What are NFTs and what do they mean for DeFi?

Last week, history was made in the art world when a JPG image of a digital artwork created by artist Mike Winkelmann, aka “Beeple”, sold at Christie’s auction house in London for more than $69 million. What separates this JPG from the images you upload to Facebook, and what makes it so valuable, is its registry to the Ethereum blockchain as a non-fungible token (NFT) — one of the hottest trends in the cryptosphere right now.

NFTs are a type of cryptographic token that sits on the Ethereum blockchain, with the ERC-721 format the most popular version of what we call an NFT. Unlike their ERC-20 cousins, NFTs are not interchangeable with each other, cannot be replaced nor reproduced, hence the moniker “non-fungible.” In comparison, a fungible asset is something you can replace or reproduce, like a dollar. If you buy something for $10, but decide to return it a week later, it is highly unlikely you will get your exact dollar bills back. This doesn’t matter though, as all dollars are the same.

In comparison, the Mona Lisa is NOT replaceable. It is one of the most valuable non-fungible assets in the world. If that smile went walking, as it did in 1911, and was replaced in the Louvre Museum with something that hadn’t originated from Leonardo Da Vinci’s hand, hadn’t hung in King Francois I’s bathroom, then people would certainly worry. This worry will never materialize with NFTs, as copying them is impossible.

The Mona Lisa is the most copied piece of art in the world, yet the posters, mugs, and t-shirts bearing the likeness of this masterpiece are not the Mona Lisa itself. The framed portrait sitting behind glass, secured in the Louvre, insured to the teeth, holds all the value because there is just one Mona Lisa in existence. Or, as reported by the BBC, could there be another? Put on your tinfoil hat: could it be possible that the painting visited by 10 million people a year is not the Mona Lisa at all?

The question of validating authenticity is where blockchain technology really shines: NFTs, by residing on the Ethereum network, are the ultimate answer to securing the provenance, history, singularity, and validity of an object, whether it be physical or digital. The history of an NFT will be permanently recorded on the blockchain. There will never be a gray area in an NFT’s genesis chain or title, and future buyers will also know exactly what they are getting: something scarce, something valuable. The Louvre doesn’t have this level of assurance.

Flow / Rarible / Aavegotchi / Axie Infinity / Decentraland

This brings us back to what is now the world’s most famous NFT. The enormous sum of $69 million went into a distinguishable asset: an ERC-721. News outlets can publish JPG after JPG depicting the same work of art but, like the Mona Lisa and a poster of Mona Lisa, the NFT makes all the difference. When you send someone an NFT, much like placing it in their hand, only one copy exists.

Scarcity means value, and the digital world ensures copy and paste kills value. If you send a picture to someone over social media, there are now four copies of that picture in existence: one in your phone gallery, one on your social media app, one in your receiver’s app, and one in your receiver’s gallery. Twenty years ago, Napster nearly killed the music industry by allowing music to be copied freely between users over the Internet. A JPG selling for tens of millions of dollars, also transferred over the Internet, signals a major paradigm shift.

Besides revolutionizing the art world, NFTs are capturing value in myriad ways, and projects like CryptoPunks show us how. The lifetime sales of CryptoPunks is rising above $171 million with an average sale price of $24,029. Recently, a pipe-smoking alien fetched $7.5 million. The National Basketball Association (NBA), one of the world’s most recognizable brands, now sells NFT memorabilia. An NFT of Lebron James dunking a basketball sold for more than $200,000 and NBA’s Top Shot has accrued over $200 million in total revenue.

The application of NFTs in the DeFi space is still in its earliest stages, however one promising area is loans. To protect lenders from the swings of a volatile market, DeFi loans are overcollateralized, usually at a rate of 150% or higher. Translated into traditional finance terms, this is akin to the bank saying, “We need you to give us $300,000 before we can lend you $200,000.” This scares away the average user, and DeFi thrives on a strong and growing base of users.

NFTs offer another route. NFTfi provides a marketplace where users can advertise their NFTs as collateral for loans of fungible tokens. Substantial loans are now being drawn against NFT collateral. Rocket, a lender on Ethereum, announced on March 2, 2021, that it will grant its largest loan to date: 20,000 DAI. This loan is backed by Decentraland property valued at $100,000 — an NFT asset.

As anyone familiar with traditional finance will know, the insurance industry is a multi-trillion-dollar behemoth rife with unscrupulous practices. The transparency and accountability of the blockchain means NFTs provide solutions for unique, mathematically verifiable and unchangeable insurance contracts that benefit the crowd, not a corporation.

Nexus Mutual, describing itself as “a people-powered alternative to insurance,” now covers close to $620 million in crypto assets, and if you click that link, you can watch this number rise. While Nexus operates as a KYC insurer, Yearn Finance began offering insurance underwritten by Nexus Mutual in mid-2020, and now offers KYC-free insurance for DeFi protocols through yInsure. Recently, Yearn faced an $11 million hack, and Nexus Mutual honored claims to a tune of $2.5 million.

NFTs are now helping to create a secondary market akin to insurance derivatives for DeFi insurance policies. NFTs can be wrapped and tokenized into yNFTs. This means your insurance policy can then be used for yield farming and creating even more value. Trading yNFTs is possible on Rarible, where your trade comes with KYC-free insurance for the value of your trade.

The possible applications of NFTs are numerous. As well as art, collectibles and even supply management in the “real world”, the implementation of NFTs in DeFi could help to solve some of its current sticking points. From making loans more accessible to NFT holders to decentralizing and broadening the DeFi insurance market. In the coming months and years, NFTs may evolve from a headline-grabbing curiosity to an intrinsic part of the crypto-economy.



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