JPEG'd: An NFT DeFi Primitive
NFTs have gained significant value and have transformed from simply digital art into self-sustaining ecosystems with built-in token emissions, airdrops, and other revenue generating mechanisms. Much of their value, however, remains locked and users must sell their NFTs to realize their value. JPEG’d has developed a novel DeFi primitive, non-fungible debt position (NFDP), that unlocks this value. NFDPs enable users to deposit their NFTs into JPEG’d as collateral and take out a loan for a portion of its total value. These collateralized debt positions are trustless and permissionless, and give users access to their NFT’s value using their NFTs as capital collateral.
The total value of the NFT market eclipsed $40B in 2021, with popular collections such as CryptoPunks and Bored Ape Yacht Club now valued at well over $1B. As NFTs continue to evolve into something beyond just pieces of static art and begin to embody more functionality and utility, there needs a way for owners to access these layers of capital. Otherwise, the value becomes locked within the NFT and owners must sell the NFT in order to deploy it. In some ways, this situation is analogous to the earlier days of Ethereum, prior to the advent of DeFi. Token holders had limited ways of accessing the value of their tokens other than selling them on the secondary market. DeFi introduced many different ways for users to gain liquidity and deploy their otherwise locked capital, such as collateralized lending, leveraged yield farming, and self-repaying loan protocols. As new Defi primitives emerged, users were given more ways of accessing liquidity and realizing more efficient capital allocation.
JPEG’d has developed a new DeFi primitive in the space that enables NFT owners to utilize their NFTs as collateral. The primitive, non-fungible debt position (NFDP), operates similarly to traditional collateralized debt protocols in DeFi, but with a few additional features specific to NFTs. Part of its functionality relies on a given collection’s liquidity and market capitalization. To that end, only select collections will be added to the protocol. Minimizing volatility, leveraging high price floors, and focusing on well-established collections helps JPEG’d minimize their potential for bad debt exposure and preserve sufficient internal collateral. Over time, DAO governance can vote to whitelist new projects into the protocol.
Overall the process for using a JPEG’d NFDP is quite simple. Users can deposit their whitelisted NFT into a JPEG’d smart contract as collateral and begin to borrow against it. Once this NFDP is opened, JPEG’d mints a synthetic stablecoin, $PUSd, commensurate to the loan amount, and then sends the $PUSd to the user. The user can then deploy their stablecoin loan to other opportunities while their NFT remains locked on the JPEG’d platform. This effectively transforms NFTs from static pieces of art into yield-earning products. Once the user is finished using their loan they repay the principal along with the interest accumulated and can retrieve their NFT from the JPEG’d vault.
In order to bootstrap liquidity, the JPEG’d DAO initially acts as the primary liquidity provider. The protocol employs various mechanisms to incentivize the broader community to provide additional liquidity. This is especially important for maintaining $PSUd’s peg 1:1 with USD and enables users to easily convert $PUSd to other stablecoins with as little slippage as possible. It’s also critical as more NFT collections are whitelisted and approved as collateral. Each time a new collection is approved, the number of potential market participants increases. Depending upon the total number of users and the aggregate value of the collection, this potential could be quite large. So JPEG’d must ensure that there is indeed sufficient liquidity to meet these demands
The Interest rate for loans is generally around 2% APY and is dynamically adjusted over time to remain competitive. Users also pay a 0.5% withdrawal fee. Both of these fee structures help to power the treasury and incentivize continued liquidity provision. Interest accrues as long as the user has an open debt position, and full repayment is required in order for the user to retrieve their NFT from the JPEG’d vault.
Users are permitted to take out a debt position as large as 32% of the collateral value. They can also increase their borrowing limits by depositing and locking $JPEG tokens for 1 year. This helps keep upward pressure on the value of the $JPEG token and creates a sink on circulating supply. As the value of the NFT market continues to grow, demand for $JPEG tokens can scale with it under this model. A user’s position is liquidated if the debt to equity ratio is 33% or higher. In general, governance can adjust these parameters to fit the goals of the community. Once an NFT reaches or exceeds 33% of its loan-to-value ratio, the DAO can choose to liquidate it. This can be done in a few different ways. The DAO can choose to hold the NFT within the treasury or sell it on the secondary market or OTC. JPEG’d is integrating permissioned liquidation in which entities are whitelisted by the DAO to conduct liquidations and mitigated the protocol’s risk of undercollateralization. This also allows the protocol to scale as more collections and more users join the network. Liquidators are incentivized to offer their services through the provision of liquidation fees; they will earn half of the total liquidation fee.
JPEG’d also has a novel insurance mechanism in which users can pay a non-refundable 1% fee on the loan they draw. In the event that they are liquidated, they can retrieve their NFT back from the DAO by repaying their outstanding debt along with any accrued interest and along with a 25% liquidation penalty. Users also have the option to deposit their NFTs into liquidation free vaults, in which they can earn a return on their NFTs without any risk of liquidation. The yields earned are lower than the returns earned through participating in the vaults subject to liquidation.
Finally, in order to accurately monitor different NFTs in real-time JPEG’d has incorporated Chainlink Oracles. These enable the protocol to effectively monitor existing debt positions, determine the maximum size of loans, and proactively liquidate under-collateralized positions.
Mechanism Design and Tokenomics
$JPEG is the native utility and governance token of JPEG’d with a total supply of 69,420,000,000. Token holders can participate in governance by submitting and voting on proposals. Governance is primarily limited to modifying the different parameters of the protocol, such as changing debt limits on vaults, interest fees, or approving increased credit limits for certain NFTs.
$JPEG was originally developed as an intentionally valueless governance token that is used to vote on proposals. Users can change a variety of the protocol’s parameters including interest rates and liquidation fees. The token can also be used to increase the credit limit of selected NFTs approved by governance by locking it into a smart contract.
The JPEG’d protocol earns fees from deposits, interest, liquidations, arbitrage on liquidity pools involving $PUSd, as well as earnings from assets held in the treasury. Thus, as more loans are issued, the more fees the protocol will earn. So it is in the protocol’s best interest to continue whitelisting the most popular NFT collections and facilitate more user activity.
$PUSd is a synthetic stable coin, native to the protocol. Each time a user sends their NFT to a JPEG’d vault and initiates an NFDP, they receive their loan amount denominated in $PSUd. This enables seamless disbursements of loans and gives the protocol more direct control over how it services and settles debts. This stablecoin is designed to be pegged 1:1 with USD and JPEG’d has several mechanism in place to help ensure that it does, such as liquidity bootstrapping initiatives and partnerships with other protocols, such as Abracadabra and Tokemak, to develop Factory Pools on Curve. This allows users to take out their loan in $PSUd and then swap it for other stablecoins like $MIM, $USDC, or $USDT. Users can also earn liquidity provider rewards by adding liquidity to this Curve pool.
JPEG’d token allocation is directed towards the protocol team, its advisors, the DAO, and a public donation event. So the total distribution will be:
1. Team: 20,826,000,000
2. Advisors: 3,471,000,000
3. DAO: 24,297,000,000
4. Donation Event: 20,826,000,000
Team and advisor allocations are vested 2 years linearly with a 6 month cliff, while donation allocations are unlocked immediately. Overall, the JPEG’d team, advisors, and the DAO will be in control of 70% of the token supply, while remaining 30% of supply is was allocated to the public donation event. Currently, there are 20,826,000,000 tokens in circulation, which are from the donation event.
$JPEG currently has a market cap of approximately $92M with $4.5M in recent daily trading volume, and Fully Diluted Valuation of $315M.
One general concern with $JPEG is that it is tied almost entirely to governance without much of a utility function. The token’s pricing power could be improved by directing a portion of protocol fees to token holders. More novel approaches such as fractionalized NFT ownership of liquidated JPEGs could provide long-term upward pressure on price, as secondary market speculators would keep a close eye on JPEG’d vaults in the hopes of getting a piece of a valuable collection.
Another concern is that many NFT projects are illiquid and have significant volatility. Onboarding new projects over time will be critical to the protocol and while the very top tier projects are relatively easy to identify and integrate into the protocol, others might be more challenging. One obvious risk is that whitelisting the wrong project could prove to be disastrous. Users could potentially use an NFT as collateral that has a large value at the time of deposit, but if that value significantly decreases, then JPEG’d is left with collateral that is much less valuable than the capital they lent out for it.
Maintaining a 1:1 peg between $PUSd and USD will also be vital to the long-term success of protocol. If users take out a loan in $PUSd, but cannot convert it to another stablecoin without incurring significant slippage, then it inherently limits their borrowing power and dilutes the true market value of their NFT. So users need to be able to move between different $PUSd positions without experiencing issues of illiquidity and slippage. One way to help preserve this peg is for JPEG’d to burn a portion of the $PSUd after a repayment. This will help keep inflationary pressure down.
Another challenge is related to $PSUd’s ability to scale liquidity. Typically when a protocol utilizes a synthetic stablecoin that is native to their project, they need to bootstrap sufficient liquidity to enable users to easily convert between other stablecoins. Anytime a new collection is whitelisted, an entirely new cohort of participants will enter the market for NFDPs. JPEG’d will need to be able to scale with this demand. In order to do so, proper incentives must be provisioned to get users to continuously provide liquidity, otherwise these efforts will fall solely on JPEG’d governance and treasury.
Determining proper valuation for each NFT collection will also be essential, as this is directly tied to the inherent risks associated of lending. Limiting collections to an outright floor price might be an effective short-term approach and limits risk exposure. But overall it is not the most efficient approach, as some specific NFTs will be inherently more valuable than others from the same collection. So discerning fair-market value is important for the long-term success of JPEG’d. Otherwise the protocol could potentially limit significant returns that could be gained by allocating more funds to more valuable individuals NFTs
One especially promising opportunity for JPEG’d, however, is that market volatility may result in rare and valuable NFTs getting liquidated. As a result, these NFTs could become part of the JPEG’d treasury at a significant discount.
Further Reading and Sources
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