Just as people are starting to understand DeFi lending, the crypto world is witnessing the boom of yet another crypto lending alternative. Unlike DeFi lending, through which people can lend or stake their cryptocurrencies, investors can now stake their NFTs for incentives.
But what exactly does NFT staking mean? How does it work? And how is it any different than NFT renting? To begin with, let’s break down how to define NFT staking.
What Is NFT Staking?
Just as the name implies, NFT staking refers to the process in which an investor locks up their non-fungible token(s) (typically known as NFT) on a dedicated platform in return for staking incentives and other unique benefits.
NFT staking operates similarly to DeFi staking, except that NFTs are staked in place of cryptocurrencies. Aside from that, NFT stakers can enjoy passive income yield while still maintaining full ownership of their assets.
Considering that NFT staking is fundamentally the same as DeFi staking, it also employs the same yield farming concept utilized across most DeFi lending protocols.
When an investor locks up an NFT on a given protocol, they can expect incentives based on the annual percentage yield (APY), alongside other determining factors, including staking duration and the unit or quantity of the NFT being staked at a time. That said, what problem is NFT staking trying to resolve?
Understanding the Need for NFT Staking
For as long as NFTs have existed, they have faced the inherent major illiquidity problem. This can be attributed to many factors, including that most NFTs do not have intrinsic value, making it difficult to attribute a specific market value to them.
As a result, after acquiring an NFT, most investors are left with few options, and the most attractive of these is often to sell immediately while demand is still high, lest the need for it run out, and its value take a dramatic dip. The nature of the niche market leads to many investors finding it difficult to invest in NFT projects that are not highly unique.
NFT staking solutions were introduced to tackle this issue, bridging the gap between owning NFTs and preventing illiquidity. Through such NFT staking protocols, investors can stake their NFTs and earn passive income while maintaining ownership of their staked assets.
While this particular approach is still relatively new, not all NFT staking protocols have yet figured out the perfect solution. The critical obstacle remains in determining the value of an NFT because ownership is frequently attributed to a single person, which is partly to blame for its illiquid nature.
Some staking protocols are coming up with advanced solutions, including attaching a randomly generated hash power to each NFT when it’s minted, thereby ensuring that the yield rate is set in stone as soon as an NFT has been created.
Another way to address NFT illiquidity has been to offer fractionalized ownership of NFT items, which is to say, bringing together a group of people to buy a single NFT, similar to buying shares in a stock. This way, NFTs can be seen as more liquid, as more than one person determines their value. So from here, how do NFT staking and renting differ?
What Is the Difference Between NFT Staking and Renting?
Staking and renting are two distinct words grammatically, with the former implying ‘support’ and the latter defined as ‘borrowing.’ However, in terms of crypto, these two terms are used interchangeably.
Essentially, the underlying concept for NFT staking and renting is the same; even when used differently across most protocols, they ultimately aim to achieve the same result. So how does NFT staking work?
How Does NFT Staking Work?
To understand how NFT staking works, it is essential first to have a basic knowledge of how DeFi staking works in a general sense. DeFi staking can be defined in two primary contexts, the first of which is locking up crypto assets in an attempt to become a validator in a Layer-1 blockchain or a DeFi protocol.
Alternatively, the second, and the more relevant one for this article, is the process of locking crypto assets in a smart-contract-driven, automated DeFi protocol with the ultimate aim of earning incentives at the end of an allotted period.
The second situation, as described above, is often described as ‘yield farming’ whereby investors move crypto assets between multiple DeFi staking platforms to maximize their returns.
Technically, it’s akin to lending out assets, earning APY and other privileges as determined in the smart contract, before regaining possession of the locked goods at the end of the period.
Notably, the DeFi protocol combines the consensus ability of the Proof of Stake (PoS) mechanism and the automation of smart contracts to ensure that investors are rewarded accordingly.
It is also important to note that DeFi staking can involve either the locking of fungible (cryptocurrencies) or non-fungible tokens (NFTs). Hence, the underlying process of staking asset classes is practically the same.
For instance, as in yield farming, NFT staking also relies on a Proof of Stake (POS) mechanism to reward participants (i.e., stakers). Similarly, to stake an NFT, an investor must first have a cryptocurrency wallet compatible with the NFT token standard – think ERC-721 or something similar. That said, when is NFT staking applicable?
When Is NFT Staking Applicable?
As mentioned earlier, NFT staking tries to resolve the problem of illiquidity across different markets or platforms where NFTs are in demand. Ultimately, NFT staking creates a market in which NFT owners can sort of “mortgage” their NFTs in return for incentives.
Regarding DeFi, investors can stake their NFT as collateral to access crypto loans. For instance, by staking an asset from a popular NFT collection like ‘CryptoPunks’ an investor can get their preferred choice of cryptocurrency in return, albeit based on an agreed loan-to-value (LTV) ratio that’s often determined by the borrower, or protocol as the case may be.
For instance, let’s say a borrower is offering an 80% LTV rate for loans – if someone were to stake a CryptoPunk worth $500,000, the loan disbursement would be $400,000 for the collateralized asset. LTVs vary across the board depending on the individual and staking platform, so this is important to keep in mind.
NFT staking is also applicable in the gaming industry. It can enable gamers to pay a low fee to access in-game NFT items, such as weapons or unique artifacts required to unlock the badge they’ve always wanted.
Often the cost of buying these items can be very high and considering that they may only be necessary for one stage of the game, it is ideal to be able to rent them for a fraction of their actual value. In this case, the IQ Protocol is a prominent example; it’s a concept dubbed ‘NFT renting’ that allows gamers to stake their assets to rent in-game items.
Another approach to NFT staking is seen in crypto kitties, which can be loaned out in return for unlocking rare features and breeds. Essentially, by leveraging the NFT renting process, players and breeders can gain temporary access to the desired cryptokitty and proceed to breed their NFT-based cat.
In this case, NFT owners enjoy new and passive revenue streams, while borrowers, on the other side of the process, can unlock new properties, use cases, and more.
While NFT staking is still in its infancy and has yet to be fully optimized, it functions as a primary gateway between NFTs and the broader DeFi economy. More importantly, by ensuring that NFTs remain liquidatable, NFT staking will continue to find its place in the DeFi market, at least as long as NFTs stay in the equation.
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