How Can NFTs Be Used in DeFi (Decentralized Finance)?
Non-fungible tokens (NFTs) and decentralized finance (DeFi) have changed the concept of the Internet as we know it.
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NFTs introduced a revolutionary way for artists to own their digital art, while DeFi enabled transactions to take place for the said NFTs on the internet.
Together, NFTs and DeFi introduced innovative aspects of economics on blockchain technology.
Introduction to NFTs and DeFi
NFTs are digital assets, mainly in the form of art, such as painting or music, that can be owned on the internet with proof of authenticity and sold to other internet users in exchange for money.
On the other hand, DeFi is a revolutionary financial ecosystem built on blockchain technology. Being decentralized, DeFi offers users benefits like transparency, security, and accessibility.
NFTs and their role in the digital art market
Before the introduction of NFTs, artists always criticized the internet’s platform for being non-rewarding for their artistic creations. Whether it be music or a painting, users had the opportunity to own, duplicate, and distribute their work without any trouble.
NFTs introduced a revolutionary change to this by enabling artists to actually own their artwork on the blockchain network, which cannot be distributed or duplicated without being purchased from the owner. These NFTs can be monetized and exchanged, and artists can receive royalties upon selling their artwork.
DeFi and its potential for disrupting traditional finance
Traditional finance runs on the basis of intermediaries such as banks and other financial institutions that cause hurdles in financial activities and act as a centralized authority that supervises everything.
On the contrary, decentralized finance builds on the concept of decentralization, which eliminates the need for intermediaries and allows users to transact directly with each other with more freedom in transparency, accessibility, and security.
The role of NFTs in DeFi
NFTs indirectly promote the usage of DeFi instead of traditional finance for users all over the world.
Advantages of using NFTs in DeFi
The biggest advantage of the role of NFT in DeFi is its characteristic of being Non-Fungible, meaning that they are one of its own kind and can not be replaced or duplicated. These qualities in an asset are extremely useful in a financial environment like DeFi, relatively as important as gold is to traditional finance.
NFTs are secure, free from any threats of theft, and have verified ownership. Another advantage is that NFTs promote the use of DeFi and attract more demand for digital currencies. This is done by NFTs acting as liquid assets, collateral, or insurance in the financial ecosystem of DeFi.
Use cases for NFTs in DeFi
NFTs affect the DeFi ecosystem both directly and indirectly. When done indirectly, the applications of NFTs promote the use of DeFi by attracting users to invest in digital currencies and partake in financial activities. The most popular of these uses are fractionalization and gaming.
Fractionalization makes it possible for users to invest in NFTs even with a low budget, which helps them own a fraction of an expensive NFT instead of the entire thing. This fraction can be further traded as well. In gaming, NFTs are used as in-game assets or collectible rewards.
On the other hand, NFTs provide many purposes in the ecosystem of decentralized finance directly as well, mainly categorized by their uses acting as collateral, insurance, liquidity provision, and insurance.
NFTs as collateral in DeFi lending
Lending takes place in DeFi as well, where the loaner requires security against their loans. In these scenarios, NFTs can act as the perfect asset for collateral by having authentic verifiability and security.
How NFTs can be used as collateral
Third parties can evaluate the value of the NFT, and loan amounts can be determined using that.
NFTs as collateral provide a great advantage for borrowers to easily acquire loans without needing to liquefy their assets.
Examples of platforms using NFTs as collateral in DeFi lending:
Nexo and BlockFi are two examples of platforms already using NFTs as collateral for loans.
NFTs in DeFi liquidity provision
In the environment of DeFi, liquidity pools are used to liquefy digital assets and facilitate trades. Here, NFTs work as a great asset to deposit for liquid finance.
Liquidity provision in DeFi
The concept of liquidity remains the same in DeFi as with traditional finance. Some assets are difficult to cash out, while others aren’t. To tackle this, liquidity provision pools help users deposit assets (such as NFTs) and provide liquid finance against them.
How NFTs can be used to provide liquidity
Practically, NFTs are the best asset that can act as liquidity provision for these liquidity pools. By depositing an NFT in a liquidity pool, the NFTs value determines its liquidity, which estimates how much can be financed against it.
A real-world example of NFTs being used in liquidity provision:
Platforms like the Rarible marketplace have already introduced this concept, incentivizing NFTs as liquidity provision tools with rewards and commissions.
NFTs in DeFi insurance
Just like with traditional finance, DeFi also requires insurance to cover uncontrollable losses to users.
How insurance works in DeFi
Since DeFi is based on the internet, under this ecosystem, the losses are mainly against smart contract failures or hacks. To tackle this, insurance companies provide compensation against premiums just like in traditional finance.
How NFTs can be used as insurance
NFTs can be used as a token representing an insurance policy. This token can be used to claim insurance coverage by enabling users to redeem them for compensation.
A real-world example of NFTs being used in DeFi insurance:
Nexus Mutual is a popular platform already using NFTs as a token for insurance coverage.
NFTs in DeFi governance
While decentralized, DeFi gives itself room for growth and betterment by adapting to user feedback, which is collected through a voting procedure.
Governance in DeFi
To ensure positive and effective changes, DeFi makes changes in the development and management of its ecosystem by assigning users voting rights in the form of government tokens, which NFTs mostly represent.
How NFTs can be used in governance
Users use NFTs as a token that represents their voting rights and access to other rights and privileges like exclusive features and rewards.
A real-world example of NFTs being used in DeFi governance:
Uniswap is one of the most popular DeFi platforms that use NFTs to represent ownership of liquidity positions, providing users with governance and voting rights.
With the favorable characteristics of being secure, unique, and verifiable, NFTs make a strong and useful asset for DeFi.
Summary of the potential use cases for NFTs in DeFi
Currently, NFTs are already playing a crucial role in DeFi by providing collateral, liquidity, insurance, and governance to the ecosystem. However, these roles are predicted to increase, grow, and improve over time.
Potential future developments in this area
NFTs are still considered to be in their early development stages, offering a huge potential for development that will be realized in the near future. With time, we should see more innovative, creative, and helpful roles of NFTs in DeFi, such as being a liquid asset.