DeFiForAll: What NFTs Can Do for DeFi

When it comes to real world use cases of blockchain technology, decentralized finance (DeFi) and non-fungible tokens (NFTs) are the undisputed core pillars of Web3. But as activity for both has come down from recent peaks, the question is whether the key to sparking new growth lies at the intersection of the two communities.

The differences between these markets are significant, but they also hold clues for possible synergies. DeFi protocols are like financial Lego blocks that developers can use to assemble new services at will, but the set of assets with which to build them is finite. NFTs can represent just about anything on-chain, but are highly illiquid and difficult to price.

There are some properties of NFTs that make them imminently applicable to DeFi. Here are some examples:.

  1. NFTs are non-fungible, which means they are inherently unique and thus can offer more personalized and specific positions in DeFi. 
  1. NFTs have natural value derived from their utility and scarcity. DeFi protocols can fine tune the scarcity and utility of specific NFT releases to have greater control over what they imagine the initial value should be, then leaving the rest up to the free market to decide.
  1. Incorporating NFTs can untangle the price of governance power from the native protocol token. Imagine Protocol X releases a collection of NFTs required to vote on governance proposals. The native X token could still earn 80% of protocol fees, while the NFT holders get to vote on governance proposals and earn 20% of protocol fees. This allows for a fully-diluted value of native protocol tokens, creating a more accurate valuation.

Staking regular tokens in exchange for governance tokens, or veTokens, is already a popular practice that was pioneered by Curve. But this artificially inflates the price because the staked tokens are taken off the market. It also creates a marketplace that is heavily swayed by the total amount of the tokens staked.

Since it is often difficult to predict how long tokens are staked for, separating this governance process with NFTs allows for greater transparency of the value of the token. Additionally, this can separate the markets for those that simply want to interact with a given protocol from those who have an active interest in improving the mechanisms behind the protocol. This idea can be expanded to create a hybrid form of governance using both NFTs and veTokens.

  1. NFTs are easily tradable, removing the illiquidity that develops from having to lock up protocol tokens for veTokens. Using NFTs, rather than locking tokens for the utility that veTokens serve, can remove the need for liquid versions of veTokens.
  1. NFTs allow for the gamification of protocols. Typical DeFi protocols can add a gaming aspect that benefits the main use case of the protocol by incorporating NFTs, without having to go full GameFi and develop a video game.

And there are already some significant real world use cases. One is the use of NFTs as collateral as exemplified by the recent $8 million loan backed by the collection of 101 CryptoPunks. Another is in yield farming. Uniswap V3, which allows liquidity providers to choose the price range they wish to provide for, is issuing NFTs that represent the unique position of each provider. Protocols like Duality Finance are already accepting the NFT LP positions as collateral for loans.

You can read a more detailed post on this topic here, explore the broader Polygon ecosystem, and keep up with the latest news on the blog!

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