Understanding NFT Futures: A New DeFi Primitive for Cultural Assets

Overview:

Futures trading, or “perps,” dominate: At the time of writing, cryptocurrency futures trading dominates, accounting for more than 60% of total trading volume compared to spot trading. This phenomenon is not unique to cryptocurrencies but is also true in traditional financial markets.

NFT 1.0 was dominated by spot trading: Initially, NFT trading was driven by spot transactions, generating a huge volume of over $20 billion. However, this led to inefficiencies: only long positions were allowed, and small to medium collectors had limited or no access to high-value collectibles.

The NFT community is culturally driven: NFT collections successfully bring together users with shared interests, ideas, and values, creating social structures shared by people around the world. These cultural elements are reinforced in virtual or real-world events globally, much like other communities (such as anime) have done over the decades.

NFT futures could address current inefficiencies in spot NFT trading: NFT perpetual futures (“NFT Perps”) solve the inefficiency issues of spot NFT trading. They allow almost any size of trades, long and short positions, as well as leveraged trading.

Spot trading will remain significant but will transform: We expect that spot trading and collecting will continue to be important, especially for accessing utilities related to NFTs and for community and digital identity layers. Collectors seeking NFT utility and community involvement might purchase them on the spot market. Meanwhile, the futures market could be used by other types of participants and collectors seeking to hedge or pursue different trading strategies.

Market Dominance by Futures

For a long time in early cryptocurrency history, only spot trading was available, where users exchanged fiat currencies, other cryptocurrencies, or stablecoins for any other tokens. This brought several inefficiencies:

• Long-only: With spot, users could only go long (profit if the price rises), hindering market participants from hedging losses or profiting from price declines.
• Limited Leverage: Relying only on spot trading, investors had limited leverage. Although it was possible to establish short positions by borrowing assets and then selling them in hopes of acquiring them at a lower price, this method was capital inefficient (requiring collateral) and could be difficult or costly for tokens with poor liquidity (high borrowing rates).

However, everything changed with the launch of the perpetual futures market (“Perps”) by BitMEX and the introduction of the first BTC futures by the Chicago Mercantile Exchange (CME) in December 2017: Perpetual futures began to dominate. As of this writing, perpetual futures have consistently dominated cryptocurrency trading activities. For BTC and ETH, spot trading volumes are only a small fraction of the perpetual futures market: BTC accounts for 20%-70%, and ETH for 16%-44%.

Source: The Block

NFT Market: History Repeating Itself

2021 marked the beginning of an NFT bull market. During this period, NFT technology began to gain attention and adoption worldwide. NFTs were used not only for creating art and photography but also served as credentials for entering communities and became a key part of our digital identities as profile pictures, among many other uses.

All these use cases helped push the Web3 domain into the spotlight: attracting a massive influx of users, builders, collectors, as well as speculators and traders. A significant amount of capital flowed into the NFT ecosystem; according to Dune Analytics and DappRadar, the total on-chain NFT trading volume in 2021 exceeded $21 billion (a 20,000% annual growth rate), and in 2022, $24.7 billion (17% annual growth rate). This growth was driven by multiple factors, including the launches of popular NFT projects like Otherside, Metaverse, Azukis, and Moonbirds.

Source: Dune

Despite the massive inflow of funds, the non-fungible nature of NFTs and the then-scarce infrastructure allowed only individual NFT spot trading. This created friction and prevented collectors from easily entering or exiting positions. Collectors had to wait for someone to accept their listed price or match the current asking price. Moreover, as the value of the collectibles rose, it reduced the opportunity for small investors to acquire high-value collectibles. Furthermore, like the fungible token market in 2017, it allowed only long positions.

During the bear market of 2022-2023, the NFT ecosystem saw many innovations and new participants, including Blur (with its incentivized bidding pool and lending feature Blend) and NFT AMM (like Sudoswap). These platforms are working to create seamless trading experiences and enhance liquidity. However, as we will see later, these models still do not facilitate seamless short positions nor solve capital efficiency issues.

It’s important to note that this doesn’t mean NFT AMM or lending lacks a strong value proposition. In our view, NFT AMMs are perfectly capable of helping collectors establish and incentivize community-owned trading places, creating an economic cycle that benefits the entire collector ecosystem: trading fees go back to collectors, creating value for holders and managing relationships with them.

History doesn’t repeat itself, but it often rhymes: NFT 2.0

NFT perpetual futures (NFT Perps) are a new type of derivative that allows investors to trade NFTs with improved liquidity. NFT perpetual futures are similar to traditional cryptocurrency perpetual futures, except their prices track NFT collectibles. NFT perpetual futures offer several advantages to the traditional NFT spot market, enhancing the trading experience:

• Quick Access: NFT futures allow investors to immediately enter and exit positions without needing to purchase the underlying asset or list NFTs on NFT marketplaces, aggregators, or NFT AMMs. This is beneficial as it reduces the effort required to store or transfer NFTs.
• Hedging Opportunities and Long/Short Market: To date, NFT investors could only “go long” on the NFT market. By using NFT perpetual futures, investors can establish “market-neutral” positions by going short on perpetual contracts while still reaping the utility, community, and other benefits NFTs offer. Additionally, it allows them to profit from negative catalysts affecting collectibles.
• Leverage: To date, NFT investors can only use leverage by borrowing NFTs on NFT lending platforms (like Arcade or Paraspace). However, besides generating friction (users must deploy the borrowed funds into other trading activities), NFT lending can be capital inefficient in some cases, as it requires full NFT assets in inventory to obtain leverage.
• Scalable Sizes: NFT perpetual futures allow users to obtain the desired NFT collectibles at any scale because they do not need to acquire a specific NFT and pay its asking price. In this way, users can trade 100 ETH worth of BAYC or 0.1 ETH worth of BAYC. This allows smallholders to obtain positions in NFT collectibles that they would not be able to if they were trading live. Additionally, it allows institutions and large collectors to trade at a larger scale without affecting prices by sweeping the floor.
• Attracting New Users: The aforementioned small-scale availability might attract more retail collectors and traders to the space, who can then be brought into the broader blockchain ecosystem.

As mentioned before, the “bear market” of 2023 brought innovations to the NFT domain, and some might think that other vertical industries and participants can solve the above issues. Let’s delve deeper:

• On-Chain NFT Options: They address the possibility of hedging, target NFT market risks, and offer contracts of varying sizes. However, options are a more complex product than perpetual contracts, which are well-known due to their popularity in centralized venues. Additionally, different strike prices or expiry dates may lack liquidity, thereby creating friction.
• Fractionalized NFTs: Fractionalizing NFTs lowers the entry barrier for high-value collectibles and allows them to be traded at any size. However, fractionalizing has the following pitfalls:
• Capital Inefficiency: The fractionalizing process requires users to purchase an NFT and then lock it in a contract to initiate the fractionalizing process, making it capital inefficient.
• Substitutability Limitations: A fraction of one NFT is not equivalent to a fraction of another NFT, even if they come from the same collection.
• Limited Liquidity and Scale: As previously mentioned, establishing liquid trading pools interested in a specific NFT may be challenging.
• Governance and Redemption Issues: NFT redemption may encounter friction because it requires consensus among holders.
• NFT AMM: NFT Automated Market Makers (AMMs) solve the issue of liquidity incentives, creating a more liquid market and supporting trading of NFT collectibles of any size. However, they still suffer from capital inefficiency because they require NFTs to be deposited into pools. Additionally, NFT AMMs do not allow shorting.

NFT Perpetual Protocols

Nftperp: The Pioneer

Year Established: 2022 | Phase: Private Alpha | Funds Raised: $4.7 million

Nftperp is a pioneer in the NFT perpetual protocol vertical. The platform offers a seamless trading experience, integrated into a simple and thoughtfully designed user interface. At the time of writing, the protocol is currently launching v2, allowing users to trade collectibles such as Miladies and Pudgy Penguins, all while reducing Gas costs by running the DApp on Arbitrum.

According to nftperp’s Dune dashboard, the protocol’s trading volume in v1 exceeded $8.3 million, covering over 800 traders (whitelisted users).

Source: Dune

Tribe3: Gamified and Social Trading

Year Established: 2022 | Phase: v2 Testnet | Funds Raised: $2.1 million

Tribe3 is an NFT futures DEX that integrates social and gamification elements into the trading platform. In addition to NFT futures trading, users can engage in battles with others (community vs. community trading) and earn in-game items based on their trading behaviour. The platform allows users to trade multiple NFT series with up to 5x leverage.

The platform completed its v1 public test, with a trading volume of $71 million and over 840 active traders. At the time of writing, the platform is testing an updated protocol design on the v2 testnet.

Wasabi: A Comprehensive and Exciting NFT Derivatives Platform

Year Established: N/A | Phase: Public | Funds Raised: N/A

Wasabi has built a full suite of derivatives for NFTs. The protocol initially offered bearish and bullish options for specific NFT series, allowing users to go long or short before a specific date without the risk of liquidation.

To expand its product range, Wasabi launched:

• BNPL: Wasabi collaborated with different NFT lending protocols to allow users to “buy now, pay later” for seamless NFT purchases.
• Perpetual Contracts: Recently, Wasabi partnered with Flooring Protocol to launch an index-based perpetual contract product, allowing users to trade any whitelisted NFT collection with up to 5x leverage.

According to Wasabi’s Dune dashboard, the protocol’s options products traded a notional value of $6.1 million, with liquidity providers earning $300,000 in fees.

Source: Dune

The trading volume for perpetual futures products has reached over $40 million, with approximately 470 active traders.

Source: Dune

Conclusion

NFT futures apply the concept of perpetual trading to NFTs, unlocking an easier-to-access and bidirectional trading experience that was previously unavailable in the NFT spot market. While it is still too early to conclude, the potential value proposition offered by NFT futures has strong growth potential in the NFT market.

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