What is an NFT?
An NFT (Non-Fungible Token) is an ERC-721 token consisting of digital data stored on a blockchain. The ownership of an NFT is recorded in the blockchain and can be transferred by the owner, allowing NFTs to be sold and traded for a market value (more than equal to the floor price of the collection). Even though the overhyped PFP NFTs era seems to be over, the NFTs are still widely used for representing LP positions on AMMs, assets in blockchain-based games, ownership of land in Decentraland, and a plethora of different use cases. However, let us dive deeper into the ERC721 tokens currently being used in games.
Why NFT lending?
The Web3 gaming ecosystem today is in its "toddler" phase. The boost of investments that we saw in 2020–2021 in the gaming industry has helped it grow from its infancy, yet the short span has not allowed it to mature completely. The incomplete infrastructure of the Web3 gaming industry has been a reason for the negative aura around blockchain-based games. Since good games take time to build, it will probably be in the next 12 months or so that we will see enjoyable blockchain-based games.
Since the primary incentive for gamers to play games is fun, the gaming studios should work on developing PaE (play-and-earn) tournaments rather than overhyping the P2E (play-to-earn) ecosystem. The difference between "PaE" and "P2E" lies in the incentive provided for gamers to move to a new infrastructure. The infrastructure must first be developed to high fidelity levels for the organic growth of blockchain-based games that enable ownership of assets. Only then can further incentives (like earning) be added to revolutionize the gaming industry as we know it today.
Hence, let us now look at one of the problems in today's infrastructure that needs to be solved.
Most games have a limited supply of playing characters (non-fungibles) which creates a specific demand-supply market for the tokens. Since the ERC721 standard doesn't allow buying a "part" of an NFT, the cost of acquiring an NFT sometimes rises through the roof. This results in an inevitable roadblock for new users entering the ecosystem. Offering new users to buy 2000 $ sneakers to log in to your game on their smartphones doesn't get you far in terms of actual growth. But since the game devs cannot manipulate the market supply-demand on the chain, this roadblock is not easily solved. That is where NFT lending/leasing comes into play.
The thought might have come into your mind at least once when playing one of the few good blockchain games. How can I borrow an NFT? Or how to get richer with my NFTs by lending them to someone else? By locking your NFTs in smart contracts that allow NFT lending, you may take a loan on the NFT and start earning interest on the borrowed capital. On repaying the loan, the NFT can be claimed back. We will discuss some of such projects below. However, do note that currently, there exists no such no project that allows you to earn interest solely on the basis of your NFT. Nor is there any project that will enable you to take an undercollateralized loan on your NFTs. Hence, in the end, we will discuss a newly suggested approach in NFT lending that might revolutionize the blockchain gaming ecosystem as we know it.
“Make thy gold multiply” — Rule no. 2 from “The Richest man in Babylon” (George S. Clason)
Current implementations
Let's look to find out what solutions are currently available to solve this problem and — long story short — didn't find any complete solution. Nevertheless, let's look at some of the projects trying to implement NFT lending successfully.
NFTfi
NFTfi is a platform that allows owners to lock their NFT in a smart contract and take a loan against it. NFTfi is a leader in the collateralized NFT lending market today. Look at it from another side, and the platform allows people with idle WETH to earn a yield on it. The “cash kings” send their WETH to the smart contract, which forwards WETH to the NFT owner. If the loan is not paid back in full within a previously agreed-upon deadline, the WETH lender is free to take the locked NFT and sell it on the market to reimburse his loss.
Hence, upon closer analysis, we can observe that NFTfi offers two services for its potential users:
1. Allows users to be issued a loan with their NFT as collateral. The loan can then be put to good use and earn yield.
2. Allows users to earn a secure yield on their WETH (or other ERC20 tokens) by lending it to someone else and keeping their NFT as collateral. In case of a default, the NFT can be sold, and the capital is retrieved.
NFTfi solves its specific problem statement pretty well. However, gaming degens can not use the project in blockchain-based games. The NFT that is being stored as collateral cannot be used by the renter (in this case, the user offering his WETH in exchange for collateral) to play games, prove the right to lease and utilize, etc.
Fractionalised NFTs
Another market segment that may come to mind to solve the problem we set out to solve is fractionalized NFTs. Fractionalized NFTs allow an NFT owner (let’s call her Alice) to lock her NFT into a smart contract in exchange for X number of ERC20 tokens. The smart contract becomes the owner of the NFT, and Alice can then sell the ERC20 tokens on an AMM and get access to more liquidity. Whenever some other user (call him Bob) collects X number of the same ERC20 tokens, he may exchange the tokens for the underlying NFT and become the new owner.
Everything seems good. However, the problem with this system is that the NFT that Bob receives is not the same one that Alice had locked in. Even in the case of Profile picture NFTs the emotional attachment of users to their NFT is lost in case of reclaiming, and the rarity of the NFT is not accounted for. In the case of gaming NFTs, this becomes even more illogical to use. Alice may have a gold skin for some sniper rifle in an RPG blockchain game, but Bob may receive a silver skin in exchange for the same amount of tokens that Alice got when she exchanged her golden skin. Many projects focus on fractionalized NFTs (e.g., Fractional, Liquid Marketplace). Yet, they do not solve the problem of liquidity and NFT leasing for Web3 games for the same reasons described above.
Possible implementation in the future
As we saw above, the main problem to be solved is that there should be a generalised interface for NFT leasing contracts that allows games to know if an NFT is leased and amend their gameplay accordingly. Along with that, the NFT lender should be able to claim back his NFT after the lending period ends, and it should be the same NFT they lent. Also, a transfer of ERC20 tokens between the users must be possible to take place securely (so that the renter can pay the lending fees for borrowing the ERC721 token). If we have a solution like that, that would probably be too good to be true. However, let us try to see what other features it could include. Since the smart contract handles the transfer of the non-fungible token, the renter may not have to transfer huge sums in form of collateral to rent and play. Marvellous!
The above-described infrastructure is what we are proposing with the EIP-1972. More details about it can be currently discussed on the Ethereum Magicians forum here. Do check it out if you are a developer interested in this.
Some of the most popular Web3 games today have a utility token (an ERC20) that is rewarded to players based on their performance. Such examples are SLP in Axie Infinity, THG for Thetan Arena, and a native utility token for Zed Run. Games that implement NFT lending from the beginning also have to encounter the problem of dividing the utility token rewards between the NFT owner and the renter in a P2P-agreed ratio. The perfect gaming NFT lending NFT marketplace should also tackle this problem effectively and allow the native transfer of the reward tokens to the lender and the renter. Since the lending oracle will also let the games know that the NFT is rented, the rewards earned by the renter will be distributed between the owner and the leaser.
The team that can solve this problem effectively will probably have solved one of the fundamental problems of the Web3 infrastructure. Even though the difficulty of implementing a logic that does all of the above may be high, the fun in building it will probably be even greater.