How does NFT lending work?

In any financial landscape, money lending serves as a vital resource for both investors and traders. The same can be said for crypto users requiring funding for all kinds of transactions within the cryptocurrency ecosystem. A solution to this need is the use of non-fungible tokens (NFTs) as collateral, offering flexibility and accessibility. 

Key takeaways

• You can borrow money by offering NFT as collateral.
• There are many methods of NFT lending: Peer-to-peer, Peer-to-protocol, Nonfungible debt solutions (NFDP), and NFT rentals.
• NFT lending has its challenges, including NFT liquidity, smart contract vulnerabilities and lack of framework for regulations.

Accepting NFT as collateral opens a new avenue for traders and investors to create a steady flow of funds in a fully decentralised finance (DeFi) arrangement. You don’t need to use assets outside of the blockchain to get funds and it allows NFT investors to capitalise on their properties.

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What is an NFT?

An NFT, or non-fungible token, refers to a special kind of digital asset that is designed to be unique in its blockchain. Unlike cryptocurrency, utility tokens, or stablecoins, an NFT can be almost anything. It can be an image, music track, document, or an asset in a video game. Thus, each minted NFT is valued in its own merit, especially when considered as collateral within financial frameworks.

What is NFT lending?

To answer the question ‘what is NFT lending?’, it is important to clarify what ‘lending’ means. It is the process of borrowing money but the person who is asking for funds needs to offer something in return. This is the collateral which typically counts all kinds of properties like the house, car, and documents. 

In this context, NFT lending is offering an NFT as collateral and the funds you receive for it are usually cryptocurrency. Most of the time, it will be stablecoins like Tether (USDT) and USD Coin (USDC). The borrower needs to pay off their loans within the agreed time or their collateral will be forfeited, which means that the ownership is transferred to the money lender. 

How does NFT lending work? There are many answers to this question thanks to the versatility offered by platforms like Ethereum (ETH) and its various layer 2 blockchains. Here are just some of the common NFT crypto lending methods that you should be aware of:

Peer-to-peer NFT lending

The arrangement involves two people engaging in a lending agreement facilitated by a third-party platform. The process begins with the NFT owner listing their asset as collateral and how much they want for it. Another user can see this listing and meet the price asked to begin the NFT loan arrangement. Both parties start a smart contract where the NFT is set as collateral and the funds are sent to the borrower. 

Peer-to-protocol lending

In contrast to peer-to-peer lending, this method does not involve another person joining someone’s smart contract. You can make it yourself with the other party being a decentralised, automated NFT lending platform. This involves offering an NFT as collateral but the system decides the loan amount based on market trends detected by algorithms using external references.

Non-fungible debt positions

Non-fungible debt positions (NFDP) is a type of DeFi service offering an improved version of peer-to-protocol lending. You are still offering your NFT as collateral to a decentralised system and it gives you funds equal to its market value. However, the contract is represented by a newly minted asset called a non-fungible debt position or NFDP. 

The NFDP is a document representing your surrendered NFT and the money you got from it. Once you’re done with the loan, you may repay the principal along with the accumulated interest as stated in the NFDP. Then the DeFi keeping your NFT will return your asset to you after your agreement. 

NFT Rentals

Rather than offering your NFT as collateral, you can offer it as a property for rent. Interested parties in the DeFi space can take your offer so they can own and use it temporarily. This is applicable for play-to-earn (P2E) games and content creation where the borrower has plans to use the NFT. Meanwhile, you are earning regular revenue during the rental period, providing a passive income source while this arrangement is active. 

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Challenges of NFT lending 

Every system has its challenges, including those in the crypto space. NFT lending could be more flawless so there are a lot of hiccups that you can experience as a participant in its space. Here are common issues that you may encounter if you plan on lending or borrowing money with NFT as collateral:

Liquidity of the NFT

Similar to physical properties, the potential of an NFT as collateral depends on its inherent value. People will only offer money for a token that has market value. Unfortunately, the majority of NFTs minted in the past year tend to be not worth much either because they came from unpopular collections or they are not useful in anything.

The best NFTs to offer as collateral are those that are worth at least 0.01 ETH on markets like OpenSea.io, a popular NFT marketplace on the internet. Otherwise, you won’t get any substantial funds from the lending service. 

Smart contract vulnerabilities

Smart contracts can have code vulnerabilities which can be difficult to identify if you’re not skilled in coding. This makes arrangements with strangers online risky unless you use the services of a trustworthy NFT lending platform. Alternatively, the best way to avoid bad actors is to be well-versed enough in smart contracts and finance to detect potential exploits they can use against you. 

Lack of framework for regulations

Like with most cryptocurrencies, there are minimal regulations imposed on NFT. Many traders saw this as a good thing because it removes taxation from the transaction and keeps crypto decentralised. However, this poses a risk for investors who prefer having the protection of relevant authorities from bad actors. It may take a long time before proper regulations are present for NFT lending. 

Benefit from NFT ownership through lending

The main benefit of NFT lending is to provide owners with a means to liquidate their assets. It’s helpful if you have invested in some and don’t want to sell it but don’t know what else to do with it. You can offer your NFT as collateral and get funds for your ventures. 

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