TL;DR
Lack of deep liquidity is the most important issue of NFT.
Dave White from Paradigm proposed several interesting NFT primitives to solve liquidity issue.
FloorDAO tries to provide deep liquidity by protocol owned liquidity used by OlympusDAO.
Undisputed Fact
Undisputed fact; NFT is mainstream.
In less than 2 years, NFT changed from crypto-nerd’s exclusive properties to technology that draws attention from big name companies like Pepsi, Disney, Adidas, and a lot more. New NFT projects are emerging day to day, and related technologies, tools, and infrastructures are also steadily developing.
Problem to solve
Non-Fungible
Every each NFTs are unique and non-exchangeable. Unlike my 1 ETH and Alice’s 1 ETH are identical, my BAYC#4421 and Alice’s BAYC#2312 are fundamentally different and thus have different values.
Liquidity Issue
Liquidity is what we most care when we trade something. If the liquidity is shallow, it means first, price volatility is high, second, I may not instantly sell my product, lastly, price is easy to be manipulated. Unlike liquidity of cryptocurrency market, NFT market has naturally shallow liquidity because all NFTs are unique, cannot be responded 1:1, and it’s not divisable.
Existing attempts
To solve this issue, many tried to turn NFT into fungible token form.
In case of Fractional.art, NFT owner can put his NFT into vault, and mint according ERC20 tokens. Each tokens represent the fraction of the NFT. NFTX, which is going to be explained later uses similar mechanism. However, both weren’t able to propose fundamental solution to liquidity issue.
Accordingly, more creative ideas or attempts have recently emerged to solve this issue.
Base Layer
Decentralized NFT Marketplace: NFTX
The most famous NFT marketplace now is OpenSea. However, OpenSea is centralized marketplace which operated by small number of team. This structure may have serveral side effects, and one example is the OpenSea employee fraud happened last year. For metaphor, if OpenSea is Coinbase, NFTX is Uniswap.
In NFTX, NFT owners can deposit their NFT into vault and mint ERC20 based vToken(ex: $PUNK by Cryptopunks). Owners can stake or provide liquidity with this vToken and make some profit. For investors, investors can access to expensive NFT projects by purchasing the project’s vToken.
Dave White
Dave White, research partner of paradigm, proposed some thought-experimental NFT primitives like Floor Perps, Mortys, RICKS to solve the liquidity issue of NFT.
Floor Perps
Floor perp is perp that tracks the floor price of NFT.
Floor price & Perps
NFT project’s floor price is a maximum price which buyer is willing to pay, assuming that buyer receives random NFT from that project. In a nutshell, floor price the cheapest price to buy NFT from that project.
Perp, perpetual future is future contract without expiry date. Because there is no expiration date, to prevent the disparity of Mark price(price of perp) and Index price(price of underlying asset), concept of funding fee is used. If there’s more demand in perp than underlying asset, people who long perp sends funding fee to who short perp. In opposite situation, people who short perp sends funding fee to people who long perp. Margin is the asset which is used as collateral to invest in perp. If the margin goes under the specific set amount, you can be liquidated.
Problem to solve
For example, let’s say I own Koala Agent#2503, which is NFT from Koala Intelligence Agency(KIA) traded near the floor price. Floor price of KIA is 0.15 ETH.
I want some liquidity, but still I want to keep my ownership.
Also, because floor price fluctuates a lot, I don’t want be affected by this volatility when I get my liquidity.
Lastly, I want to be exposed to the upside of my NFT because I believe that my NFT is undervalued and has higher value relative to the floor price.
How it works
Floor perp is similar to normal perp like BTC-PERP, but big difference is that it tracks the floor price and I deposit NFT as collateral.
I deposit my NFT as collateral, mint 1 KIA Floor perp and sell it to market. As current floor price is 1.5 ETH, I got 1.5 ETH liquidity. In future with this perp, I can redeem my NFT which I deposited as collateral.
Case1 | floor price : 1.0 ETH, My NFT : 1.2 ETH
I buy 1 KIA Floor perp with 1.0 ETH from 1.5 ETH and redeem my NFT. Then, my overall asset becomes 0.5 ETH + 1.2 ETH(NFT) = 1.7 ETH. My overall asset has increased, even my NFT’s value decreased!
Case2 | floor price: 2.0 ETH, My NFT : 2.1 ETH
I buy 1 KIA Floor perp with 2.0 ETH from 1.5 ETH plus 0.5 ETH(debt) to redeem my NFT. Then, my overall asset becomes -0.5 ETH(debt) + 2.1 ETH(NFT) = 1.6 ETH. Although my NFT’s value increased, overall asset decreased relative to Case1.
As can be seen from above cases, floor perp decides the value of asset on how much the price of NFT has increased compare to floor price.
Mortys
Mortys represents the fractional ownership of specific class of NFT projects.
Problem to solve
Same with floor perp, I want liquidity with not giving up the ownership of my NFT. Big difference is that my Koala Agent #3069 has unique space suit attribute, which makes its value quite different from the price value.
Theoretically, it’s possible to create floor perp that tracks the KIA NFT with space suit attribute. However, as data is too small, it’s easy to be manipulated and inaccurate. So, I want to sell fraction of my NFT to get some liquidity.
Lottery Fractionalization
The most clear and simple way is to sell fraction of NFT as a lottery ticket. For example, someone can pay me 1.5 ETH and I give him the right to redeem my NFT for 50%. However, it’s no applicable if I don’t want to take the risk of loosing ownership of my NFT.
How it works
I create a vault that only takes the space suit KIA NFT. I deposit my NFT into vault and mint 100 Space Suit KIA Mortys. One important fact is that because this vault takes any NFT with space suit attribute, I can replace another space suit KIA NFT with mine. Additionally, I can mint new Mortys by depositing another space suit KIA NFT.
I sold 50 Mortys to market and got 50% of liquidity. Now I have 50 Mortys. From today, with a probability of 1/2 every day, 1 Morty is given to me or buy pool. So, in tomorrow, it will be (Me: 51 Mortys, Buy pool: 49 Mortys) or (Me: 49 Mortys, Buy pool: 51 Mortys). These process repeats until my balance of Mortys become 0 or 100.
My balance : 0
My collateral NFT would be send to marketplace like NFTX and anyone who has 100 Space Suit KIA Mortys can redeem it.
My balance : 100
I can redeem my NFT.
RICKS
RICKS is new NFT fractionalization primitive. If NFT is fractionalized to RICKS, new shards are minted in constant rate and sold in auction. Profits are distributed to existing RICKS holders.
Problem to solve
Goal of RICKS is to solve reconstitution problem in NFT without any side effects like low liquidity.
Problem of fractionalizing NFT is how we can reconstitute shards back to sole NFT. If I sold 25% of my NFT for liquidity and I got into situation where I need my NFT bakc, How can I get it? Also, what if buyer of my NFT fraction lost private key? This is all about reconstitution.
Buyout auction is one way to address this problem. Which used in Fractional.art, if anyone want to buy NFT, he can trigger buyout auction and person whoever bids most gets the NFT. Profit from the auction is distributed according to the shares of NFT.
However, buyout auction has some fatal side effect, which is that I may be forced to sell even if I don’t want to. For example, let’s say I own 25% of KIA NFT. Alice triggers the buyout auction and bids for 5 ETH. Even if I want to sell at a price higher than 5 ETH, if I don’t have more than 5 ETH, I can’t beat the bid, forced to sell my 25%. To prevent this, it’s possible to set minimum reserve price in Fractional.art, but it’s not easy to coordinate this price between multiple NFT shard owners.
How it works
Let’s say I fractionalized my NFT into RICKS and sold 50% of my Koala Agent #3069 at 5 ETH valuation to Alice. Now I and Alice owns 50 RICKS each. New RICKS are minted at 1% every day and sold in auction. Next day, Bob bids 0.6 ETH for newly minted 1 RICK, which means that Bob valued whole NFT at 6 ETH.
However, I think my NFT values at least 8 ETH and want to beat the Bob’s offer. If it was ordinary buyout auction, I would need whole 8 ETH, but because it’s auction for only 1 newly minted RICK, I only need 0.4 ETH to bid. The reason why it is not 0.8 ETH is that I own the 50% of the total RICKS shares, so I will receive half of the auction sales anyway, so I only need to bid 0.8/2 = 0.4 ETH.
So eventually, If we use RICKS mechanism, I can beat the unwanted offer with small amount of capital. One problem of RICKS is that it is mathematically impossible for one person to own 100% of total shares. This is because new RICKS continues to be minted. This problem can be solved using Mortys, if someone has collected a certain level of shares, he can redeem the NFT at a certain probability.
FloorDAO
FloorDAO aims to become the first decentralized NFT market maker.
Problem to solve
Currently, decentralized NFT marketplace like NFTX has shallow liquidity about vTokens like $PUNK, $PUDGY.
How it works
FloorDAO seeks to increase liquidity of NFT by using the Protocol Own Liquidity (POL) used by OlympusDAO or Fei Protocol in the DeFi sector. For example, FloorDAO plans to offer chances to buy $FLOOR, governance token of FloorDAO at discounted price if one deposits $PUNK or PUNK-ETH LP token. With this asset, FloorDAO can directly provide deep liquidity to NFTX and get profit from staking or swap fees.
FloorDAO's success also means the success of decentralized NFT marketplaces, and as long as high liquidity is guaranteed, NFTX may catch up with Opensea's trading volume.