NFT Use Cases in Decentralized Finance (DeFi)
Exploring NFTs’ role and benefits in Decentralized Finance
The crypto market keeps expanding by the day. From cryptocurrencies to NFTs and Decentralized Finance (DeFi), the possibilities of a decentralized future are endless. Today, NFTs and DeFi, are the two most prominent trends in the crypto market, and for good reason. Utility NFTs are changing the narrative for NFTs from ‘digital collectibles’ to tokens with derived values. In DeFi, the advantages and possibilities are beyond incredible; from peer-to-peer loaning platforms to pool-to-peer loans.
The evolution of these two trends has caused many to reflect on the possible advantages that could arise from a combination. What could businesses stand to gain from the leveraging of NFTs in DeFi?
This article will explore the use cases of NFTs in DeFi, what advantages we stand to see, and examples of DeFi projects that have already started using NFTs.
But before that, let’s take a look at these two trends independently.
Overview of DeFi
Everyone knows that DeFi is an acronym for decentralized finance, but what exactly does DeFi mean?
Decentralized finance is an umbrella term that describes financial applications built on blockchain technology to circumvent the traditional economic ideals of a centralized system. DeFi application uses automated agreement programs — smart contracts — to enforce an agreement and eliminate the involvement of a third party. DeFi is important because it creates free, open financial markets unburdened by third parties.
People access DeFi services through decentralized applications (dApps), most of which run on the Ethereum blockchain. Some of the DeFi services available are:
- Borrowing, lending, and saving
- Getting a loan
- Token Swaps
What are the benefits of Decentralized Finance (DeFi)?
Other than removing the third party in financial transactions, here’s what DeFi brings to the table:
- Transparency: Because DeFi is built on blockchain technology, every transaction is visible to anybody. This maximizes transparency and accountability.
- Accessibility: DeFi makes it possible for anybody with an internet connection to access financial services. Unlike traditional financial institutions where people are limited by factors like geographical restrictions, DeFi ensures access to financial services for people who otherwise would not have access to them.
- Fast transaction times: DeFi transactions are fast and occur without the need for time-consuming verification processes as with traditional finance.
- Interoperability: A key feature of DeFi is interoperability. DeFi platforms allow the transfer of data and assets across different blockchains, essentially making DeFi transactions limitless.
- Decentralization: DeFi is Decentralized Finance and the implication of this is the lack of a limiting central authority. Users do not have to deal with frustrating bureaucratic bottlenecks before getting access to use their funds as they want.
Overview of NFTs
NFTs is an acronym that stands for non-fungible tokens. They are unique digital tokens that people use to represent things. Unlike other cryptocurrency tokens like Bitcoin and Ethereum, NFTs cannot be exchanged with other NFTs because each one has unique properties and value.
The most significant feature of NFTs is their uniqueness, which means that there can only be one of each NFT at a time. As a result of this uniqueness, NFTs are rare collectibles whose ownership can be easily traced.
With NFTs, you can tokenize anything, including music, videos, images, real estate, art, etc.
For many years since NFTs became popular, they’ve been solely seen as collectibles that had no value beyond their rarity, but utility NFTs are changing that narrative and heralding innovative uses of these unique tokens.
Benefits of NFTs
- Proof of ownership: NFTs can be used as a means to assert ownership of real-world assets such as real estate, paintings, etc. This makes NFTs useful as receipts that signal to other accounts on and off the blockchain about the true ownership of a particular asset.
- Eliminates the Middleman: It eliminates the need for third parties or middlemen for creators. Creators can now assert full ownership of rights over their creations. NFTs also allow them to be fully compensated for their work.
- Unique Identifier: There can be no duplicates of NFTs. This is implicit in the word NFT, which means non-fungible token. This means that each NFT is unique and there can only be one of any particular NFT at a time.
How NFTs Benefit Decentralized Finance (DeFi)
The advancements in NFTs mean that collaboration with DeFi could be very beneficial to the growth of decentralized finance. NFTs are still seen as digital collectibles, so how can they benefit the finance industry?
There’s an easy way to look at it. NFTs are value lockers, which means that each NFT contains an inherent value in its rarity. NFTs 1.0, known more commonly as digital collectibles, have their value in their rarity alone. Utility NFTs, on the other hand, have added value. For example, a bored ape NFT from the bored ape collection unlocks more value than a regular NFT painting of an apple.
NFTs are applicable in DeFi because people can tokenize physical assets, such as property that require a lot of documentation. Where NFTs lock value, DeFi harnesses value by providing ways NFT values can appreciate and accrue income. The collaboration between the two is based on this difference.
Use Cases of NFTs in DeFi
NFTs can improve the process of some DeFi activities in the following ways:
NFTs make it easier to manage debt, especially in large corporations. If someone who has an NFT owes you a debt and can’t pay, the borrower can easily take the NFT as collateral until they pay. If you need the money to be liquid, you can also fractionalize the NFT and sell it in small units until you have the monetary equivalent.
Also, using smart contracts to track and automate most of your routine financial operations reduce the chances of mistakes and errors.
Loan collateralization is perhaps the most common use of NFT in DeFi. One of the primary services in DeFi is peer-to-peer loaning platforms built to improve the process of getting loans without third-party interference. The problem with securing collateralized loans is proper evaluation of the collateral. This is where NFTs save the day.
When a borrower requests a loan, they can put up an NFT as collateral. The lender then considers the NFT’s current price and secondary market value before choosing to accept it as worthy collateral. An interest rate is then decided based on the type of NFT, the loan amount, loan to value ratio, loan duration, and the currency.
Insurance is one of the services under DeFi for crypto assets and traditional insurance assets. However, NFTs can improve decentralized insurance processes by having insurance policies tokenized. These NFT policies can be sold or transferred.
The best part about NFTs in DeFi insurance is that you don’t have to deal with the pesky matter of renewing your documents or meeting with a third party to certify you.
Most NFTs fall between the average price of $1,300 to $6,900, but some NFTs also sell for millions of dollars. The bottom line is that most people cannot afford to buy an expensive NFT, limiting the number of willing buyers, the volume of liquidity, and the number of investors in NFT projects.
In such cases, an NFT creator might decide to fractionalize their NFTs into several ERC-20 tokens and sell them off in small pieces. Now, people who wouldn’t have considered placing a bid for a $2million NFT might consider paying $20,000 for one piece of an NFT out of one hundred available NFTs.
This process is known as fractionalizing NFTs, and it solves the problems of efficient price determination and illiquidity. Fractional NFTs can be traded or used as collateral for loans on DeFi platforms.
Easy Content Monetization
Another way NFTs can be used in DeFi is to monetize content. Few people are as happy about NFTs as content creators. Under traditional finance, content creators are unable to be fully compensated for their intellectual properties because of third-party organizations. For example, artists needed art galleries to show their work for it to be sold. These art galleries take a share of the income for their marketing work.
NFTs have made it easy for artists to tokenize their intellectual property and get paid completely and directly for their craft.
How and where does DeFi come in?
After tokenizing their work, artists can use DeFi platforms to set up payment plans and royalties for their work. Not only does this help artists avoid unsavory third-party organizations like Spotify, but it also helps them easily monetize their content.
Examples of DeFi Projects Using NFTs
NFT uses in DeFi may be new, but some DeFi projects have already started leveraging this collaboration. Here are some of the top examples of DeFi projects using NFTs:
Solarr is the quintessential one-stop destination for everything NFT. Being a versatile tool is Solarr’s forte, as the company offers a platform for users to liquify their NFTs, compose utility NFTs, and unlock value for their NFTs.
This DeFi project is a liquidity protocol for fractionalizing and improving liquidity for NFTs. NIFTEX improves peer-to-peer NFT borrowing and lending.
The Solv protocol is a DeFi platform that enables users to mint and trade solv vouchers, a financial NFT. This NFT is then locked down for a vested period before being released to users, who can then decide what to do with it.
Uniswap3 is a DeFi protocol for decentralized exchange and liquidity provision. They use NFT liquidity pools to reduce the risks for liquidity providers while also increasing their exposure to desired assets.
Pods is a non-custodial options protocol that allows hedging cryptocurrency in the new NFT DeFi space. They give out NFT rewards to the first users of their services and their most active community members. Long term, pod NFT holders would have other perks like access to early testing, the ability to vote on governance decisions, access to research groups, and eligibility to take on prominent positions in the community.
There is still a long way to go for all the advancements in crypto that we see, particularly in DeFi and NFTs. The possibilities of what DeFi and NFTs can be is still beyond anything we can think of. The first mergings of NFTs and DeFi are just entering the crypto market, and yet, there are already significant changes that have everyone excited for what could come in the future from this partnership.