Decentralized finance DeFi

[The platform] makes it possible for any artist that does not have any knowledge regarding blockchain to mint the artwork. The verifiability of ownership is one of the most crucial elements related to the uses of NFT and DeFi combined. Due to how simple it is to demonstrate NFT ownership, NFT holders now have more opportunities to use their NFTs as collateral for loans.

Unfortunately, there seems to be an inherent trade-off between usability and security. For example, some decentralized blockchain applications will ask for permissions to transfer an infinite number of tokens on behalf of the user—usually to make future transactions more convenient and efficient. A complete set of sub-tokens consists of 1 sub-token for each potential outcome.

  • This process is costly and, in many cases, not entirely transparent for the token holders.
  • We think there are good reasons to foresee that NFT-backed securities will become a popular investment vehicle, solving the over-collateralization problem and offering solutions suitable for all types of investors.
  • Basically, meaning one NFT is not changeable for another NFT and each unique token has its own value.
  • On the other hand, privacy may be a desirable attribute for some legitimate financial applications.
  • To understand the novelty of smart contracts, we first must look at regular server-based web applications.

This flexibility allows for an ever-expanding range of possibilities and unprecedented interest in open financial engineering. Yearn Vaults are collective investment pools designed to maximize yield for a given asset. Strategies are quite diverse but usually involve several steps and active management. In many cases, these actions would be too expensive (in terms of transaction fees) for smaller amounts. Yearn Vaults mitigate these issues by employing the knowledge of the masses and using collective action to split network fees proportionally among all participants.

7 For example, such a token was created in regard to the outcome of the recent U.S. presidential election. While it is questionable whether regulators can (or should) regulate a decentralized infrastructure, there are two areas that deserve special attention, namely, fiat on- and off-ramps and the decentralization theater. It is important to mention that the MakerDAO system is much more complicated than what is described here. Although the system is mostly decentralized, it is reliant on price oracles, which introduce some dependencies, as discussed in Section 3.2. AirSwap is the most popular implementation of a decentralized P2P protocol. NFT collectors, too, can increase their chances of selling NFTs by sending initial signals about the NFTs they want to sell.

Blur’s NFT Market Domination

Tranches, from the French word for slice or portion, are sections of a pool of securities that are divided up by criteria like time to maturity and risk, so they can be sold to different investors. Risk tranches are among the most common forms of tranching, and divide securities by the level of risk they carry. Typically, investors who are more risk averse will opt for a tranche offering a lower, but more certain, return; others will seek to maximize returns at the risk of potential losses.

This ensures that no one entity has total power over a network, vastly reducing the chances of corruption and malicious takeovers. Decentralized networks also value transparency, using distributed ledger technology (DLT) to display transactional history publicly. Another important aspect regarding the use of NFT DeFi together is the concept of fractional ownership. As a result, investors and fans of NFT creators could get the opportunity to owing NFT without purchasing the whole NFT. However, the applications of fractional ownership of NFTs in the DeFi space are still in the initial stages. One of the foremost aspects about the NFT DeFi combination is the capability for unlocking value.

These features allow various smart contracts and decentralized blockchain applications to interact with each other and to offer new services based on a combination of existing ones. If there is an issue with one smart contract, it may potentially have wide-reaching consequences for multiple applications across the entire DeFi ecosystem. Moreover, problems with the Dai stablecoin or severe ETH price shocks may cause ripple effects throughout the whole DeFi ecosystem. A popular derivative token platform is called Synthetix (Brooks et al., 2018).

These indexers assume the role of a directory in which people can advertise their intent to make a specific trade. In other words, the non-fungibility is currently applied to the token representing the transaction of the purchase — not necessarily the owner of the physical (or digital) piece of art. Every investment and trading move involves risk, and readers should conduct their own research when making a decision. The growth of NFT applications and rising on-chain activity makes them difficult to dismiss as an emergent asset class.

It is implemented so that the total debt pool of all participants increases or decreases depending on the aggregate price of all outstanding synthetic assets. This ensures that tokens with the same underlying assets remain fungible; that is, redemption does not depend on the issuer. The flip side of this design is that users assume additional risk when they mint assets, as their debt position will also be affected by everyone else’s asset allocation. Another approach is to consolidate liquidity reserves through a smart contract that allows large liquidity providers to connect and advertise prices for specific trade pairs. A user who wants to exchange token x for token y may send a trade request to the smart contract. The smart contract will compare prices from all liquidity providers, accept the best offer on behalf of the user, and execute the trade.

In this case, the smart contract ensures that asset managers adhere to the predefined strategy and act in the investors’ best interest. In particular, asset managers are limited to actions in accordance with the fund’s ruleset and the risk profile stipulated in the smart contract. The smart contract can mitigate many forms of the principal-agent problem and incorporate regulatory requirements by enforcing them on-chain.

Value creation and capture in NFT markets

Consequently, the lender will only start to earn interest once there is a match. The advantage of this approach is that the parties agree on a time period and operate with fixed interest rates. Interest payments and liquidation fees are partially used to “burn” MKR, thereby decreasing the total MKR supply. In exchange, MKR holders assume the residual risk of extreme negative ETH price shocks, which may lead to a situation in which the collateral is insufficient to maintain the USD peg. As such, MKR holders have skin in the game, and it should be in their best interest to maintain a healthy system.

Nonetheless, whether such an object could still be considered a store of value remains to be seen. If, instead, the NFT gets burnt on a blockchain, the underlying artwork could continue existing and serving as a physical store of value. Again, the fact that an NFT has an underlying work of value distinguishes it considerably from fungible tokens (Anselmi & Petrella, 2023). One risk that NFT collectors face is uncertainty about the underlying asset’s condition and origin (and even existence). While the NFT is easily trackable thanks to blockchain, it is difficult for potential buyers to ensure that the underlying asset is in the promised state.

About this article

Just Liquidity is a financial system aiming to create a fully decentralized experience with global fiat applications such as Visa and Mastercard Debit Card. For example, if you deposit Aave tokens that then get converted to aTokens by the protocol into an NFT, you will generate yield-bearing assets. The interest generated is programmable, which means that you have full control and can send it to any wallet. Uniswap3 took the issue of impermanent loss (common in the Curve protocol) into account and introduced non-fungible liquidity pools, thereby creating a brand new application for NFTs. This has resulted in NFT lending being the most popular segment of decentralized finance, with TVL reaching $49 billion in 2021.