Waterdrip Capital: Exploring new breakthroughs in NFTFi leasing NFT liquidity

Original author: Ryan, gt, coucou Mentors: Jademont, Elaine, Bill @Waterdrip Capital

1. Introduction

1.1 NFTFi

Before explaining NFTFi, you need to understand two basic concepts about NFTFi

NFT (Non-Fungible Token): A digital asset based on blockchain technology, each NFT has a unique identity and value. Unlike interchangeable tokens in cryptocurrencies, NFTs represent unique assets such as digital artwork, virtual real estate, virtual items, game props, and more. The uniqueness and indivisibility of NFTs make them very popular in the field of digital collectibles and culture.

DeFi (Decentralized Finance): A financial system built using blockchain and cryptocurrency technology, designed to achieve decentralized, transparent, and trustless financial transactions. DeFi applications provide various financial services through smart contracts, such as lending, debt collateralization, trading, asset management, etc., without the intermediary of traditional financial institutions.

NFTFi, or "NFT Finance", is actually NFT + DeFi, which refers to the emerging ecosystem of decentralized protocols and applications, mainly to provide financial utility for NFTs. In practice, the NFTFi protocol provides DeFi functionality to NFTs, unlocking the ability of NFTs to lease, borrow, and fractionate, create derivatives and prediction markets around them, and more.

1.2 NFT Leasing

NFT leasing refers to the process of trading NFTs as leased assets. In the traditional leasing model, people can rent various items, such as cars, houses or equipment, while in NFT leasing, people can rent digital artwork, game props, virtual real estate or other types of NFT. The NFT rental track can currently be divided into two categories: protocol and platform. In terms of protocols, Double Protocol and IO Protocol are well-known NFT leasing protocols. In terms of platforms, platforms such as Rarible and reNFT have high visibility.

Common NFT leasing methods:

• Fixed lease period: Users lease NFT and choose a fixed lease period, such as one week, one month or longer. Users pay the corresponding rent, during which they can enjoy the rights to use NFT. Once the lease period ends, the user will lose the right to use the NFT.
• On-demand lease: Choose the time to lease NFT according to your own needs, without being limited by a fixed lease period. Users may be required to pay rent by the hour, by the day, or by other units of time. This approach provides greater flexibility, allowing users to determine the length of the lease based on actual needs.
• Shared leasing: Multiple users can jointly lease the same NFT, and share the use rights and rental fees in accordance with the agreed method. This method can distribute the rental cost to multiple users, reduce the burden on a single user, and enable more people to enjoy the value of NFT.
• Lease repurchase: Some NFT leasing platforms provide lease repurchase options, allowing users to choose to convert the rent paid into an NFT purchase fee after the lease period ends. This method gives users the opportunity to decide whether to buy after understanding and experiencing NFT during the lease period.

At the same time, according to whether the assets are mortgaged, they can be divided into:

• mortgage lease NFT

Mortgage leasing is a mortgage-based NFT leasing method, which usually requires the lessor to provide a certain amount of cryptocurrency as collateral to ensure payment ability and responsibility during the lease period. The collateral can be digital assets such as ETH, BTC, or other NFTs. In this leasing method, NFT owners mortgage their NFT in the smart contract to obtain a certain amount of collateral tokens. Renters can use these tokens to lease NFT. When the lease expires or the rent is not paid on time, the collateral will be deducted a certain penalty or confiscated.

Projects that adopt mortgage leasing can better guarantee the payment ability and responsibility of the lessee, and also provide certain risk protection for NFT owners. There are already some NFT projects that mortgage leases, such as reNFT, NFTfi, etc.

• Unsecured Lease NFT

Collateral-free NFT leasing allows users to rent NFTs without providing collateral and return them after the lease period ends. This model is very attractive for users who do not have enough collateral or do not want to take the risk of collateral.

Double Protocol proposed a standard called ERC-4907, which designed a new type of NFT, doNFT. This NFT has an expiry date and a guaranteed expiration time. This means that users can rent NFT for a certain period of time, and after the lease period ends, the NFT will be automatically returned to the original holder. This model is different from the traditional NFT ownership model, it is more like a rental agreement, which can help users save costs and risks. In addition, Double Protocol also provides an NFT wrapping method called wNFT. Instead of receiving the original NFT directly, the user receives a wrapped NFT with the same characteristics and backed by the original NFT. When the lease time expires, the wrapped NFT will be destroyed to ensure the security of the original NFT.

The difference between the IQ Protocol that appeared later and the Double Protocol is that it does not use doNFT, but realizes unsecured lease through packaging. Users can use ETH or other cryptocurrencies to pay rent without providing collateral. At the end of the rental period, users will receive the corresponding rent and the NFT they rented. In general, this model can provide NFT holders with an additional source of income while ensuring safety.

1.3 Comparison between NFT leasing mode and traditional leasing mode

When comparing the NFT leasing model to traditional leasing models, there are some notable differences and distinctions:

2. The operating mechanism of NFT leasing

This section will analyze the rentable NFT protocol standard. ERC-4907 and ERC-5006 mentioned in this article are relative to ERC721 and ERC1155.

2.1 The basic principle of rentable NFT

ERC-4907

In NFT leasing, the lessor usually transfers the NFT to a designated smart contract and sets conditions such as the lease term and lease fee. The lessor can obtain the right to use the NFT by paying a certain lease fee. During the period of use, he can enjoy the rights and interests brought by the NFT, such as income, voting rights, etc., and also needs to bear certain risks. People suffer losses. At the end of the lease period, the NFT will be automatically transferred back to the lessor's wallet. The figure below shows an example of a leasing function.

Now suppose Alice holds an NFT, and Bob intends to rent this NFT. Then there will be 4 pieces of business logic, namely:

1. Alice authorizes the lease contract to transfer the NFT she holds.
2. Alice "lists" her NFT, marking it available for rent.
3. Bob chooses the rental time according to his own needs. After choosing, he transfers the rent to the lease contract. The rent is calculated based on the unit rental price and the rental time. After the rent is transferred, the rental contract will transfer the NFT listed by Alice to Bob, and at the same time set the renter as Bob, and the expiration time is Bob's rental time.
4. After the lease expires, Alice can withdraw her NFT from the lease contract.

The ERC721 protocol does not support the separation of NFT between the right to use and the right to own, that is, only the owner of the NFT has the right to use. The ERC4907 protocol constructs an additional role that can be granted to the address, and automatically cancels the lease relationship after the role is automatically revoked (expires), realizing the separation of ownership and use rights of NFT, and providing "native leasing" on the chain. Technical support is an important infrastructure to solve the problem of NFT liquidity shortage.

ERC-5006

ERC-4907 corresponds to the ERC721 standard, which defines a model in which an ID corresponds to a user. In the ERC-1155 standard, one ID can correspond to multiple users. However, from a principle level, there is not much difference between ERC-5006 and ERC-4907. In terms of specific implementation, ERC-1155 is more complicated and introduces some new variables, which will be introduced in detail below.

2.2 Function analysis of NFT leasing agreement

ERC-4907

The core of NFT's successful lease is to separate its use right from ownership. ERC-4907 uses the dual role owner and user to divide the authority, and the role has a validity period, which means that the lessee's authority will be automatically terminated after expiration without further verification. Any on-chain operation.

The ERC-4907 protocol mainly provides three functional interfaces, namely setUser, useOf and userExpires. These three interfaces will be introduced below.

• setUser mainly sets the new user and expiration time for the "listed" NFT. Inside the function, it is first necessary to check whether the NFT is owned by the initiator, and if so, write the leaser information.
• userOf can query the current user of an NFT. Returns an empty address if the current NFT is not leased or the lease has expired.
• userExpires can query the lease expiration time of an NFT.

ERC-5006

ERC-5006 is an extension of ERC-1155, which proposes an additional role - user, which defines two core variables

UserRecord defines rental records.

_frozens defines the balance that is frozen after the lease of the address corresponding to the token ID.

_records defines a mapping table for recording token leasing records, and UserRecord records a token leasing record, where dual roles owner and user are recorded for permission division.

_userRecordIds defines each token ID and a Mapping, which is the relationship between each user address and the token lease record ID of the address.

The ERC-5006 protocol mainly provides five functional interfaces, namely usableBalanceOf, frozenBalanceOf, userRecrodOf, createUserRecord and deleteUserRecord.

• usableBalanceOf is used to query the available balance of a token leased by a lessee.
• frozenBalanceOf is used to query the frozen balance of a token held by the leasing party.
• userRecrodOf is used to query a token leasing record.
• createUserRecord is used to create a token holding record.
• deleteUserRecord is used to delete a token holding record.

3. Application fields of NFT leasing

3.1 Application of NFT leasing in Web3 games

Game Player Classification

According to whether they like games and whether they hold encrypted assets as the horizontal and vertical axes, users can be divided into four quadrants:

• Game enthusiasts and hold encrypted assets

Like games, enjoy the fun brought by games, and hold encrypted assets.

• Game enthusiasts but do not hold encrypted assets

I like games and enjoy the fun brought by games, but I do not hold encrypted assets, and there are high threshold restrictions for playing encrypted games.

• Non-game enthusiasts but want to try encrypted games

Not a game lover, but want to try crypto games.

• Non-game enthusiasts but holding encrypted assets

I am not a game lover, but I hope to make money by playing games on behalf of others.

Pain points of Web3 games

As a traffic portal of Web3, Web3 games undertake the function of educating Web2 players and guiding more Web2 users into Web3. However, due to the particularity of Web3 games, there are the following difficulties:

• High barriers to entry continue to dissuade traditional users.
• Most games adopt the method of stitching Web2.5. Non-encrypted players play games without the blockchain version, and Web3 players play blockchain games. There is a split in the economic system.

Therefore, there is a lack of a way to lower the threshold and allow non-crypto users to experience Web3 games smoothly. One way of thinking is to directly lower the threshold, such as using abstract accounts. Another way of thinking is to transfer the high threshold and let Web3 players bear the high threshold, similar to helping to open a ChatGPT account. NFT lending is exactly the second way of thinking. It not only allows more non-encrypted players to enter the game, but also allows players with low asset holdings and even zero-dollar parties to enter the game.

Rentals in the Web2 Game Marketplace

In fact, leasing also exists in the Web2 game market, and the core lies in resource allocation, that is, to realize the exchange of time and money between groups with "abundant time but insufficient wealth" and "sufficient time but abundant wealth". Here, leasing can be divided into two types according to the purpose:

• Get rent:

In Web3, there is not only rent, but also additional gold.

• Spend money to get achievements and experiences in the game:

In Web3, this situation is almost non-existent.

However, the advantage of Web3 is that algorithms built through blockchain and smart contracts ensure a trustless environment. Whereas in most Web2 games, leasing is unofficial, off-site, with a lot of scams and mistrust at the same time. Although the cost of identity fraud on the chain is too low, everyone can easily create anonymous addresses, but in the game scenario, the game data has become a hidden cost of fraud.

In the traditional "time-poor but rich" gamer, they either just pay money for a better gaming experience, or earn a fixed amount of money (i.e. entry fee, no ongoing income). But in Web3, leasing is more of an investment. Individual investors can invest their assets more reasonably through borrowing and lending, so as to obtain continuous income.

Early Exploration of NFT Leasing

In the early days, many well-known GameFi projects, such as Axie Infinity and StepN, have appeared in the figure of off-site NFT lending. From this, we can also see that NFT leasing has exposed some problems in the GameFi 2.0 era:

• Bring out a mature gold mining industry chain and disrupt the balance of the game's economic system, thereby accelerating the game's death spiral. But in fact, even if the lease is not open, this problem cannot be avoided. In addition, most players in current GameFi games mainly focus on playing gold.
• Leasing releases too many uncertain and uncontrollable factors, which can easily lead to difficult control of game values and accelerate collapse.

However, the advantages of leasing are also obvious. As can be seen from the player numbers of Axie and StepN, leasing is beneficial for both parties:

• Lowered the user threshold, opened up the game market, and allowed more players who not only want to make money to enter the game, which is conducive to the game ecology.
• Because leasing to others can make more money, it increases the willingness of large whales to invest funds.

The application status of NFT leasing in Web3 games

According to the data from mymetadata.io on June 12, 2022, ranking the games with the highest daily average number of unique active users within 30 days, we can find that the current stage of Web3 games

• 7% of games with their own NFT rental marketplace/feature.
• 18% of games that have not yet implemented NFT leasing, but have publicly expressed interest or committed to doing so in the future.
• 75% of games that have not yet implemented NFT leasing, nor publicly expressed interest or made commitments.

However, despite only 7% of games having their own NFT rental market/feature, rental games represent a disproportionate 20.4% of the player base.

Special form of NFT leasing in Web3 games

The characteristics of the game also allow NFT leasing to give birth to new organizational forms in Web3 games, including guild leasing and project built-in leasing systems.

The most famous example of guild leasing is YGG (Yield Guild Games), originally known for providing Axie leasing services for Axie Infinity players. This model takes the guild as the main body to purchase a large number of game assets and then rent them out to game users, but at the same time it also brings a lot of pressure to the game side. From the perspective of the game side, the guild is a tool for growth, but it also brings a potential "Sword of Damocles". Therefore, if gamers can acquire new customers and find healthy and suitable users at a low cost, they will most likely not choose guilds.

However, the form of guild leasing can also be opened by the project party itself, which is more efficient and convenient to manage, and can directly bypass the guild. From the perspective of the project party, they may not be able to avoid the occurrence of leasing, so it may be a better choice to open the leasing system by themselves.

3.2 Application of NFT lease in Metaverse

Virtual land leases in the Metaverse are a major part of NFT use cases, helping to bridge the virtual world with the physical world. Just like in the brick-and-mortar real estate business, Decentraland LAND owners can lease out their virtual land to tenants, who can use them to host events or develop them into malls, offices, entertainment centers, and more. Decentraland and Double Protocol will launch an on-chain NFT leasing solution in July 2022, which can be used in conjunction with LAND. In short, Double provides an infrastructure that simplifies the leasing process while offering a wider variety of leasing services, benefitting both LAND owners and potential tenants.

Brief Analysis of Leasing Solutions

By utilizing ERC-4907, the Double NFT leasing protocol runs on two main smart contracts: a "marketplace" contract and a "doNFT factory" contract. The "doNFT Factory" smart contract adds new NFT contracts to the platform, while the "Market" smart contract handles all NFT rentals. The dual NFT leasing protocol allows leasing any ERC721-based NFT.

When tenants pay rent for an NFT, they will receive a doNFT. A doNFT is minted by a doNFT contract created by a doNFT factory. DoNFT is ERC-721 compatible and has a duration list with a start and end time. The duration specifies that the owner of the doNFT has the right to use a certain NFT for an agreed upon period of time.

The lessee has multiple usage rights throughout the lease period, including subletting and developing the virtual land. The doNFT contract automatically revokes the borrower's usage rights at the end of the lease period. An example of leasing on Decentraland is as follows.

Fashion industry enters metaverse

The metaverse land leasing business will shine as the fashion industry enters the metaverse. The second Metaverse Fashion Week (MVFW) organized by Decentraland will officially kick off in March 2023, and brands such as Adidas, Dolce & Gabbana, Balmain, Coach and Tommy Hilfiger will all appear. Although the popularity of the Metaverse has weakened after 23 years, many brands have instead increased their investment in the Metaverse, trying to use new products and marketing methods to gain growth (whether users or profits) on the new track. ).

They acquired digital real estate, invested in virtual advertising, and hosted wearable contests and fashion shows. These include Adidas, Burberry, Dior, Dolce Gabbana, Gucci, Nike and many more. Meanwhile, a growing number of digitally native brands have sprung up, like DressX, which sells virtual wearables ranging from basic undershirts to warrior outfits made of digital metal. This, combined with the creator economy and scope of digital ownership that NFTs bring, has the potential to democratize traditionally elite industries.

However, due to the high price of metaverse land, coupled with the continued downturn of the nft market (in fact, the entire encryption market), not all brands are willing to spend a high price to acquire a piece of metaverse land that may depreciate rapidly. Then the nft leasing business is very important at this time. On the one hand, metaverse land leasing can give non-first-tier brands the opportunity to enter the metaverse track without taking too much risk. The brand owner can choose how much land to lease, the lease time, etc. according to their own needs and affordability. On the other hand, the idle land in the hands of players can also be called up. Many nft holders are forced to hold due to the market downturn, and can only wait for the follow-up nft price to rise again. The emergence of the leasing business can help these "smashing hands" holders sit on income-generating assets and increase their source of income.

3.3 Application of NFT leasing in the community

Community equity NFT leasing first appeared in 2019, when it was mainly tried and explored in the Ethereum community. With the continuous development of blockchain technology and smart contracts, the application scenarios and business models of community equity NFT leasing are also expanding and deepening. Community rights NFT lease refers to the lease of NFT representing the rights and interests of a specific community or organization to users, allowing them to enjoy the relevant rights and interests of the community or organization during the lease period. The lease term, rent and usage rules can all be encoded in the smart contract to ensure the transparency and security of the lease process. Its function is mainly to allow non-community members to obtain relevant rights and interests of community members within a certain period of time, such as voting rights, community resource usage permissions, etc. Equity NFT leasing has a wide range of application scenarios, which can provide various types of communities with new sources of funds and incentive mechanisms, and can also provide renters with more flexible and safer use rights, helping them obtain better experience and income.

business model

The community is the basis for community equity NFT leases. A community can be a virtual community or a physical community. The lessor is the core participant of community equity NFT leasing. The renter can rent community NFT tokens through the leasing platform, and enjoy the right to use specific rights and interests of the community within a certain period of time. During the lease period, the renter can participate in community activities as an NFT holder in the community, or obtain corresponding community rewards. The leaser's rent will be paid to the leasing platform, part of the rent will be used as the income of the leasing platform, and part of the rent will be distributed to the contributors or holders of the community as a community reward. In addition, the leasing platform is an intermediary platform for community equity NFT leasing. The leasing platform provides NFT leasing services for the community, and collects a certain percentage of handling fees from the rent as its own income. Leasing platforms can also promote their brands and services through NFT leasing activities.

The business model of community equity NFT leasing mainly includes the following aspects:

**1. Platform charges: **The rental platform charges a certain handling fee or rent from the lessee.

**2. Community income: **The rental platform cooperates with the community, and the platform charges a certain percentage of rent as its own income, and the remaining rent is distributed to the contributors or holders of the community.

**3. Brand promotion: **The rental platform brings exposure and attention to its own brand promotion through NFT leasing activities.

4. Advantages and challenges of NFT leasing

4.1 Advantages of NFT Leasing

Summarizing the advantages of the above three scenarios, the advantages of NFT leasing are as follows:

• Lowering the threshold: NFT leasing can reduce the threshold and cost, allowing more users to enter. Whether it is games, metaverses or communities, it is beneficial to the ecology, encourages more user participation, and enhances interactivity and community cohesion.
• Improve asset liquidity: NFT leasing can improve asset liquidity. Make it easier for people to buy, sell, lease and invest in virtual assets.
• Provide financial support: NFT leasing can increase the inflow of funds, provide financial support for the sustainable development of the project ecology, and promote its development and growth.
• Create a new economic model: NFT leasing creates a new economic model. It can facilitate the efficient utilization and trading of assets, create value for owners, lessors and developers, and provide them with new revenue streams.

4.2 Challenges and risks faced by NFT leasing

Summarizing the above three scenarios, the challenges and risks faced by NFT leasing are as follows:

• Market bubble risk: Excessive speculation of NFT market prices may lead to instability and investment risks.
• Legal and regulatory risks: The ownership and leasehold interests of virtual assets may involve complex legal and regulatory issues, and risks in compliance and legal protection need to be carefully considered.
• Technical security risks: Transactions using NFT leases may involve technical obstacles, smart contract vulnerabilities, and network security risks.
• Market demand and acceptance risk: The successful implementation of NFT leasing also requires market demand and wide acceptance.
• Uncertainty of rental price: The rental price is affected by market supply and demand and other factors, and the price fluctuates greatly. It is difficult to guarantee the stability and fairness of the rental price.
• Lack of norms: The NFT leasing market lacks uniform norms and standards, and there may be uncertainties and unpredictable risks in the leasing process.

Five, the future development of NFT leasing

Summarizing the above three scenarios, we believe that the future development of NFT leasing will present the following three trends

• In the future, NFT leasing will achieve a higher degree of automation and autonomy with the support of smart contracts and blockchain technology. In addition to technical specifications, market norms and standards will be specified to create a smoother and low-threshold user experience while ensuring that the rights and interests of all parties are protected. The future NFT leasing model will be more flexible, intelligent and diversified, and can be personalized according to the needs of participants to meet different usage scenarios and business models.
• With the development of NFT in the future, there will be more and more application scenarios of NFT, including social, metaverse, games and other fields. As more rights and more scenarios emerge, NFT leasing will also benefit from these new application scenarios, with more gameplay and empowerment. At the same time, the trend of globalization will also bring more opportunities for NFT, promote the global development of NFT leasing, and attract more participants and users. In this context, NFT leasing will continue to innovate and develop, becoming an indispensable part of the future Web3 ecosystem.
• As a way to lower the threshold, NFT leasing can bring more users the opportunity to participate in the Web3 ecology, reversely empower NFT and Web3, and promote the development of Web3 and Mass Adoption. The existence of NFT leasing allows more users to own NFT, which in turn promotes the expansion of NFT application scenarios and helps the prosperity and development of the NFT ecosystem. At the same time, NFT leasing can also provide empowerment for more Web3 scenarios. By lowering the threshold and providing more usage scenarios, it will bring more possibilities and opportunities to different application scenarios in the Web3 ecology, and promote the diversification of the Web3 ecology. sex and development.

6. Summary

This article first introduces the basic concept of NFTFi leasing in detail, and at the same time points out that NFT leasing is different from traditional leasing in that people can lease digital artwork, game props, virtual real estate, or other types of NFT. Secondly, from a technical point of view, this paper analyzes the currently widely used ERC-4907 protocol and ERC-5006 protocol, and briefly introduces the functional interfaces of these two protocols. Due to the rapid development of NFT leasing, its application fields are becoming more and more abundant. Web3 games, Metaverse, and community equity NFTs are all typical application scenarios for NFT leasing. This article explains in detail the business logic and representative projects of NFT leasing in these three fields. Finally, the article summarizes the advantages, challenges and risks of NFT leasing, and looks forward to its future development direction.