It has recently come to the crypto community’s attention that a large NFT The lending/borrowing app is about to start liquidating 20 Bored Ape Yacht Club (BAYC) NFTs worth about $59 million. This event could signal the beginning of a major collapse in NFT valuations, not just for BAYC, but for the entire NFT industry.
NFTs, or non-fungible tokens, can be used as collateral to borrow fungible assets such as cryptocurrencies. However, lending/borrowing services for NFTs are very different from Decentralized Finance (DeFi) lending/borrowing systems such as those developed by MakerDAO and Aave. DeFi systems can operate autonomously through blockchain smart contracts and code, but cannot be used for NFTs due to their non-fungible nature, which must instead be sold via auction mechanisms that require time, willing buyers, and “floor price” valuations. Platforms like BendDAO and others have created various systems to facilitate this service. In BendDAO’s case, lenders deposit ETH (Ethereum’s native cryptocurrency, ether), and receive an interest rate taken from the borrowers who deposit their BAYC NFTs as collateral . the value of their NFT falls too low compared to what they borrowed, then it is sold at auction (“liquidated“) to get back the amount of ETH they borrowed and repay the lenders.
As Crypto Briefing reported, BendDAO is currently on the brink of a severe liquidity crisis that could threaten to collapse the entire NFT market. The crypto community’s fears escalated when it became known that 20 BAYC NFTs valued at $59M are now on the brink of mass liquidation, triggering a bank run by the protocol’s lenders. The bank run drained all the ETH inside the smart contract, with many thousands of ETH still owed to the defaulting lenders. The only way to recover this ETH is to start liquidating the BAYC NFTs, which will push the floor price of BAYC lower with each liquidation, thus triggering more liquidations across BendDAO and other platforms, likely creating a self-fulfilling cycle of destruction.
There is not enough money to buy them all
BendDAO has now issued a governance proposal to its DAO community governance unit to change the terms of the loan/lending model terms for the future, and some of the terms may help to mitigate or avert the collapse. BendDAO uses a similar method to DeFi lending/borrowing protocols which involves referencing an external price to determine when a borrower’s position should be liquidated, but this is problematic due to the way NFTs are valued. Unlike cryptocurrencies, NFTs are valued according to their lowest listing price (“floor price“), not of their actual selling prices, and this discrepancy blinds sellers to the reality of what their NFTs are actually worth to buyers.
This method of NFT valuation and liquidation also assumes that there is enough money interested in buying the NFTs, but as CoinTelegraph points out, NFTs marketplace and coinage service OpenSea’s trading volume data says there is not enough money to buy the NFTs at their current market value. If there aren’t enough people willing to spend the 1,360 ETH (worth over $2,040,000) collected on the 20 BAYC NFTs that are about to go into liquidation, each one will have to be sold for far below the collection’s current floor price at 68 ETH (roughly $102,000 per NFT), which is already down 55% from its 2021 peak. This situation will push the market down much faster, and will almost certainly result in a “death spiral” for the BAYC NFT collection, which could send NFT prices crashing across the market in a wave of extreme fear.
It is hoped that wealthy buyers will suddenly come out of the woodwork to scoop up BAYC NFTs for just below the floor price to prevent a collapse, but this seems highly unlikely. Without interested buyers willing to buy dozens of NFTs for below market value, each one would have to be listed at lower prices to attract more buyers, pushing the floor price lower, triggering more liquidations and potentially resulting in a death spiral for the entire NFT market.
Sources: Crypto Briefing, CoinTelegraph, BendDAO
