The Financialization of NFTs

a day ago ⋅ Enterprise Research
Similar to assets within DeFi, non-fungible tokens require similar primitives like lending, liquidity, and asset management, an area that is currently being built on. Additionally, while the fundamental value proposition for NFTs lies within their uniqueness, fungibility is important for increasing liquidity and the financialization of NFTs.
Source: The NFT Stack by Messari

Liquid tokens have thousands of buyers and sellers, but every NFT transaction requires a single buyer and a seller––pointing to lower liquidity. To date, the projects focused on the financialization of NFTs are attempting to, unironically, make non-fungible tokens as fungible (and liquid) as possible.

Show Me The Liquidity
Similar to physical collectibles, like trading baseball cards, NFTs face the illiquidity issue especially for projects that are not highly valued and coveted. Though the NFT market is on the rise, we typically see that the potential for this asset is untapped. NFT trading volume has surpassed $13 billion on Ethereum alone and will continue to increase over time as new types of assets are tokenized onto blockchains.
The market possesses the greatest liquidity among bluechip NFTs (e.g. Punks), which are inaccessible to the majority of collectors since they’re concentrated and expensive.
NFT Liquidity Protocols
Most NFT liquidity protocols have taken one of two approaches. The first approach is creating liquidity by facilitating the creation of liquidity pools where individuals can deposit similar NFTs into the pool and redeem them at any given time. The benefit of protocols like NFTX and NFT20 that effectively become marketplaces, built on top of liquidity pools for a group of assets.

The second approach––taken by Unicly and Fractional––is to create fractions/pieces of an individual NFT that trade as fungible fractional tokens (e.g. 1 NFT becomes 10,000 fungible tokens). The second approach facilitates greater liquidity by lowering the purchase price to acquire a part of a whole NFT, similar to how Robinhood fractionalized stock shares so that an individual doesn’t have to buy 1, $1000 Tesla stock and instead can purchase 2 fractional Tesla shares at $100.

The top four NFT liquidity protocols––NFTX, NFT20, Unicly and Fractional––hold nearly $80 million in combined total value locked (TVL).

Note, the calculation for TVL for NFT20 is potentially lower as it doesn’t factor in the value of the NFTs as it does for NFTX. Still, NFT20’s total reported TVL is ~$9 million which is still lagging NFTX which currently sits at $15 million in TVL. Additionally, the liquidity for fractional does not account for vault tokens locked in pools.

Unicly currently possesses the greatest market share amongst the four protocols with 43% of the total value locked. NFTX leads NFT20 among liquidity pool protocols. Fractional has accrued considerable market share since its recent launch in late July.
NFT Liquidity Pool & Marketplace Protocols
There are two primary NFT liquidity pool protocols that we’ll examine, NFTX and NFT20.
NFTX
NFTX is a marketplace and liquidity protocol that facilitates buying and selling of NFTs.

Collectors can deposit whole NFTs into an NFTX vault and mint fungible tokens (vToken) that represent the value of the NFT. At any point, the collector can use their vTokens to purchase a random asset from within the vault. Alternatively, an individual can redeem a specific token from the same vault by paying an additional fee.
In order to earn fees on the vault transactions, a collector must stake their vTokens in the respective liquidity pool (e.g. SushiSwap). Every time an individual sells or buys an NFT, stakers earn a fee.

One feature enabled by NFTX’s model is that users can obtain instant liquidity for NFTs with high vToken liquidity. For instance, a BAYC owner can immediately deposit their Bored Ape into the NFTX vault obtaining BAYC vTokens. However, instead of staking the BAYC vTokens, the owner can market sell the tokens on a decentralized exchange like SushiSwap. If liquidity is poor, an NFT owner might sell the NFT for less money than on an exchange like OpenSea, however, the ability to obtain instant liquidity is often worth the haircut in price.

Recently, NFTX has also partnered with Futureswap in order to offer perpetuals on NFTs which will enable speculators to short or long derivatives of NFTs represented in an NFTX Vault.
NFT20
NFT20 is a decentralized NFT exchange that also enables individuals to trade, sell, and swap NFTs. Similar to NFTX, NFT20 enables an NFT owner to add their NFT (e.g Cryptopunk) to a liquidity pool and in return they receive fungible ERC20 tokens (e.g. 100 $Punks tokens) for the specific pool. Using the fungible tokens (ERC20), an individual can purchase an NFT (e.g. CryptoPunk) in the corresponding pool or sell them via an exchange like Uniswap.

Further, the NFT ERC20 tokens can be used to LP into a SushiSwap or Uniswap pool to increase the liquidity of the fungible tokens, thereby making the underlying NFT more liquid. Certain NFT20 pools have liquidity mining incentives in NFT20’s native token MUSE.

Of NFT20’s existing NFT pools, Boring Banana’s Co, Cyber Kongz, Wrapped Moon Cats, and Gutter Cats account for ~50% of the total value of NFT in the protocol.

Everyone Needs A MUSE
NFT20’s native governance token MUSE maintains a supply of 1 million tokens with 500,000 distributed to the community who played the Very Nifty game in Sept 2020. Further, 300,000 tokens were reserved for liquidity mining incentives. Of the remaining 200,000 tokens, 50% (100k) were distributed to the NFT20 DAO with the other 50% reserved for the founding team.

Each time an NFT is deposited into the NFT20 protocol, 100 tokens are minted with 5% of the tokens allocated to the NFT20 protocol. The NFT20 protocol sells the ERC20 NFT tokens for ETH which is then used to purchase MUSE. Finally, 50% of the MUSE purchased is distributed to MUSE stakers.

The Floor Problem
The floor price is the lowest or minimum value that an asset in a collection sells for – is a widely tracked metric in NFTs. Among collections like Punks or BAYC, the floor price is often set by assets with the least rare (least desirable traits) within the collection. Protocols like NFTX and NFT20 naturally create pools that necessitate being comprised entirely of floor NFTs in a collection because a user that deposits a more valuable NFT in a collection into a pool will have their NFT purchased and/or replaced with a less valuable NFT. For instance, if someone deposited a zombie Punk (the most valuable) into a Floor Punk NFTX Vault, another collector would immediately buy Floor PUNK tokens to purchase the Zombie Punk.

NFTX tries to alleviate the floor issue by creating parameters in an NFTX vault that require an NFT possess specific criteria(e.g. features, records, etc.). NFTX facilitates this by letting collectors create multiple vaults for different classes of NFTs. For example, there is a Cryptokitty floor vault as well as a Generation 0 Cryptokitty vault where only Cryptokitties with metadata reflecting generation 0 are allowed to be added to the vault. NFT20 aims to combat the floor problem by enabling NFT sellers to create a decentralized dutch auction within the NFT20 asset page to get paid a higher amount of the ERC20 tokens for that NFT project.

NFTX & NFT20
While both protocols have been live for over a year, NFTX’s V2 upgrade in late June has already shown to be quite successful in accruing NFTs. In a matter of months, NFTX has significantly absorbed a large amount of high-valued NFTs with its top liquid Vaults comprised of CryptoPunks ($PUNK), HashMasks($MASK), and CryptoPhunks ($PHUNK).
Conversely, NFT20 possesses more NFTs in its liquidity pools, however, these NFTs on average tend to be less valuable (its TVL is significantly lower than NFTX) and the protocol’s NFT growth has stagnated over the past few months.

Over the past several months, fees for NFT20 have dropped significantly and while fees from NFTX have also decreased, still remain at 50% of August's all-time high.
Notably, all fees from NFTX vaults accrue to vault stakers as opposed to NFT20 where fees from the marketplace accrue directly to all MUSE stakers. While direct fee capture isn’t necessary at this current stage for NFT Financialization protocols, NFTX has a credible path towards fee generation in the future.
NFT Fractionalization Protocols
Asset fractionalization has grown increasingly common in the traditional financial system. Traditional financial assets from real estate to fine art to cash flows are creating innovative solutions to fractionalize these asset classes in order to appeal to more buyers.
Source: Jump Capital

Although there are existing startups trying to fractionalize assets using their own proprietary networks and systems, cryptonetworks offer better solutions that are more open, liquid, and composable.

A few protocols have taken up fractionalizing tokens, with Niftex being one of the first. It allowed  NFT owners to create “shards” (fractions) of an NFT into fungible tokens. Niftex was recently acquired by an unknown entity, but the situation suggests that a large exchange is the likely purchaser. In the meantime, users can access their shards but new fractions cannot be created.

Meanwhile, there are two major protocols now that lead the way in fractional NFTs: Unicly and Fractional.
Unicly
Unicly is a permissionless platform that allows users to combine NFT collections and fractionalize them through the creation of uTokens.The fractions of the collection (ERC-721 and ERC-1155 tokens) can then be traded, mixed in with an AMM and used for yield farming right on Unicly instead of heading to a third-party exchange.

Once an NFT collection is tokenized, the specific collection (e.g. uPunks, which is the ERC-20 token that represents a collection of NFTs) is locked in Unicly’s smart contracts until enough of the collection’s tokenholders choose to unlock the collection. The largest vault on Unicly, JennyDAO, has chosen to collect and manage all their NFTs on Unicly. The uJenny token is used to govern the DAO’s treasury. As of now, the DAO has to reach a 50% threshold in order to unlock the collection.


The spikes in the number of fractionalized NFTs align roughly with NFT market cycle peaks this year. There has been a slight downturn in usage for Unicly, in part, due to the launch and popularity of fractionalization competitor, Fractional.

The $UNIC Token
Unicly had a mostly fair launch in May, where 90% of the $UNIC token was available through liquidity mining for the community and 10% reserved for the core development team. $UNIC can be earned through staking UNIC, which converts it into xUNIC. Additionally, 0.05% of all volume on the Unicly exchange is taken as fees, which is put towards buying back $UNIC. The monthly mint rate of the $UNIC token decreases by 5% in order to ensure the supply never hits 1M.
Fractional
Fractional allows anyone to buy, sell, and mint fractionalized NFTs. The owner of an NFT or collection of NFTs can use Fractional to fractionalize their token(s). A curator is essentially the asset manager for each NFT or collection of NFTs that undergoes fractionalization and collects fees from each auction. Collectors are able to create fractions of an NFT into fungible tokens which can be combined to redeem the NFT or the underlying NFT can be purchased for above its reserve price. Any purchaser can bid on the NFT or bundle at the reserve price which is set by the majority of fraction holders. For example, if the Art Blocks Curated Bundle has a live valuation of 175 ETH, but the reserve price is 230 ETH, token holders of the Art Blocks bundle are stating they won’t entertain any sales of the entire bundle unless someone bids at least 230 ETH.

If owners of a fractional NFT want to sell the whole NFT, they first vote on the reserve price. If there’s a buyout, or a deposit of ETH greater than or equal to the reserve price, fractional owners of the NFT will be able to redeem their  fraction tokens for ETH. Currently, there are 2,277 NFTs locked on the platform.

To date, Fractional has recorded over $1.5 billion in fraction token trading volume, a fairly impressive stat considering the protocol's recent launch.
Similar to most trading, the story is one of long tails where a few NFT collections on Fractional comprise a large percentage of the volume. Two memes – The Doge NFT and Etherrock #72 – account for over $300 million in volume.


PartyBid, a protocol that allows anyone to start a “party” to collectively bid on any open auction, uses Fractional’s smart contracts in order to facilitate its bidding process. PartyBid just recently started supporting Opensea auctions, which we expect to bring on more activity on PartyBid and Fractional.

Unicly & Fractional
Unicly was established before Fractional, and still maintains more vaults in place and a much higher TVL. However, since June, Unicly saw a massive drop in TVL (~50%), which is likely due to new players entering the space and obtaining a greater share of NFTs that typically would have ended up on Unicly. Note, the chart above examines vaults on Fractional which can have multiple NFTs, but the total NFTs locked in Fractional is still ~10% of all the NFTs locked in Unicly. Similar to the case with NFT20 and NFTX, both NFTX and Fractional possess less NFTs, but the average NFTs/collections they possess are more valuable than their competitor.

The major difference between the two protocols ties to what the user is able to do after obtaining their fractional tokens; with Fractional, the user can sell or take tokens to a third-party exchange such as SushiSwap. Unicly, on the other hand, is an AMM and allows the user to participate in staking or yield farming with their uTokens. Though it has less functionality than Unicly, Fractional is much more user-friendly, especially for new NFT users.
The World of Fractionalized Tokens
Even while going from an NFT to a fractional, fungible token, there are still plenty of interesting use-cases outside of DeFi that the owner can participate in. As with NFTs, systems can be put in place to:
Gate communities or DAOs
Unlockable content with fractions
Provide royalties
In-Game/Pfp Avatars
An ETHLisbon hackathon project, defragment.art, enables Fractional vault curators to create new derivative NFTs which are able to be minted by the fractional owners of the original NFT. This unlocks utility for the fractional NFT community as well as the chance to build and govern together.

A Note on Bridging NFT Exchanges and Fractionalization Protocols
While these protocols are inherently competing for NFTs, usage is not necessarily mutually exclusive. As discussed previously, each NFT liquidity category has a different set of functions that might fare better depending on the user’s preference in what they’d like to achieve. For example, NFTX might be better suited for specific NFT asset classes. For example, Sorare issues dozens of the same card around the same player which are all equally valuable. NFTX or NFT20 can also be utilized for improving the floor pricing of NFT collections with a high number of floor assets. Conversely, fractionalizing NFTs via collections or individual collections enables for DAOs to create portfolios of different assets (BAYC + floor Punks + non-floor Punks) to potentially create a more valuable and liquid bundle of NFTs.

However, it’s worth noting that many of these protocols are converging on how they provide liquidity – creating liquidity pools for a portfolio of uniquely valued NFTs (Fractional & Unicly) or individual NFTs (NFTX & NFT20) in a similarly-valued collection. Still these protocols are competing for liquidity which will naturally pool among a few protocols.
The Future of NFT Liquidity
As the NFT market continues to grow and onboard new users, the liquidity problem for NFTs needs to be desperately addressed. NFT financialization is currently tackled through liquidity and fractionalization protocols. As traditional asset classes get issued as NFTs, financialization protocols will become increasingly vital. Further, as nonfungible assets become accepted as collateral for DeFi protocols like Maker or Compound, finding fungible ways to add these nonfungible assets into the system has the potential to make meaningful improvements in the event of a liquidity crisis.

Importantly, composability will enable these financial NFT protocols to further grow and integrate with other protocols. Fractional has leveraged Party Bid to enable strangers to crowdfund and purchase NFTs like Nouns. Elsewhere, Genie aggregates across NFT20 and NFTX to provide instant liquidity for NFTs and facilitate large batch transactions. This further enables for easy NFT behavior like floor sweeping – purchasing a large set of floor NFTs from a given collection. Existing NFT liquidity protocols will have the unique opportunity of benefit from new protocols that leverage their existing features and enabling new user behaviors.
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