ForkLog publishes the third installment in Dmitry Bondar’s cycle of articles on non-fungible tokens (NFTs) as a new class of virtual assets. First part is an introduction to the NFT market, second about the close kinship between cryptocurrencies and collectibles, third about the prospects of NFTs.
NFT Collections and Their Tokenization
There is no collectible without a collection and a collector. NFTs are still young, so historically significant NFT collections and NFT collectors have yet to emerge, although large NFT investment portfolios уже существуют. Collections can be built around the main NFT categories: land and real estate in virtual worlds, gaming items and characters, digital art (by the way, take a look at the exhibition in the виртуальном мире Cryptovoxels), domain names, fan memorabilia. It is possible to imagine something more original – the concept of a collection is limited only by the imagination of the collector.
An NFT collector can be not only a person, but also an autonomous smart contract or a DAO. This opens up new possibilities for experiments with models of collection and NFT collection tokenization. We will consider three such models: collection shards, shard collection and a DAO of collectors.
Collection Shards
Shards, issued to collateralize a single NFT, have a limited capitalization. Underpinning a collection of NFTs, you can issue shards with capitalization an order of magnitude higher. These shards operate on the same scheme as шарды одного NFT: issuance and initial placement, trading on the secondary market, redemption through a collection of 100% of the shards or a buyback clause.
A collection may be owned by either a single collector or several collectors who combined their NFTs into one collection in exchange for a share of its shards. The limitation of this arrangement is that the makeup of the collection that backs the shards is determined by its issuer. A collection’s shards are a stake in the collection, the composition of which you cannot alter. This is overcome by collecting shards.
Shard Collection
You can assemble a collection of shards of individual NFT and thus obtain a share in a collection whose makeup you choose yourself.
Non-custodial portfolio-management solutions such as TokenSets can be used to create an ERC-20 token backed by a basket of shards. This basket can be immutable in composition as well as rebalancable. A smart contract can manage the shard portfolio behind it 24/7: by a strategy set by an algorithm (robо-sets), or by the strategy of a chosen portfolio manager (публичные трейдерские сеты). You can redeem this basket token at any time for the basket of shards that backs it. WHALE tokens, positioned as backed by an NFT collection, do not do this.
Another option for managing a shard portfolio is the Balancer pool. First you decide which shards and in what proportion will enter your pool. For example, this could be a thematic pool: a pool of shards of digital land from different virtual worlds, a pool of shards of crypto-punks, a pool of shards of NFTs linked to Axie Infinity, etc. Then you launch the pool, adding liquidity in the form of the corresponding shard portfolio, and you receive pool tokens that can be redeemed at any time for these shards. You also allow arbitrageurs to rebalance your portfolio and pay you a fee for doing so.
A standard market index can be assembled by purchasing the assets that comprise the index in the appropriate proportion. The index of unique and indivisible NFTs can be assembled from shards and packaged into an ERC-20 token. TokenSets and Balancer enable various configurations of such an index basket.
The risk of owning a shard collection and the collection backing it is that the NFTs backing them may be bought out via a buyout, after which these shards will be backed not by NFTs but by ETH paid in the buyout. This can be avoided if tokenising the NFT collection is not done through shards but through DAO governing tokens.
DAO of Collectors
A DAO for collective ownership and management of an NFT collection may look like this.
The DAO issues and sells governance tokens, which simultaneously confer rights to a share of its future collection. The funds raised by the DAO are used to purchase NFTs chosen by the holders of the governance tokens. If the DAO successfully manages its collection by buying and selling NFTs, as well as renting them out, the value of the assets under its management, and thus the value per governance token, increases.
You can redeem a governance token for some NFT from the DAO’s collection only in two cases: if the DAO decides to sell something from its collection at auction, or in the event of the DAO’s dissolution. If that redemption model seems strange to you, recall that the redemption of the DAI stablecoin also works: either through a collateral auction or through the MakerDAO emergency shutdown. If the idea of a Collectors’ DAO seems odd to you, meet Flamingo and ARK Gallery.
We have explored three models of fractional ownership of an NFT collection. If more collections tokenized in various ways emerge, there may be collectors of collection shares, however surreal that sounds. The concept of a collection is limited only by the imagination of the collector.
The ability to purchase the smallest share of an expensive NFT or an entire collection of expensive NFTs democratises access to collecting top-tier NFTs, but you do not necessarily have to buy NFTs. They can be farmed. Experiments at the intersection of NFTs and farming constitute another area where NFT and decentralized finance intersect.
NFTs and the Almighty Farming
Farming models using NFTs can be divided into two categories: “ERC-20 for NFT” and “NFT for ERC-20”.
ERC-20 for NFT
The first NFT staking was proposed in the game ChainGuardians in 2019: players stake special NFTs and every 20 minutes one of them, like a miner, earns a fixed reward in the game’s currency CGC.
WHALE tokens reward NFT creators who list their NFTs exclusively for WHALE.
Первичная дистрибуция токена MEGA, currency and governance token of MegaCryptoPolis, occurs in two ways: 10% are placed in AMM pools in MEGA/ETH and MEGA/TRX, and 90% in AMM pools where MEGA is exchanged for various game assets. If in farming the initial distribution of governance tokens occurs by rewarding for using the application, here it is through AMM pools in exchange for tokenized gaming assets.
NFT for ERC-20
The most successful NFT farming case is Meme, which rewards liquidity providers with MEME tokens and those who simply stake MEME with exclusive NFTs. More precisely, they receive daily from one to five points, “pineapples”, which can be exchanged for limited NFTs at a fixed price.
The Meme farming model can be used to reward liquidity providers of any token and in fact any user of any DeFi application. Meme has shown that to attract users you do not need to reward them with governance tokens — you can distribute NFTs to them.
Gamification through NFTs can help overcome apathy among DAO governance-token holders and its community, becoming an additional incentive to actively participate in the life of the DAO. Even if the DAO ceases to function, such NFTs may retain value as collectibles.
Coingecko, CoinMarketCap and Binance are not DeFi projects and not DAOs, but they too are experimenting with NFTs as a means of boosting brand loyalty. Members of the Bankless and WhalePunks communities are rewarded for their contributions with membership NFT badges.
NFT marketplace Cargo directly соединяет staking of its governance token Cargo Gem with NFT: the stake is tied to a specific NFT, and the staking reward goes to the current owner of that NFT. Thus selling such an NFT is simultaneously selling the Cargo Gem stake.
In the Aavegotchi project, the NFT is also tied to income – a deposit in Aave. In addition, the Aavegotchi team разработала a model of “rarity farming” for NFTs, through which you can increase the rarity of your Aavegotchi character. This is a markedly different form of farming. The user receives their own Aavegotchi only while their deposit remains in Aave. When the user decides to withdraw the deposit, they do not take with it any rewards they earned. On the contrary, they are penalised by the destruction of their Aavegotchi, no matter how rare it is.
The Aavegotchi project is also notable in the context of NFT regulation, for which there is as yet no answer.
NFT Regulation
In the white paper of Aavegotchi there is a long provision in a strict and dull legal style describing GHST, the game’s currency and the AavegotchiDAO governance token. Previously such a provision could be found only in a Terms of Service contract, which no one reads, and now we read it in the white paper:
“The purpose of GHST is to provide a convenient and reliable means of payment and settlement among participants who interact within the Aavegotchi ecosystem, which is not, and is not intended to be, a medium of exchange accepted by the public (or part of the public) as payment for goods or services or for the repayment of debt; it is also not created, and it is not intended to be used by anyone as payment for any goods or services that are not provided exclusively by the issuer.”
This clause justifies that GHST is not a Type 3 virtual currency under the ECB’s classification, with which we began this cycle. Such caution from the Aavegotchi team is understandable: 2020 was not 2010, authorities have long understood that virtual currencies are more than a toy for a nerdy crowd, and crypto projects have to live with this reality.
The ECB’s first report classifying virtual currencies appeared in 2012, three years after Bitcoin’s emergence. The rules governing the production and circulation of various NFT categories are still absent, but the Bitcoin story teaches that they may come one day. One day authorities may realise that freely tradable digital objects from virtual worlds, including Aave deposit certificates wrapped in Aavegotchi characters, and shards backed by these digital objects, including Aavegotchi shards, are not toys but a new class of virtual assets.
Until authorities decide to which asset class such virtual goods as digital land and real estate, or gaming items and characters, belong, regulating the frontier of financial thought embodied by Aavegotchi and its shards will be impossible.
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