Tom J. Pandolfi

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What to do about NFT lending ?

Instead of the short lived dopamine rush of twitter feuds, I decided to compile my thoughts on the recent NFT lending drama into a 5 minute article, and debunk some of the claims being made.

A history of NFT lending and floor prices

NFT lending has been around for a few years now, at least in it’s infant Peer-to-Peer forms. It first made headlines as the root cause of NFT floor prices dropping in the summer of 2022:

Cirrus’s thread was more than your average FUD.There was a serious problem.

Bored Apes were losing value, and dangerously approaching a point of cascading liquidations

2.8% of the Bored Ape collection was collateralised on BendDAO alone, and 45 loans were quickly approaching liquidation.

BendDAO began to implode, as it owed lenders 15,000 ETH in bad debt, but miraculously recovered through DAO risk management and some whales.

The same story began to take place on Solana with the ABC collection. As ABC NFTs had their value increasingly tied up to the price action of the $HADES token, ABC NFTs began to go down.

Leverage was not the catalyst of ABCs’ rapidly declining floor price, but it added fuel to the fire with cascading liquidations.

Perhaps an insight I can offer as an NFT lending founder, is that defaults in NFTs are even more irrational than you might assume.

In the majority of cases (and this has also been observed by most of my peers / competitors in the space) borrowers will repay a loan even if it has gone underwater.

What does make sense however is that this tends to happen when borrowers have an emotional connection to the NFT, which is not so much the case for staking NFTs or NFTs backed by a declining intrinsic value.

As liquidations began to go through, lenders were left with the hot potato collateral that was quickly depreciating in value, and thus had to be sold fast.

This lead to valid skepticism about NFT leverage. The problem was evident, people had been hurt, but the solutions were tone deaf.

There are very few principles in Decentralised Finance more important than sovereignty over one’s assets. This will be increasingly problematic as Solana embraces “creator first” NFT standards giving creators more control over their community’s assets.

Note: I am not warning you about loss of sovereignty over your assets in some attempt to be a crypto purist. There will be lots of innovation in the space, and I am convinced that soon NFTs will be unrecognisable from their current form.

However, DeFi is made to empower individuals. Any tool which displaces power from individuals into the hands of centralised authorities will always irk me.

When project founders tell you that the masses are not prepared for the tools made available to them, run.

This is the same rhetoric that has stopped average Americans from having access to a large part (and the most profitable part) of the financial system, through “accredited investor” programs.

Patronising rhetorics from Solana influencers aside, a more dangerous point is usually made about NFT lending’s similarities with the 2008 financial crisis.

I’ve always been very surprised to hear this from people, but I think it shows the disconnect between DeFi builders and DeFi investors.

There are few people for whom 2007–08 did not shatter their perception of the financial world (despite the frequent “I told you so”s from economists with a case of hindsight-itis, almost nobody thought it could be as big nor as corrupt as it was).

I was a 6 year old at the time with no perception of the financial world to begin with, and could not explain to you the dangers of re-hypothecation. But I did understand that it hurt people in the same way that spectators of NFT lending today can understand communities are being hurt by the over-leveraging of a few individuals. Back then, something had to be done, and for many, that something was DeFi.

Make no mistake, the financial crisis was the result of over-leveraging, but of a very different kind. One that is enabled by a lack of transparency, criminal (to not say psychopathic, with complete disregard of human consequences) behaviour, and horribly mis-aligned incentives between institutions, regulators, and average Americans.

To compare such an opaque financial system with one that is both automated and open-source is ignorant at best, but underlines a critical misunderstanding of the entire industry.

DeFi is not perfect by any means — but futile attempts at limiting the power it can offer individuals can’t succeed, and we are much better off doubling down on increased transparency and education.

Final thoughts

Before, NFTs were plagued with illiquidity: an infrequent but painful problem.

Now, NFTs deal with over-leveraging: a rare but even more painful problem. It’s hard to arbitrage between the two and say which one is more desirable for everyone.

If you consider the NFT’s floor price to be the product in it of itself, you are not going to have a fun ride.

However, if you see the NFTs as more than their price in the short-term, and instead as part of a mission or project, NFT lending should provide a great solution for you in the long-term.

At the end of the day, we are in a permissionless ecosystem, and as safe as you think good actors will be, bad actors will abuse the system. The best we can do is not have them build the system or tell us how to run it, and remain transparent at every step.