What Is An NFT Loan?
This is a loan in which an investor offers collateral in the form of an NFT. The non-fungible tokens are growing more and more valuable and therefore their capability to serve as collateral cannot be underestimated.
Thanks to the introduction of the concept behind the NFT loans, the decentralized finance system has continued to evolve more as investors do not have to rely on the sales of their NFTs alone.
How Does The NFT Loan Concept Work
Each of the steps has been discussed in detail below:
1. The investor asks for a loan
On the lending platform, the user requests a loan and offers their NFT as collateral. This is fully dependent on whether or not the lending platform supports NFT loans.
2.Assessment of the NFT
After the NFT has been presented, it undergoes a thorough background check. Factors such as stable secondary market history are looked into to determine the value it has. The process can be rendered difficult if the NFT has just entered the market. Each NFT possesses a unique trait and therefore performance appraisal can be a little bit tricky since none of the values can’t be undermined.
3. Issuing of the Loan
Here, the lender and the recipient of the loan discuss the terms and conditions. Most of the loans are usually issued in stablecoins. The NFT is sealed on a smart contract until the loan repayment process is complete. The smart contract mainly consists of the terms and conditions that have been agreed on. They include the amount given, the interest rate charged on the loan and the duration of payment.
4. Repayment of the loan
After the borrower has finished repaying the loan, he or she receives the NFT that had been offered as collateral. In the event that the borrower fails to satisfy the terms of the loan repayment that had been agreed on, then the NFT is moved to the lender using the smart contract. The process is referred to as liquidation.
If you are interested in applying for an NFT loan, there are a variety of sites offering them and you can access them by checking the product pages on the platform. You can equally carry out research on various decentralized finance (Defi) Apps. It is advisable to be as thorough as possible while carrying out your research to avoid being a victim of scams and fraud.
NFT Loan Metrics You Need To Know
The interest rate: While discussing the terms and conditions of the loan repayment process, you need to settle on an interest rate that is fair for you and the lender to avoid defaulting in the end.
The Loan-to-Value (LTV) ratio: This is the ratio of the amount offered to the value of the collateral. If the collateral has a value of 100 and the amount borrowed is 50, the ratio becomes 50%. This tool is critical as it helps the lender determine how far the value of the collateral may fall in the event that the recipient fails to repay the loan completely.
The LTV ratios tend to vary depending on the platform being used although most of them have shown values ranging from 50% to 75%. Highly volatile assets tend to have lower LTV ratios for price fluctuations.
The liquidation ratio: This refers to the LTV ratio at which the collateral can undergo liquidation in order to meet the loan repayment terms. In cases where the LTV ratio and the liquidation are similar, the loan platform can sell the NFT to get back the money that it lent the recipient.
In the case where the ratios match due to a drop in the value of the collateral, the collateral will undergo liquidation. To account for the drop in value, the platform charges a penalty fee.
The NFT floor price: With regard to the term floor, we can tell that the floor price of an NFT refers to the commodity with the lowest price within a collection of many items. This metric or factor enables the buyer to realize the least amount of money required to invest in an NFT.
Floor prices influence the borrowing limits and LTV ratios. Common NFTs have average prices and therefore if they are being offered as collateral, the amount of money the recipient will get will be pretty low as compared to a recipient offering an NFT of a higher quality.
Significance Of NFT Loans
- The investors who own high-priced NFTs can get access to liquidity without having to let go of their assets. They can gain access to a loan while still maintaining their assets while hoping they will gain value.
- There is the introduction of decentralized finance (DeFi) to the digital art space: NFT buyers and sellers can now get loans using their assets.
- The recipients don’t undergo credit checks like other loan applicants: With fiat currencies loan issuance, the banks and other financial institutions perform a credit on the loan applicant. In the NFT loan platforms, the credit check is not performed.
Risks Of NFT Loans
- The NFTs are less liquid in nature and therefore selling the collateral doesn’t guarantee full amount returns.
- The smart contracts that seal NFTs may experience vulnerabilities and glitches. Hackers can exploit them and this could lead to the loss of the NFT.
- The risk of NFT regulations also exists as they are part of the cryptocurrency world.
- NFTs possess high volatility and at the same time, difficulty in appraising them due to their unique features.
NFT loans are becoming more popular every day and therefore their significance cannot be taken for granted. It is crucial, however, to carry out research on the platforms before settling on the loan application process.