NFTs as Collateral in DeFi (Part III)
3月 11, 2022
Inspired by the booming NFT market and the plethora of NFT-related use cases emerging on a daily basis, we launched this Mettalex Research series to take a closer look at the use of NFTs in DeFi. In Part I we examined projects that accept NFTs – primarily digital art ones – as collateral for yield farming, lending, and borrowing. Taking into consideration the nature, conditional scarcity, and liquidity of this type of NFTs, two main price discovery mechanisms are being identified and used – Auction and Fractionalization.
However, when other types of NFTs are at stake, like tokenized real-world property, for example, these two valuation models are deemed inefficient or non-applicable. The integration of non-crypto-related asset classes into DeFi has been a goal for the whole space for years and is essential for the achievement of stability and maturity. Therefore, a third price discovery method – the Appraisal one – is being introduced. We examined some of the protocols that are already employing it in Part II of our research.
This third article will be dedicated to other DeFi use cases involving tokenized real-world assets.
Real Estate and DeFi
Real estate NFTs are a hot topic in DeFi since the integration of such an asset class would position the space in direct competition with the traditional financial system. Though, the tokenization of an entire property asset i.e. the property deed being tokenized and uploaded to a blockchain network is currently almost impossible due to regulatory and taxation hurdles. Consequently, most of the decentralized solutions built around real estate overcome this obstacle by setting up a Special Purpose Vehicle (SPV) entity as the owner of the property. Therefore, it is usually the legal entity wrapping the underlying asset that is actually tokenized and not the asset itself.
As opposed to the lending/borrowing projects we discussed in Part II, the protocols we are about to explore use this same model but as soon as the real estate is tokenized, the property ownership gets fractionalized into pieces. Here, the investment and/or loan collateral takes the form of a fractional ownership of the underlying asset. The fractional ownership tokens can be used as a guarantee for loans, as partial investment exposure to high-end real estate, or as generators of farm yields or passive rental income.
Real Estate fractional ownership has the potential to revolutionize property investment by opening up the access of small investors or regular crypto users to opportunities previously available only to major institutional players. That way, it practically enables real estate crowdfunding. Moreover, borrowing is getting democratized as well thanks to home equity and mortgage-backed loans.
Therefore, the projects listed below combine two of the price valuation models we discussed in Part I 和 Part II – the Appraisal model is used to source the market price of the physical asset and Fractionalization – to convert the property NFT into regular ERC-20 tokens.
Real Estate Investment Through Fractional Ownership
Real estate is traditionally illiquid so it is usually quite hard for owners to convert their property into cash or other liquid assets. Using the fractional ownership method, homeowners can sell part of their property to get fresh capital. They no longer need to sell their whole asset or put it as collateral to get a loan. On the other hand, investors can get portfolio exposure to real estate in exchange for a limited investment. They may then opt to sell, trade, or leverage these real estate tokens or to simply hold them and receive a passive rental income or profit once the whole asset got sold.
The NFT fractions actually represent shares in the Special Purpose Vehicle entity. That is why these ERC-20 tokens rather act as stock and are mainly categorized as security tokens.
Find out below the projects putting this model to work.
LandShare is built on BNB Chain and aims at facilitating real estate investment. Through real estate tokenization, investors can choose from a number of listed properties and gain exposure to them for as little as 50$. Each property is rented out to tenants and provides monthly rental yields.
Similarly to the model described above, each listed asset is owned by a dedicated legal entity. When buying the associated Asset Token, the investor becomes a legal shareholder of the respective corporation – and by extension to the underlying property.
LandShare’s tokenomics consist of:
- Asset Token – Each listed property has its own Asset Token. Since it represents a share in a legal entity, it is practically a security token. When acquiring it, investors gain voting and governance rights over the property, as well as the right over a cut of rental and other property-associated profits.
- LAND Token – This is the utility and governance token of the LandShare ecosystem. LAND is used for the purchase of Asset Tokens and its holders will have the right to govern the platform itself.
In the future LandShare targets to tokenize and crowdfund house flipping – investors will buy in Asset Tokens in the same way but instead of rental profits, they will count on the property’s appreciation after renovation.
CitaDAO is a protocol being developed on the Ethereum blockchain that gives small investors access to high-value real estate projects. Their mission is to introduce more inflationary-resistant assets into DeFi as opposed to stablecoins.
CitaDAO’s first so-called IRO or Introducing Real Estate On-Chain was launched on March 8th, 2022, and will continue for 10 days – it entails investors committing USDC stake for a 10-day lockup period and earning rewards in return. The amount of the rewards will be based on the percentage contribution to the launch pool.
The first property to be tokenized on CitaDAO is located in Cardiff, the UK, and is priced at more than $20M. If the IRO is successful i.e. the value price is accumulated, an NFT under the ERC-721 standard will be minted to represent the title deed. Consequently, the NFT will be fractionalized into regular ERC-20 RET (Real Estate) Tokens and distributed to investors in accordance with their share of rights. RET tokens will give holders the right to buy out other RETs in order to claim the NFT and redeem the title deed as well as the assets of the Special Purpose Vehicle (SPV). According to the CitaDAO documentation, RET is not a security token.
As opposed to LandShare, rental yields are not the main goal for investors on CitaDAO, nor are they guaranteed. CitaDAO’s model is similar to regular yield farming as the RET token can be staked on farms and pools for rewards, with the added advantage of being backed by physical properties.
Aqarchain offers a similar fractional ownership model but targets high-value assets like real estate, yachts, and jets. Apart from the partial ownership deed for the asset, investors can actually benefit from having access and using the asset based on a sharing model with the rest of the investors.
Moreover, Aqarchain is replicating its platform into the Metaverse. Every investor buying an entire property or a fraction of it has the right to claim a similar area in AqarLand – Aqarchain’s Metaverse equivalent. If successful, they will get an independent NFT with the gamified utility of the land.
The minimum investment is $100 and no lockup period is required.
RealT is maybe the most mature project of all – it runs on the Ethereum blockchain and focuses on the US real estate market. It has a bunch of properties currently listed as well as several that are already sold out. The minimum investment amounts to around $50. The expected income for most of the properties revolves around 10% as it is based solely on rental yields and does not factor in potential asset appreciation.
Omni Estate Group and Passive Income market themselves as the first Europe-based real estate NFTs marketplace. The minimum investment they offer amounts to EUR100 giving an annual interest rate of around 10%.
Ekta, MyBricks Finance, Rentible are also protocols working toward democratizing the access to real estate investment or rental management through fractional ownership. They are, however, still in the early stages of development and haven’t launched their products yet.
An emerging use case for real estate-related NFTs in DeFi is the tokenization of mortgage/debt and its collateralization for lending/borrowing. It is now possible for a homeowner to issue an NFT backed by their property ownership and fractionalize it to attract a number of investors, each acquiring a small fraction of the debt. Borrowers would get fresh capital using their property equity without selling it, whereas investors would receive repayments in proportion to how much they lent out.
LoanSnap-financed Bacon Protocol is a pioneer in the Mortgage NFTs space. It aims at democratizing access to the $11T- worth US residential mortgage market currently controlled by banks and governments. Due to heavy regulation and capital requirements, it is practically impossible for small-size and hobby-investors to take part in mortgage lending. By tokenizing housing debt, Bacon removes most of the entry barriers and liberates the access to a considerably low-risk and consistent yield-bearing asset class.
Bacon enables property owners to exchange a lien on their property for an NFT representing a portion of its value. Once the lien is wrapped in the NFT, the Bacon protocol uses it as collateral for lending.
Bacon’s bHOME stablecoin is backed both by stablecoins and by liens and loans against US-based properties and, according to their documentation, the value of the token grows as the loans are being repaid. The interest rate borrowers pay after minting their mortgage is between 1.5% and 3%. This is also the rate retail investors would get as returns as opposed to the 0.1% interest on savings accounts offered by traditional banking institutions.
The protocol has already wrapped several mortgage liens at the combined value of $1.5M.
This article is not financial advice and its only goal is to manifest the burgeoning innovation currently taking place in DeFi. The real estate and property NFTs have the potential to remove middlemen and democratize both borrowing and investment.
However, these novel approaches hide their risks so approach them with caution. Significant matters like real-world transfer of ownership or taxation are still not regulated and it is not always clear how a potential borrower default would be handled.
This article is based on research conducted for Mettalex by Felix Bucsa and Albena Kostova.
The Mettalex Research blog post series dives deeper into the latest innovations in Decentralized Finance. Apart from Part I 和 Part II of the research on NFTs as collateral in DeFi, check also our analyses on DeFi 2.0 principles with focus on the MetaversePro implementation, on the novel tokenomics model Ve(3, 3), and on The 8 Hottest DeFi Trends to watch in 2022 with Part I exploring Regulations.
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