NFT Bubble Heats Up: Investors Are Borrowing Against Their NFTs And Defaulting

NFT Bubble Heats Up: Investors Are Borrowing Against Their NFTs And Defaulting

NFT bubble

Photographer Gabriel Guerra Bianchini poses holding his photo collage, in Havana, Cuba, Wednesday, March 31, 2021. The cityscape photo collage of Havana is the first NFT, Non-Fungible Token, to be auctioned by an artist resident in Cuba. (AP Photo/Ramon Espinosa)

Investors are borrowing against their non-fungible tokens (NFTs) as the market bubble heats up but some are defaulting on their repayments due to the volatility of the new asset class.

NFTs are a blockchain-based record of ownership of digital items such as an image or a video. The NFT market is considered a bubble — an economic cycle marked by a rapid escalation of market value, particularly in the price of assets.

NFT-backed borrowers and lenders are using a startup blockchain project known as NFTFi, a peer-to-peer lending platform described by CoinDesk as a pawnshop for NFTS.

NFTFi was specifically created to allow users to lease their NFTs in exchange for other cryptocurrencies that can then be sold for cash while keeping NFT safe — if the borrower can repay the loan.

NFTFi has handled more than $12 million in volume since it was launched in June 2020, with loans averaging $26,000 and reaching as high as $200,000. These loans have come with a default rate just below 20 percent. That’s very high compared to the average loan default rate, which is usually less than 3 percent. Even the mortgage default rate was lower than 20 percent during the subprime mortgage crisis in 2007, peaking at 9.3 percent in 2010.

A trader who borrowed 3.5 ETH, equivalent to around $12,000 on the NFTFi platform — gave an NFT that was selling for 11 ETH at the time of borrowing. Over the next three months, the value of NFTs shot up to around $300,000 on the low end. When the loan period ended, the borrower failed to repay the loan, and the NFT, which is now worth many times more than the original loan, was claimed by the lender.

“Some lenders also use NFTFi to potentially acquire assets. They offer loans on high-value art blocks and glyphs that don’t go for sale very often in the hopes that the borrower defaults,” said Stephen Young, the CEO of NFTFi, in an interview with The Defiant.

There are fractionalized NFTs, whereby the ownership of an NFT is divided into smaller fractions. This makes it possible for several people to own a single NFT, and even as prices soar, everyone wins.

Once bought, NFTs are normally hard to use in a productive way, unlike fungible tokens which can be staked, lent out, or otherwise put to work to generate yield.

An investor with a CryptoPunks who needs cash but does not want to sell can use the investment as collateral, according to Young. The loan can then be used in a variety of ways: converted into fiat, deployed into decentralized finance (DeFi) protocols, or even used to buy more NFTs.

CryptoPunks was released in June 2017 as one of the first NFTs on the Ethereum blockchain. It is a series of 10,000 images tokenized as NFTs on the Ethereum blockchain.

There is a wide range of NFT users, according to Young, including university students, DeFi traders looking for liquidity to pay margin calls, and yield farmers trying to generate the highest returns possible from their assets.

Listen to GHOGH with Jamarlin Martin | Episode 74: Jamarlin Martin Jamarlin returns for a new season of the GHOGH podcast to discuss Bitcoin, bubbles, and Biden. He talks about the risk factors for Bitcoin as an investment asset including origin risk, speculative market structure, regulatory, and environment. Are broader financial markets in a massive speculative bubble?