In the last year, DeFi exploded, moving from $650M in total value locked (TVL) in January to $15B in December 2020. Permissionless networks and programmable money are not an idea anymore. You can use a tens of different DeFi protocols today and many more projects are in the works.
At the same time NFTs received a lot of attention in 2020. Artists are digitising and selling their work through the blockchain. One of Beeple's drops sold for $777,777, setting a new record. Furthermore, blockchain games such Axie Infinity have seen tremendous growth in usage and volume. 2021 started strong, as Sothebys, the largest auction house, claimed one of Pak's pieces. Mainstream adoption is coming, and 2021 will see much more experimentation around NFTs.
One key area of experimentation is the mix of DeFi and NFTs. NFTX is one of the projects that is attempting to bridge these two worlds.
Bitcoin and other currencies are fungible. Each BTC is interchangeable 1 to 1 with another BTC. Digital art and collectibles on the other hand are non-fungible and take the shape of Non-Fungible Tokens (NFTs) on the blockchain.
For example, in Axie Infinity, each Axie is an NFT, which has a combination of different traits, and a unique ID.
In digital art, one piece might come in many editions. For example, Beeple’s Politics is Bullshit piece has 100 editions. However, each version has a unique ID. On the secondary market, editions are valued differently. For example, edition #1 typically sells higher than others do.
NFTs on the market
The non-fungible nature of NFTs makes them inherently illiquid. Since NFTs are non-fungible, their prices may differ. Unlike fungible tokens, traded on exchanges, users must buy and sell NFTs by bidding and/or buying directly from the seller.
Being illiquid has certain disadvantages for market participants. It is a lot more difficult to enter and exit the market. If someone wants to get exposure to Crypto-Punks for example, which are popular collectibles, he will first need to approach a seller and place a bid. Similarly, a Crypto-Punk owner will have to put his punk up for sale and wait for a buyer. It becomes even harder if someone wants to buy or sell many Crypto-Punks at once.
The exact value or price of an NFT is hard to determine outside of purchases and bids. This makes it a lot more difficult to use NFTs as assets in DeFi (for borrowing and lending for example).
Finally, NFTs are not divisible (natively). This means that you cannot simply buy 0.1 Crypto-Punks if you wanted to.
NFTX tackles these issues by wrapping NFTs into ERC20s that represent the NFTs in the fund. NFTX pools together similar NFTs into so-called Funds. ERC20 tokens represent the NFTs in the fund. Essentially, NFTX turns the NFTs into fungible tokens.
While two NFTs are never 100% the same, some have similar attributes and are worth about the same. There are some exceptions but most pieces of art from the same edition will sell within the same range. So will collectibles from the same universe with similar rarity.
There are five Crypto-Punk funds on NFTX. Each fund groups Crypto-Punks with the same level of scarcity. The Basic punk fund comprises basic Crypto-Punks NFTs, locked in NFTX. $PUNK BASIC (ERC-20) tokens represent the underlying NFTs. If a user deposits a basic Crypto-Punk he will receive the ERC-20 token. A user can also redeem a random NFT from the fund, in exchange for the token.
As the $PUNK BASIC token is an ERC20, anyone can buy or sell a fraction or several tokens through an exchange such as Uniswap. One could also use the $PUNK BASIC token as collateral for borrowing and lending in DeFi protocols.
While NFTX will make these NFTs much more liquid, liquidity won't be comparable to larger cryptocurrencies. The market-cap of a fund (ex: $PUNK BASIC) is dependent on the amount of NFTs locked. NFTX's goal is to get a large amount of NTFs locked, becoming an NFT black hole.
These Funds will eventually create a price floor for the NFTs that compose them. Arbitrageurs can sell Punks to the fund if the NFT market price is lower than on NFTX. In general, these funds will not cater to specialised collectors. Instead, they allow anyone to get exposure to NFT assets with minimal effort.
These first funds, called 'D1 funds', are currently the core product of NFTX. Anyone can create a fund and set its rules. Fund managers decide which NFTs are eligible, the fees, and the incentives given to suppliers. Eventually, they can give up control of the fund once all is up and running.
In the future, NFTX will also allow the creation of so-called ‘D2 funds’. These are essentially funds that mix tokens from lower level funds together. One could thus have a Punk fund which is 1/5 $PUNK BASIC & 1/5 of each of the other 4 D1 crypto-punk funds. Anyone could thus get exposure to the broader crypto-punk universe by purchasing the $PUNK token.
It is also possible that fund managers on protocols such as dHedge, Melon or Set, make use of NFTX’s ERC20s in their own ‘D2 type funds’.
NFTX's business model
The NFTX token is the governance token of the platform. Token holders also have control over the treasury which includes ETH, NFTs and remaining NFTX tokens. Currently the projects focus is on increasing NFTs locked in the funds (TVL). There are several possible avenues for the project to generate revenue in the future.
The primary offering of NFTX are the D1 funds. NFTX could charge a small fee (2.5%) to mint and redeem NFTs and ERC20s. Depending on the amount of NFTs locked in the fund, this could be a substantial amount. Similarly, D2 Funds could also capture some fees
Furthermore, the Litepaper already discusses potential roadmap features. NFTX funds could be well suited to serve other purposes such as gifting and borrowing/lending of NFTs.
In the current model, individuals that redeem NFTs from the fund, receive a random NFT. NFTX could also charge a premium for the ability to select an NFT from the fund. The Litepaper discusses a potential use case around gifting. The $PUNK BASIC (ERC-20) could be given away as a gift. The recipient could then choose an NFT from the fund.
Maker gives users a DAI loan, when depositing ETH. In a similar fashion, NFTX could allow a user to deposit his NFT as collateral in order to receive a loan. NFTX would return the NFT to him after he pays back his loan. NFTX could allow also lend out NFTs. This could be useful for a gallery that wants to borrow a piece of art for an exhibition. In the same vein, an Axie player might want to borrow a specific Axie for a tournament.
Finally, NFTX's treasury may grow independently of direct revenues generated by the platform. Good management of the treasury can also yield solid returns if the treasury holds the best assets. Given the strong community of NFT enthusiasts, one can believe that this will not be a problem.