Liquidity provision for crypto’s non-fungible and synthetic tokens has never been an easy path to tread. The tokens bear the innate properties of not being easily transferable. Therefore when PawnFi came in with a viable idea in 2021, it was touted as the first DeFi product of its kind and was able to raise money from household names quickly.
What is PawnFi?
PawnFi is a lending and leasing market. It appraises, liquidates, and provides use cases for non-standard assets (NSAs). Supported NSAs include non-fungible tokens (NFTs), liquidity provider tokens (LP tokens), tokenized rights, minor cryptocurrencies, and bundled assets. PawnFi built on the concept that with the development of the metaverse, more NSAs will emerge, and how these assets are priced, traded, and liquidated will be crucial to the revolution of the entire financial industry.
To stay ahead of the evolutionary metaverse, the company strives to allow asset holders to access diversified cash flow and maximize their asset efficiency. On PawnFi, owners of these NSAs can deposit their assets and take loans against them. The assets serve as collateral that can be liquidated in the event of a margin call. PawnFi ranks second in NFT lending in terms of total loans given and total value locked, only NFT lending behind NFTfi. On paper, PawnFi has been great, but is it necessary?
Why NFT Lending?
Within the past two years, NFT technology has proliferated beyond profile pictures into the industries of Art and Collectibles, Games, Entertainment, and Fashion, as well as use cases for community engagement, content monetization, and social interaction have created deep and meaningful implications for all stakeholders of the NFT ecosystem — users, creators, and founders alike. With all the rapid development and NFT’s ambitious roadmaps, money has gone and will continue to go into the space, raising critical issues that need to be addressed. These issues comprise;
- The difficulty of accessing liquidity for blue-chip NFT holders (i.e., Can I generate interest or take out loans against my CryptoPunks and Bored Apes?)
- Problems with maintaining community growth without raising barriers to participation
- Scaling issues with gaming guilds as they continue to grow their scholar base, as well as incubating new DAOs
- Limitations to yield generation on NFT assets owned by Metaverses landowners and developers
Therefore, it became imperative for the sector to find solutions to these challenges. Here comes the need for financialization.
PawnFi operates in the NFT Finance (NFTFi) crypto sector. NFTFi means using NFTs to finance transactions by providing and accessing more liquid assets. It is a collision of the DeFi and NFT world and has opened up various possibilities for NFT holders by making their NFTs a much more liquid asset. Several sub-sectors exist within NFTFi, including:
- NFT fractionalization
- NFT renting
- NFT derivatives
- Lending\Borrowing using NFTs
PawnFi has established itself as a pioneer in NFT lending and borrowing as so unlocks the immense value stored in NFTs. Let us take a look at how PawnFi makes all of these work.
Several criteria for NFT lending and borrowing platforms are similar to what DeFi lending facilities like Aave already have, which are fundamental to developing such protocols. These include:
- Risk Management: The presence of a robust risk management system in place in case of large-scale liquidation, sudden NFT floor price collapses, and bad actors.
- Protocol Design: Accessibility to sustainable liquidity and yield generation, whether it’s P2P or liquidity pool-based protocols.
- NFT Pricing: Implementation of a decent NFT pricing mechanism and the effectiveness of loan term generation.
- Liquidation Process: Creation of incentives for liquidated NFTs to be acquired.
- Token Economics: Proper design of token economics to encourage both lenders and borrowers to participate in lending and liquidation.
Consequently, PawnFi’s mechanism is simple — lenders deposit assets (like wETH, USDC, etc.) in the protocol and choose to whom they want to lend their assets. Borrowers will deposit their NFT as collateral and make requests (open interest). As in any P2P lending marketplace, the lenders and borrowers can decide on the best deal and secure the loan on-chain. Lenders on PawnFi are driven by two distinct lending strategies — lending for profit (aka interest) and lending to acquire the collateral. They can also lend to a select whitelisted group of wallets (family and friends); however, this can be expected to be a small portion of the market.
PawnFi uses 3 distinct lending approaches; Crowdfunding, pool-based lending, and a fast loan approach. Each lending approach caters to a different type of NFT with low to high turnover rates. An in-built appraisal system allows borrowers to provide one-time fair pricing on their assets based on market trends.
- Crowdfunding; This feature is similar to syndication loans in traditional finance. It supports a single user to borrow against multiple NFTs from multiple lenders, with an initial focus on blue-chip NFTs and whitelisted assets. Borrowers can set loan terms based on their own liquidity needs. If borrowers need quicker access to liquidity, they can choose lower loan-to-value ratios with higher APYs, or vice versa. Lenders can decide whether to participate and how much they want to contribute to the syndicated loans. If a lender is willing to take 100% allocation, it becomes the case of P2P lending.
- Pool-based lending; This approach operates as an NFT money market similar to what is available in DeFi, where they have become popularized by platforms like Aave and Compound. Lending pools on PawnFi use an over-collateralization approach. Borrowers post NFTs as collateral. That enables them to borrow funds for a fee for lending, with a market value that is less than the total value of the collateral. This fee is distributed to lenders to incentivize them to provide liquidity.
- A fast loan approach; Similar to flash loans on DeFi platforms like Aave, fast loans enable one to take and pay back loans without providing collateral, all in one transaction. The technicalities of a flash loan can be found here.
Over time, PawnFi has partnered with Biconomy (a multi-chain transaction infrastructure), Lympo (a sports NFTs minting platform), bitsCrunch (a “guardian” of the NFT ecosystem), and Flare Network (a layer-1 blockchain that enables secure decentralized interoperability between chains and ecosystems) to bolster network activity on its platform.
The partnership with bitsCrunch led it to adopt bitsCrunch as one of its NFT analytics partners to verify the validity of all transactions and ensure that assets circulating across the platform are authentic. With bitsCrunch’s AI-enabled security tools like Scour, a wash trade watchdog, and Crunch DaVinci, a forgery detection system, Pawnfi stopped suspicious activities like wash trades and fake price estimations of NFTs within the marketplace. PawnFi also collaborated with bitsCrunch to integrate bitsCrunch’s price value estimator, Liquify, into its appraisal module to provide a real-time valuation for users to invest with less effort and pressure.
PawnFi EVM version currently supports Ethereum, BNB Chain, Polygon, and Arbitrum; therefore, NFTs on these blockchains can be deposited as collateral on PawnFi. Polkadot and Moonbeam chains are still in the works.
Given their importance, projects building for NFT Finance are likely to scale. Global research firm VMR (Verified Market Research) expects NFT market value to rise to $230 billion by 2030, while NFT lending and borrowing demands are no longer exclusive to collectibles (13.93%) and PFPs (12.02%) holders. Evidence shows a great portion of the market is servicing Art (16.39%) and Gaming (15.57%) NFTs. Other types, such as domain names (11.2%), virtual worlds (9.29%), and music (7.65%), are also frequently mentioned in research reports as important underlying factors within the business. Sector leaders like PawnFi and NFtfi will be looking to compete for market share and grow larger as the entire sector grows.
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