are being used as collateral to cover loans, plus interest, there is a real expectation on the lender’s side that tokens will increase in value over time. A reasonable expectation of profit exists, and if this is proven true it could impact everyone involved in the sector. Not just the lenders.

NFT Collateral is Here to Stay (For Now)

For more on the NBA Top Shot situation, which unfolded earlier this year, click here. It’s important to note, though, that we don’t expect NFT collateral to disappear anytime soon. With more and more interest in NFTs it stands to reason there will be more and more reasons to use them in this way. As such, we imagine platforms like Hoard Exchange, one of the first to offer loans against NFTs, will continue to grow in popularity.