No, it was already Bent…
Let’s talk about an imaginary NFT liquidity protocol called “Bent” (nope, we’re not pointing any fingers here). One day, Twitter learns what an NFT death spiral is, and how underdeveloped the NFT financialization market currently is. The discussion really starts to gain attention as a few BAYC NFTs are waiting to be liquidated via Bent’s liquidation auction system — what happened was that the floor price dropped and the borrowers’ LTVs decreased. Sounds like a pretty standard scenario, right?
Not really. The problem here is that many people and protocols were pretending that what is working for liquid assets would work for illiquid assets too. There’s a reason why you can’t sell a car using the New York Stock Exchange — it might sound like a good idea, but unfortunately, your grandma’s 1984 Lincoln Town Car is not a liquid asset. For roughly the same reason, forking AAVE for NFT liquidity is not going to work long-term.
After the market saw the panic caused by LTV-triggered liquidations, it swore it would forever remember the golden rule of NFT liquidity: the desire to sell does not always lead to a sale.
A Small Confession
Prior to the recent bear market drop, the Sodium team was also developing a similar mechanic where NFT value could be unlocked via Pool Liquidity. Originally, Sodium was using a neural network-driven price estimation system (aptly named the “Fair Price Engine”), to accurately estimate the market value of every individual NFT in a given collection, resulting in a more precise LTV ratio.
Development was going quite well, yet we realized that a pure pool mechanic would eventually lead to bad debt, liquidation cascades, and possibly, even a bank run. Although our Fair Price Engine consistently achieved an industry-leading 7% WAPE over weeks of testing, we couldn’t help but think, “Isn’t there a better option?”. We paused further work on the FPE, and went back to the drawing board, re-thinking and rebuilding our platform’s most important mechanic…
NFT Liquidity 2.0
Sodium doesn’t pretend to control risk for Lenders — it’s simply not gonna work. Instead, Lenders will be able to invest according to their own risk profile. They’ll know how long a loan is supposed to last, and therefore can do a proper risk evaluation according to market conditions. Sodium allows Lenders to participate in a Loan Request at a certain collateral valuation without contributing the whole amount, e.g. the lender can increase a collateral’s valuation by contributing additional funds on top of previous Lenders’ offers, therefore earning higher interest.
If a loan is not repaid by the end of the loan term, liquidation will be triggered. If the Lenders’ provided liquidity matches the market’s evaluation of the collateral, auction participants will repay the outstanding debt by bidding above the valuation at which the loan was provided. If no bid was placed during the Liquidation Auction period, the collateral will be transferred to the first Lender in the Lending Queue, as the liquidity they provided acts as a bid by default.
Too complicated? Don’t worry, we gotchu.
Imagine thinking an NFT you see being used as collateral will be worth 10+ ETH in 30 days. As a Lender, you can contribute 1 ETH (9 ETH was already offered to the Borrower before you came along) to earn interest, and you’ll potentially have an opportunity to flip the NFT. In 30 days, if the Borrower has defaulted, you’ll be able to pay the 9 ETH owed to other Lenders and claim the collateral (unless somebody is willing to pay more than 10 ETH, which settles your debt as well).
In case you don’t want to add the extra 9 ETH, but your valuation of the collateral was accurate, someone else can still pay 10+ ETH to take this NFT off the market, and you as a lender will be fully repaid.
What if you realize your valuation was too high and you don’t want the NFT? Most importantly, what happens if nobody else wants to buy it at a price higher than what you valued it at? Well, we cannot force anyone to buy it (sadly) and Lenders who participate at high-risk levels might lose some of their money. But it won’t lead to a death spiral, simply because liquidations are not triggered by price movement.
What’s Next?
Peer markets, lending pools, custom lending markets, hybrid liquidity — this, and more, all on Sodium. Easy now! Giving you all those details would be too much fun for one single post. We promise you, you will hear more pretty soon, degen.
We’re not happy about what has happened recently in the NFT liquidity space, as it doesn’t only hurt one player, but hurts the industry as a whole. Yet, we know that this moment of crisis will soon pass, NFT Twitter will move on, and players both old and new will be able to get back to buidling.
Speaking of new players, Sodium is going to change the NFT financialization game — keep your eyes on our Twitter page for further announcements, as our launch date will be announced soon!
