Put NFTs to Work
VeradiVerdict - Issue #181
NFTs grew explosively in 2021, reaching over $41 billion in sales, but most of their value today is realized by simple buying and selling on exchanges. For NFTs to reach their full potential as a powerful asset class, it’s critical to develop better primitives and applications in DeFi that allow investors to utilize them in their portfolios in more complex, nuanced ways.
Arcade is a new DeFi project building a suite of applications and infrastructure to accelerate the growth of NFTs as a financial asset class. Their flagship product today is an NFT borrowing and lending marketplace using a protocol they built called the Pawn Protocol: a peer-to-peer lending protocol that allows NFT holders to unlock ERC-20 liquidity by posting their NFTs as collateral.
The Pawn Protocol’s key innovation is the concept of a wrapped NFT (wNFT). Borrowers can mint a wNFT by composing any hybrid of their ERC-20 assets and NFTs into a token basket. These wNFTs can then be used as collateral for loans of ERC-20 assets; borrowers must simply specify the terms of their loan (amount, currency, duration, and interest rate) and post it to the Arcade loan marketplace.
Lenders can shop Arcade’s marketplace to view various loan requests from borrowers, annotated with their loan terms and wNFT collateral. Once they’ve identified a loan they want to fulfill, lenders can simply approve the deposit of their ERC-20s to fund the loan and digitally sign the loan terms. If a borrower defaults on the loan, the lender can claim the assets that the borrower has packaged into the loan’s wNFT. Altogether, this combines the convenience of off-chain negotiation with the robustness of on-chain settlement to facilitate an incredibly intuitive, secure user experience.
The Pawn Protocol additionally allows borrowers to easily roll-over loans, enabling them to use loans to fund longer-term positions. This is accomplished using Aave’s flash loan technology; the protocol simply takes out a flash loan to repay the borrower’s loan, issues a new loan to the borrower, and uses the proceeds of the new loan to pay off the flash loan––all in a single block transaction.
To date, the platform has facilitated over $5 million in loans in its private beta. Arcade plans to release its platform to the general public in the coming months, and also plans to develop even more financial functionality around NFTs, including applications for asset management, peer-to-pool liquidity, and more.
Ultimately, Arcade enables users to unlock unprecedented degrees of liquidity in a single loan from their NFT portfolios, offering an incredibly promising vision for how NFTs might be more tightly composed into the expanding DeFi landscape.
From DeFi to NFT-Fi
2021 was a breakthrough year for NFTs––by December, the global market reached over $41 billion in sales. Collections like Bored Ape Yacht Club (BAYC) and NBA Top Shot have become household names, while celebrity artists like Beeple sold some of their digital creations for more than $69 million. It was more than just jpegs, too; verticals like gaming, music, and sports merchandise grew increasingly eager to integrate NFTs into their ecosystems, nurturing the launches and growth of projects like Royal and Axie Infinity. Altogether, 2021 cemented the demand for a digital primitive for verifiable ownership, and the ecosystem continues to capture value at an incredible pace.
Unfortunately, despite this remarkable rise in value, the means for users to realize this value remain incredibly limited. Most of NFT finance simply involves trading NFTs on exchanges like OpenSea and profiting off of price movements. These digital assets––many of them worth millions of dollars––have significantly more to offer as a financial resource. As a corollary, consider in traditional finance how real estate has much more material value than simply being bought and sold; mortgages are frequently traded on the secondary market, home equity is commonly used to finance immense lines of credit, and property can even secure medical or educational loans and leverage stock positions. To fully realize the value of NFTs as a financial asset class, it’s absolutely critical to develop more primitives and applications in DeFi that surface more complex, nuanced ways to compose these assets in holders’ investment portfolios.
What is Arcade?
Arcade is a new DeFi project building a suite of applications and infrastructure to accelerate the growth of NFTs as a financial asset class. Arcade enables end users––including NFT creators, collectors, and liquidity providers––to utilize their NFTs across a myriad of financial use cases, which is particularly important as NFTs evolve from simple digital representations of artwork into a versatile, high-utility primitives for metaverse assets and media ownership.
Right now, Arcade’s core flagship application is the Pawn Protocol: a peer-to-peer lending marketplace that allows NFT holders to unlock ERC-20 liquidity by posting their NFTs as collateral. The protocol has already supported over $5 million in loans through its private beta, including a massive loan of $800,000 against a portfolio of NFTs from a lender with more than $10 billion AUM. In the coming months, Arcade plans to open access to the Pawn Protocol to the general public and roll out additional features including peer-to-pool liquidity, flash loan interest payments, and asset management applications.
How do I borrow on Arcade?
The crux of Arcade’s ability to support NFTs as loan collateral is the concept of a wrapped NFT (wNFT). In a general sense, a wrapped token is simply a token whose price is pegged to the price of another cryptocurrency, or a basket of cryptocurrencies. For example, wrapped Bitcoin (wBTC) is an ERC-20 pegged to the price of Bitcoin, which allows BTC holders to virtually use their Bitcoins on Ethereum.
The Pawn Protocol allows users to mint a wNFT pegged to the value of a hybrid basket of ERC-20s, ERC-721s, and/or ERC-1155s. Users sign-in to Arcade with their MetaMask wallet and can choose which cryptocurrencies, stablecoins, and/or NFTs from their portfolio they want to use as loan collateral. Users can then mint a wNFT which represents the value of the tokens in their basket. Importantly, this wNFT technology allows for immense flexibility in how borrowers collateralize their loans; because borrowers can mix-and-match various NFTs and ERC-20s, they are able to acquire larger loans and greater liquidity than they would be able to on other competing NFT liquidity protocols.
With their wNFT, a user can request a loan on Arcade’s marketplace by simply specifying their loan terms––namely, the amount they wish to borrow, the currency they wish to borrow in (any ERC-20, typically wETH or a stablecoin), and the amount they will repay (or equivalently, the interest rate). Users can then post this loan request to the marketplace by digitally signing their loan terms and approving the deposit of each of the items they selected as collateral; these items are then transferred from the user’s wallet into an escrow during the duration of the loan. Finally, the request is submitted to Arcade’s peer-to-peer marketplace, where it might be matched with a lender who accepts the user’s specified loan terms and collateral. When their loan is originated, a borrower also pays a flat 2% of the principal as an origination fee to the protocol.
Currently, borrowers must pay off their loan in full at any point before the conclusion of their loan duration; the team will soon add support for periodic payments as well. Moreover, the protocol will soon support the ability to roll over open loans, or effectively extend a loan’s duration to allow borrowers to continue to use loaned funds without potentially compromising their leveraged positions. This is accomplished using flash loans on Aave; essentially, the protocol takes out a flash loan to pay off the user’s existing loan, issues the user a new loan, and pays off the flash loan using the proceeds from the new loan––all in a single block transaction. This is incredibly useful for borrowers looking to leverage long-term positions with NFTs as collateral.
How are loans funded on Arcade?
Lenders can explore Arcade’s marketplace to shop unfulfilled loan requests that have been submitted by borrowers. Upon finding a loan they’d like to fund, lenders simply have to select the loan, approve the transfer of the loan funds from their MetaMask wallet, and digitally sign their end of the loan terms. In sum, this enables off-chain negotiation, on-chain settlement of loans; lenders can carefully choose loans to fund via an intuitive, off-chain interface, but can guarantee that loan conditions are upheld via on-chain, automated transaction execution. If a borrower defaults on their loan repayment, lenders can claim the borrower’s collateral from Pawn Protocol’s escrow.
Who’s behind the project?
Arcade is built by NFTech, a group of developers creating financial tools and platforms for non-fungible assets. The team has an illustrious background at various web3 projects and companies, including BitGo, BlockFi, Sommelier Finance, and BitMEX. The project has also raised $15 million in Series A funding from firms including Pantera Capital, Castle Island Ventures, and Golden Tree Asset Management, and angels including BlockFi CEO Zac Prince and Quantstamp CEO Richard Ma.
As more complex applications for digitally-verifiable ownership emerge, NFTs will continue to grow increasingly popular and appreciate significantly in value. The existing DeFi ecosystem offers very limited means for users to utilize this value; for the most part, users can only buy or sell their NFTs to capitalize off of price movements. Importantly, this limited usability restricts the ways that institutional and retail investors can realize the value of NFTs in their portfolio, ultimately slowing the growth of NFTs as a financial asset class as a whole.
Arcade presents a platform that greatly expands the scope of what NFT users (collectors, creators, and liquidity providers) can financially accomplish with their NFTs. Pawn Protocol’s mechanism to bundle NFTs and ERC-20s alike into wNFTs for loan collateral unlocks degrees of liquidity from NFTs greater than ever before. Its design additionally combines the convenience of off-chain negotiation with the robustness of on-chain settlement, facilitating incredibly intuitive, secure user experiences for both borrowing and lending. With the protocol’s impending public release, and with the development of even more applications around asset management and liquidity provisioning, Arcade offers an incredibly promising and tangible vision for how NFTs might be more tightly composed into crypto’s ever-expanding financial landscape.
- Paul Veradittakit
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Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. I’ve been in the industry since 2014, and the firm invests in equity, early stage token projects, and liquid cryptocurrencies on exchanges. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.