NFT as collateral: borrowers can now secure a loan with NFT | Ingram Yuzek Gainen Carroll & Bertolotti, LLP
Backed by renowned crypto investors including Franklin Templeton and Pantera Capital, Arcade, a decentralized finance (DeFi) marketplace, closed a $ 15 million Series A funding round to launch its guaranteed fundraising activity that enables borrowers get loans with the NFTs they own.
According to the news, Arcade has previously facilitated “Largest and First $ 800,000 Unauthorized Chain Loan Against NFT WalletIn its private version and now goes one step further to launch its NFT Guaranteed Funding feature, aimed at providing liquidity to NFT’s general owners while allowing institutional and high net worth lenders to access a new source of income. With such a feature, the borrower can choose to get a loan with one NFT or a single ‘wrapped NFT’, which as stated by Arcade consists of multiple NFTs bundled together to reduce processing costs (i.e. – say gasoline costs). Once the borrower and the lender have agreed on the loan terms and the loan proceeds must be disbursed, the promised NFT (s) will be “escrowed” in the smart contract deployed by Arcade and will remain unrecoverable. unless the loan is fully paid or in default. . At the time of this writing, the Arcade platform supports “45 to 50 NFT collections” who have “some value against them”, Such as CryptoPunks and Bored Ape Yacht Club.
As can be discerned from Arcade’s new functionality, securing a loan with NFT is inherently very similar to conventional secured finance arrangements, in which borrowers would secure a loan with equity interests and / or assets that have a determinable value. However, new issues may still arise as the NFT guaranteed loan agreement is in its early stages of development, and the risk allocation for NFT guaranteed loans may therefore differ from that established in the funding frameworks. guaranteed conventional.
For example, one issue to watch out for is the risk allocation arrangement for loss of collateral. In conventional secured financing contexts, a borrower pledging equipment to secure a loan is typically required by the lender to obtain insurance coverage for the pledged equipment, as more often than not physical possession of the lender. The equipment is retained by the borrower after the loan proceeds have been disbursed. . Therefore, even if the pledged material is destroyed, the lender’s interest is still protected because the borrower will receive the insurance proceeds and allocate that proceeds to the lender as a replacement for the destroyed material.
In the world of NFT, however, asking the borrower to obtain insurance coverage for the pledged NFT might not be appropriate as the NFT would be deposited into a third party’s smart contract rather than being owned by the borrower. In the absence of insurance coverage, can the lender request additional collateral from the borrower if the third-party smart contract is broken and the sequestered NFT is stolen? Or, should the third party assume the risk and obtain insurance coverage for all warranties? Further, would insurance coverage itself be considered an effective risk-allocation arrangement between borrower and lender given the nature of DeFi (i.e. the majority of transactions are automated by codes with little or no human intervention)?
Another problem to watch out for is the fluctuation of the determined value of the collateral. In conventional secured funding contexts, the value of the collateral is largely determinable and is not subject to dramatic changes, as this value can be objectively assessed with reference to independent factors. (For example, the value of an offshore wind farm generator provided as collateral for a syndicated facility can be determined by referring to the price of the same type of generator currently available in the market.) The value of an NFT, however , is largely based on a subjective assessment and may therefore fluctuate over time. For example, if in a very short period of time the general public regards CryptoPunk NFTs as ‘old fashioned creations’ and all CryptoPunks are trading at $ 1, could the lender ask for additional collateral from the borrower if the loan was initially guaranteed by a CryptoPunk then traded at $ 500,000?
No answers are currently available to these issues, as the use of NFTs as collateral is still in its infancy. It would take time for the market to form customary practices, and such problems, in the end, might not even occur. Nevertheless, it should be observed how the loan guaranteed by NFT will differ from conventional financing arrangements and what the borrower and lender will be entitled to when the NFTs are pledged as collateral.