Let’s face it: NFT interest and trading volumes have declined significantly in 2023. However, lending against NFTs remains an important option for investors seeking liquidity.

To make the most out of the opportunities available to us in a bear market, it’s important to determine appropriate lending terms. This requires carefully calculating recovery rates–i.e., the percentage of collateral value recovered in default. This is essential for assessing your risks, even if fewer deals are being written.

In this blog post, we’ll dive into the calculation, usage, and adjustment of recovery rates for NFT lending.

Understanding this process provides key insights, regardless of market conditions.

## The Complex Calculations Behind NFT Recovery Rates

Determining appropriate NFT lending terms requires estimating recovery rates. But how exactly are these rates calculated for different NFT collections?

We use some robust calculations. To start:

![recovery rate formula](//images.ctfassets.net/lhkcghnr8ql4/6QgOJuwa1bveSxX05fbhhT/8a1981885ff88c14aa7b91f3da98a94e/recovery_rate_formula.png)

In this calculation, recovery rate R serves as a forecast of the change in an NFT's appraised value over a fixed time horizon. This rate is expressed as a relative change, where R < 1 signifies a decline in asset value, while R > 1 indicates an increase.

Recovery rates are inherently uncertain, and 
therefore, we treat R as a random variable following a skew-normal distribution.

To estimate the parameters of this distribution, we utilize the daily relative changes in floor prices based on Upshot appraisals, considering them as realizations of R.

It's important to note that when using floor prices, the resulting distribution applies to an entire collection, assuming that recovery rates remain consistent across assets within the same collection.

For point forecasting purposes, the mean of each skew-normal distribution serves as an estimate of the expected recovery rate for a given collection and time horizon.

Additionally, the default probability of a loan for a specific time horizon is determined by the probability that an asset's value depreciates below its appraised value at the loan's inception.

This probability can be derived from the cumulative distribution function (CDF) of R, specifically:

![recovery rate formula 2](//images.ctfassets.net/lhkcghnr8ql4/3I5eRhdRUz3u4W2q6sA6qD/fbe7a62a783cf32bed27601120346fda/recovery_rate_formula_2.png)

While these calculations provide valuable insights, it's crucial to acknowledge that they assume rational investor behavior.

It can be challenging to model and account for irrational behavioral patterns, which may impact the accuracy of these estimates.

To address this uncertainty, lenders must validate and adjust recovery rate forecasts to account for real-world irrationalities.

One approach is to compare projected returns to actual market performance over time. The gaps between projections and reality can then be used to refine your recovery rate estimates.

## Adjusting Recovery Rates for Forecasting Uncertainty

To assess forecast performance, we compare forward-looking returns based on floor prices with the forecast distribution means over rolling windows of 60 days. By calculating the mean absolute percentage error for each time horizon, we can adjust the recovery rate downward to account for forecasting uncertainty.

This adjustment, known as the "uncertainty margin," is calculated as the uncertainty-adjusted recovery rate equals the recovery rate multiplied by (1 - uncertainty margin) for each collection and time horizon.

With rigorously validated recovery rate estimates, lenders can incorporate these projections into competitive lending terms.

## Utilizing Recovery Rates in the Lending Process

The recovery rate model's output serves as a critical component in determining two key aspects of the lending terms: the loan amount and the interest rate.

### Loan Amount Determination

The uncertainty-adjusted recovery rate plays a pivotal role in determining the loan amount. For each collection, the loan amount is calculated as the maximum of the uncertainty-adjusted recovery rate multiplied by the appraised value of the asset.

The maximum uncertainty-adjusted recovery rate corresponds to the time horizon selected as the loan duration.

However, to prevent concentration risk and ensure a diversified lending strategy, the loan amount is capped at twice the collection-level loan median.

### Interest Rate Calculation

The interest rate for each asset is calculated at the collection level using the formula:

![Interest rate formula](//images.ctfassets.net/lhkcghnr8ql4/5txevxMsgxShLHHhNbNBUl/2963beaaf68539c981312403bb135ecc/Interest_rate_formula.png)

The risk-free rate is set at 4.3%, reflecting the long-term average of the 10-year US Government bond.

The premium, set at 0%, 2.5% and 5% depending on each NFT’s value bucket, is added to compensate for the additional risk associated with NFT lending.

The default probability utilized in this calculation corresponds to the default probability associated with the best recovery rate. The term (1 - default probability) increases the overall interest rate as the default probability rises, effectively compensating for default risk in the loan portfolio.

Our methodology offers various levers that can be adjusted to tailor the lending terms and enhance competitiveness.

### Interest Rates

The premium contributes to the interest rate formula and can be adjusted to make the rates offered more competitive.

### Loan Duration

Currently, loan durations range from 14 to 30 days. Depending on demand and risk considerations, this range can be extended to accommodate different lending preferences.

### Loan Amount

The loan amount is based on the adjusted recovery rate at a specific time horizon. The adjustment is determined using the mean absolute percentage error. The adjustment can be increased or decreased to align with market conditions, allowing for flexibility in loan amounts.

### Range of Collections

Currently, we generate lending terms for a range of liquid blue chip NFT collections. This selection of collections provides a competitive advantage as many other NFT lenders cover a smaller number of projects.

To further enhance our offerings, we have the option to selectively add more collections to the terms provided, catering to a wider range of investor preferences.

## Building Sustainable NFT Lending with Recovery Rates

Recovery rates are indispensable for structuring competitive, risk-aware NFT lending. Thoroughly understanding rate calculations lets lenders estimate collateral value retention across time horizons. Validating projections and adjusting for uncertainty creates actionable forecasts to inform loan terms.

Ultimately, recovery rates provide the foundation for sustainable NFT lending. Rather than reacting irrationally, lenders can rely on data-driven forecasts to confidently support investors long-term.

Careful rate analysis transforms lending from speculation to discipline. As NFT markets progress, recovery-focused strategies separate resilient programs from short-lived trends.


Learn how carefully calculating, validating, and incorporating NFT recovery rates into lending terms enables sustainable programs that withstand bear markets.

How to Calculate Recovery Rates for NFT Lending (Even in a Bear Market)

NFT financialization is experiencing rapid growth, spurring innovation, liquidity, and usability across the broader crypto market. NFTs are expanding beyond collectibles as pioneering projects harness DeFi mechanics to amplify liquidity within these traditionally illiquid assets, giving rise to novel financial markets.

Each liquidity mechanism presents its own set of advantages and disadvantages, making certain mechanisms more suited for NFTs with particular attributes than others. The multifaceted nature of NFTs, stemming from their unique qualities, provenance, and underlying assets, introduces new complexities in sourcing and maintaining liquidity.

Many projects are leading the charge in maturing of NFTs, propelling the financialization sector into its next stage of evolution. The NFT-Fi movement expands participation, draws in additional capital, and offers opportunities for users to engage in novel use cases for their unique digital assets.

Let's explore the current state of the many verticals within the [NFT financialization](https://research.binance.com/en/analysis/financialization-of-nfts) space.

## NFT Financialization Market Map - July 2023
![NFT Financialization Map July 2023](//images.ctfassets.net/lhkcghnr8ql4/7fZDYq3lnbCJv9ok043iJc/8062b83672cec9b3810719558f678478/NFT_Financialization_Map_July_2023.jpg)

### Marketplaces
Marketplaces were the initial catalysts of the NFT revolution. Platforms like [Opensea](https://opensea.io/), [LooksRare](https://looksrare.org/), [Zora](https://zora.co/), [X2Y2](https://x2y2.io/), [Blur](https://blur.io/), and [Rarible](https://rarible.com/), platforms that empowered creators and collectors alike.

### Specialized Marketplaces
Specialized Marketplaces like [Nifty Gateway](https://www.niftygateway.com/), [SuperRare](https://superrare.com/), [Makersplace](https://makersplace.com/), [KnownOrigin](https://knownorigin.io/), [Async](https://async.art/), [Foundation](https://foundation.app/), [Catalog](https://beta.catalog.works/), [Parcel](https://parcel.so/), and [Sound](https://www.sound.xyz/) have redefined the landscape by focusing on specific NFT types.

### NFT Lending
NFT Lending, a rapidly expanding sector, unlocks the liquidity tied up in NFTs by allowing holders to collateralize their assets for loans. Many of these [NFT lending platforms](https://upshot.xyz/post/nft-lending-platforms) can be broken down into the following categories:

#### Peer-to-Pool Lending
Platforms such as [BendDAO](https://www.benddao.xyz/en/), [JPEG'd](https://jpegd.io/), [Pawnfi](https://pawnfi.com/), [PWN](https://pwn.xyz/), [Zharta](https://www.zharta.io/), and [Unlockd](https://www.unlockd.finance/) allow NFT owners to obtain loans from a liquidity pool instead of an individual.

#### Peer-to-Peer Lending
Platforms like [Arcade](https://www.arcade.xyz/), [NFTfi](https://nftfi.com/), and [X2Y2](https://x2y2.io/) are facilitating direct lending contracts between borrowers and lenders.

#### Three-Actor Vault Model
With a unique take on NFT lending, [Astaria](https://astaria.xyz/) is pioneering a three-actor vault model where strategists help manage vaults capitalized by external LPs.

For a closer look into these lending categories, read more in our in-depth [NFT lending](https://upshot.xyz/post/nft-lending-101) blog post.

### NFT Fractionalization
This approach, exemplified by [Szns](https://www.szns.io/), [Unicly](https://www.unic.ly/), [Furion](https://furion.io/), [Insrt Finance](https://www.insrt.finance/), [Nibbl](https://nibbl.xyz/), and [NFTX](https://nftx.io/), involves dividing a single NFT into smaller, ERC-20 tokens, allowing many people to own a single NFT.

### NFT AMMs
Pioneers like [sudoswap](https://sudoswap.xyz/#/), [Ditto](https://dittohq.xyz/), [leNFT](https://lenft.fi/), and [Caviar](https://www.caviar.sh/) are leading the charge in establishing Automated Market Makers (AMMs) for NFTs.

### Derivatives and Options Markets
Projects like [Hook Protocol](https://www.hook.xyz/), [Wasabi](https://www.wasabi.xyz/), [Revest Finance](https://revest.finance/), [Cally](https://www.cally.finance/), and [Putty](https://www.putty.finance/) offer NFT options contracts that give users the right to buy/sell an NFT at a predetermined price, creating unique avenues for risk management and speculation.

### NFT Perpetual Futures
Projects like [nftperp](https://nftperp.xyz/) and [Tribe3](https://tribe3.xyz/) offer contracts that allow traders to speculate on the long-term value of NFTs without an expiration date. This allows for hedging, diversification, and optimization of investment strategies.

### NFT Aggregators
Projects like [Skillet](https://www.skillet.ai/), [SnowGenesis](https://snowgenesis.com/collections/all), [Uniswap](https://uniswap.org/), [Blur](https://blur.io/), [DefiLlama](https://defillama.com/) ,and [AAA](https://www.aaa.is/) aggregate listings and liquidity from across numerous marketplaces.

### NFT Indexes
[Upshot](https://upshot.xyz/), [Fungify](https://fungify.it/), [Nealthy](https://www.nealthy.com/), [Bitwise](https://bitwiseinvestments.com/), and [Artacle](https://artacle.io/index/artcl) have curated NFT baskets that allow investors to track market segments, offering diversified exposure to the NFT landscape and reducing individual asset risk.

For a closer look into NFT indexes, read more in our in-depth [NFT Indexes](https://upshot.xyz/post/introduction-to-nft-index-funds) blog post.

Additionally, check out our post surrounding [Upshot's NFT Index Methodologies and initial indexes](https://www.businesswire.com/news/home/20230613897563/en/Upshot-Unveils-Novel-NFT-Index-Methodologies-Empowering-Developers-to-Build-New-Financial-Infrastructure-for-NFTs-and-Enhance-Market-Insights).

### Buy Now, Pay Later Solutions
The flexibility of payment schedules comes to the NFT world with platforms like [HighSwap](https://twitter.com/highswap), [Cyan](https://www.usecyan.com/), and [Zumer](https://www.zumer.xyz/).

### Portfolio Trackers
Allows users to stay informed about the value of their digital assets through projects like [Floor](https://www.floornfts.io/), [Flip](https://flip.xyz/art), [Zapper](https://zapper.xyz/), [Soho](https://www.soho.xyz/), [NettyWorth](https://nettyworth.io/), [MetaLink](https://metalink.com/), and [Recap](https://recap.io/en-US).

### Liquidity Scaling
Protocols like [Goblin Sax](https://www.goblinsax.xyz/), [Spice Finance](https://www.spicefi.xyz/), and [SPICYEST](https://spicyest.com/) are pioneering liquidity solutions that cater to the unique characteristics of NFTs.

### Trading Infrastructure
Projects like [Reservoir](https://www.reservoir.tools/) and [oSnipe](https://twitter.com/oSnipeNFT), providing critical infrastructure and tooling to build faster, efficient NFT trading applications.

### Price Discovery
Providing insights into the value of NFTs, projects like [Upshot](https://upshot.xyz/), [DeepNFTValue](https://www.deepnftvalue.com/), [Nabu](https://www.nabu.xyz/), [NFT Bank](https://nftbank.ai/), and [NFT Valuations](https://nftvaluations.com/), offer solutions for NFT appraisals, fostering market transparency and providing tools for NFT-fi builders.

## Additional Resources
The insights we've shared are drawn from our comprehensive Upshot NFT Financialization Map, which you can explore in more detail [here](https://docs.google.com/spreadsheets/d/1Wp_Ky1lZXCoh8ojpTRLMTQ-Z7TIen4fOgvrU9hSoapA/edit#gid=136769421). Please note, this map provides a snapshot as of July 2023. If there are any overlooked projects, don't hesitate to reach out.

If you found this market map valuable, make sure to follow [@UpshotHQ](https://twitter.com/UpshotHQ) and [@upshotintern](https://twitter.com/upshotintern) on Twitter for more insights into the dynamic world of NFT financialization.

Here's your guide to the NFT financialization market as of July 2023.

NFTs x DeFi: A Guide to the NFT Financialization Landscape

Yesterday marked another significant moment in the evolution of NFTs and their integration into traditional art markets: the Sotheby’s auction, [Grails: Property from an Iconic Digital Art Collection Part II](https://www.sothebys.com/en/buy/auction/2023/grails-part-ii). Upshot had the opportunity to apply our proprietary valuation models to the seminal NFT pieces in the Sotheby’s auction. We evaluated this collection in advance as a real-world litmus test of our machine-learning models and appraisal methodologies. Not only did this provide a practical testing ground for our appraisals, but our estimates demonstrated significant accuracy when compared to the closing prices these pieces received at auction, reaffirming the robustness of our approach in the dynamic and evolving landscape of NFT valuations. Upshot Grails Part II estimates can be found [here](https://docs.google.com/spreadsheets/u/4/d/196hmy1FIgGAWJoDMRb9IPnSwi6C8GeMrvy_jGeXMQdU/htmlview#gid=0 "Upshot Grails Part II Estimates").

The auction, held on June 15th in New York, was a visual celebration of pioneers who have fearlessly ventured into uncharted territories of digital artistry. Artwork from artists like Tyler Hobbs, Dmitri Cherniak, Snowfro, Matt Deslauriers, and more were represented, offering a unique perspective into the expansive realm of generative artwork. The NFTs in question originate from the historic Three Arrows Capital (3AC), a formerly-renowned hedge fund that is currently undergoing liquidation. This collection, once emblematic of 3AC's adventurous foray into the digital art realm, served as a unique opportunity to not only test the precision of our valuation models but also delve into the rich legacy left by the fund in the NFT market.

Backed by our unique approach to leveraging machine learning for the valuation of NFTs, our team at Upshot provided an objective and data-driven analysis of the artworks on offer. We have previously demonstrated our capabilities in this arena during [Sotheby’s Bored Ape Yacht Club NFTs auction](https://upshot.xyz/post/sothebys-ape-auction-how-upshot-performed), where our model's valuation estimate was impressively close to the final winning bid. As we now extend this data-centric approach to a diverse array of digital art pieces, we continue to underscore the capacity of AI in making sense of the dynamic NFT market, thus contributing to its transparency and accessibility.

## How Upshot Performed in the Wild 
In an exciting testament to the accuracy of our machine learning models, the valuation provided for the entire NFT lot closely paralleled the final auction results. We estimated the total price of the lot (excluding “The Goose”) to be \$4,879,364, whereas the final auction results (excluding “The Goose”, including Buyer Premium) came  to \$4,731,004. This signifies an error rate of merely 3.14%, a figure considerably lower than Sotheby's preliminary estimate, underscoring the capabilities of our appraisal systems. We published our estimates on June 1, 2023 via [this post on Twitter](https://twitter.com/nick_emmons/status/1664387990557278211).
![upshot v sothebys](//images.ctfassets.net/lhkcghnr8ql4/6meBYKJr9PGKuuF4vYcSN5/965d2fc47ee29b17fa3dbff8eb25a379/upshot_v_sothebys.png)

For "Archetype #46," our precision is exemplified by the minuscule difference between our estimated price and the selling price. We projected a value of \$30,745.80, while the piece sold for \$30,480.00. This discrepancy of only \$265.80, corresponds to a mere 0.87% deviation from the actual price, substantially more accurate than Sotheby's initial estimate of \$10,000 - \$15,000.
![Kjetil Golid Archetype #46](//images.ctfassets.net/lhkcghnr8ql4/7nmYw04KcECACLsDE1kHGs/082e6c13174922548d15d7c9c228884f/Kjetil_Golid_Archetype_-46.png)

In the case of "Subscapes #198," we forecasted a price of \$11,699.40 and the actual selling price was \$12,065.00. The difference of \$365.60 reflects an error of just 3.12%, yet again, our estimates surpassed the accuracy of Sotheby's original range of \$5,000 - \$7,000.
![Matt DesLauriers Subscapes #198](//images.ctfassets.net/lhkcghnr8ql4/48UTQTIqFFMBSLSLq44LKb/21229e7473822f0c47b711a65882b31d/Matt_DesLauriers_Subscapes_-198.png)

With our CryptoPunk valuations, Upshot's appraisal models demonstrated their robust accuracy, reflected in their extraordinarily low Mean Absolute Percentage Errors (MAPEs) as one of our most powerful models. We successfully estimated the value of CryptoPunk #8950 at \$106,726.80, which sold for \$114,300.00. CryptoPunk #291 was appraised at \$105,257.40 and sold for \$95,250.00. Meanwhile, our prediction for CryptoPunk #6574 was \$105,388.00, and it fetched \$101,600 at auction, an extremely minimal 3.73% divergence. These precise appraisals starkly outperformed Sotheby's original estimates of \$40,000 - \$60,000, further highlighting Upshot's proficiency in valuing such iconic NFT collections as CryptoPunks.
![Larva Labs CryptoPunk #6574](//images.ctfassets.net/lhkcghnr8ql4/1KNwwpqTjxpWvm19uVx8ch/a7dc889b40af83b4590ce7c51d8a33ce/Larva_Labs_CryptoPunk_-6574.png)

The centerpiece of the auction, "The Goose" by Dmitri Cherniak, proved to be an intriguing appraisal challenge. This piece is considered the crown jewel of the collection due to its emblematic fusion of code and randomness, representing a unique blend of chance, artistic discovery, and digital art symbolism that ultimately rendered a goose. Despite its rarity and iconic status, which usually makes valuation challenging, our models estimated its worth to be \$3,707,019.57, which demonstrated a competent understanding of its value, especially when compared to Sotheby's estimated range of \$2,000,000 - \$3,000,000. Ultimately, the piece fetched \$6,215,100 at auction, underscoring the immense value the market placed on this historic NFT.
![Dmitri Cherniak Ringers -879 (The Goose)](//images.ctfassets.net/lhkcghnr8ql4/2DjG1ZmOKvGynuCdf7vf5f/af728a23a16b1dce536752406fc6379e/Dmitri_Cherniak_Ringers_-879__The_Goose_.png)

These precise appraisals are testament to Upshot's effectiveness in delivering accurate valuations, serving as a crucial tool for protecting creditors' interests during liquidation auctions, as demonstrated in the Three Arrows Capital case. Our predictive models ensure stakeholders are well-informed and guarded against potential underestimations in such high-stakes transactions.

## Moving Forward
As we look ahead, Upshot's role in the evolving NFT market is clearer than ever: to create liquid markets for anything through industry-leading ML-powered appraisals. Our goal is to provide precise, data-driven appraisals to guide both buyers and sellers in this exciting new asset class. We foresee these appraisals becoming instrumental in auctions, private sales, and even the development of innovative financial products. As the NFT market continues to grow in complexity and diversity, we are committed to advancing our machine learning models to meet these challenges, thereby fostering greater market transparency and promoting informed decision-making.

We invite you to explore our [blog](https://upshot.xyz/post/how-upshots-ml-models-work) to learn more about the sophisticated mechanisms we employ for our appraisals, and how these may be harnessed for your own ventures in the NFT space. As we continue to explore the many potential applications of NFTs and their valuation in the DeFi landscape, we remain steadfast in our belief that accurate appraisals will play a pivotal role in this growth. By providing these reliable valuations, Upshot is laying the groundwork for a future where NFTs and DeFi coalesce, unlocking novel investment opportunities, and deepening our understanding of this dynamic market. We're excited to accompany you on this journey into the future of non-fungible digital assets.

Overview of the most recent Sotheby's auction at the time of this writing and how Upshot appraisals performed alongside the auction.

The Sotheby’s Grails Part II Auction: How Upshot’s Appraisal Performed

## Introduction 
We are thrilled to announce that Upshot will be the inaugural partner/ strategist for [Astaria](https://astaria.xyz/), a new on-chain NFT lending platform. Astaria’s protocol introduces an innovative three-actor-model where strategists, such as Upshot, can outline the terms of NFT loans through dedicated vaults. These vaults accept capital from liquidity providers, which is subsequently lent out to NFT borrowers, enhancing the transparency and efficacy of the NFT lending process. 

By bringing [Upshot’s industry-leading machine learning models](https://upshot.xyz/post/how-upshots-ml-models-work) to Astaria's lending platform, we unlock an innovative frontier in NFT financial markets, ensuring seamless and accessible lending practices. With a proven track record of appraising over 104 million NFTs from a diverse range of over 87,000 collections, our robust quantitative analyses offer unprecedented breadth and accuracy. As Astaria strategists, we employ our sophisticated recovery rate models and risk management framework, not only to gauge the probability of loan default but also to maintain a diversified loan portfolio, protecting both liquidity providers and ourselves from potential market volatility. This collaboration embodies our shared vision of propelling a new era of NFT financialization, where seemingly “illiquid” assets can be leveraged for a new wave of DeFi opportunities. 

## A Very Brief History of NFT Lending Today
Historically, the NFT lending market has primarily operated on a peer-to-peer basis, similar to archaic barter systems. In this model, borrowers and lenders agree on terms and a smart contract handles the transactions trustlessly. This process allows for great flexibility, matching terms on a case-by-case basis. However, the peer-to-peer model inherently requires both parties to reach an agreement on terms, a process often encumbered by a divergence in perceived values and risk factors. Borrowers, often emotionally attached to their NFTs, may overvalue them, while lenders, cautious about the borrower's credibility or the volatility of the collection, might assign a higher risk premium. This mismatch in sentiment often leads to less efficient market-clearing outcomes.

In response to these challenges, the peer-to-pool model has emerged as an alternative option to allow for a smoother user experience by removing the need for individual agreements. Lenders contribute to a pool which manages liquidity, allowing borrowers to access instant liquidity. Despite pooling risks for all liquidity providers, this model offers a more scalable path that closely mirrors the fungible market where LPs can deposit capital and earn. Peer-to-pool models depend heavily on accurate valuation methodologies to set loan terms. Over-reliance on oracle-based price calculation methods (such as floor price) can leave the system vulnerable to manipulation as well as limited in usefulness. 

The alternative to avoid oracle-based manipulation is to use specialized appraisers employing nuanced, machine-learning-based algorithms to estimate NFT value, incorporating factors such as traits, previous owner history, and other relevant data points. This takes us to Astaria's unique approach - the three-actor model.

## Introducing Astaria’s Three-Actor Model
[Astaria](https://astaria.xyz/) is an on-chain NFT lending platform designed with the native DeFi user in mind. The protocol provides a system for strategists, like Upshot, to publish loan NFT terms through vaults, which accepts capital from liquidity providers and extends it to borrowers. For example, one strategist may allow a 10 ETH loan with a 10% interest rate to be taken out against a specific NFT for one month. These terms can be continuously updated as markets fluctuate, and borrowers can refinance to take advantage of more favorable terms.

This unique, three-actor model fosters competitive yields for liquidity providers and instantaneous liquidity for borrowers, all while mitigating the need for traditional, time-consuming bid-and-ask negotiation processes. With a dynamic ecosystem of strategists, borrowers, and liquidity providers, Astaria ensures market competitive rates and flexibility for loan refinancing, without the fear of forced liquidations on price changes.

![Astaria-3-Actor-Model](//images.ctfassets.net/lhkcghnr8ql4/37dWByvTEQMljUMghW73ej/3cf966af4c8ee0d56bbbd10559818102/3AM-ccb5b9d756e22d102d2c5eeba160f03a.png)

Strategists, including Upshot, within Astaria's framework have the responsibility of deploying vaults complete with loan terms matched to supported NFTs. These terms can be dynamically adjusted as market conditions change, creating a lending ecosystem that's highly responsive to real-time fluctuations. All of this contributes to a healthy, competitive balance that ensures fair and accurate terms, striking a balance between attracting borrowers and securing sufficient capital.

### Core Benefits of Astaria 
Astaria has three core benefits for users: 1) instant liquidity, 2) competitive yields and loan terms, and 3) no forced liquidations. Here's a closer look at these benefits:

- __Instant liquidity__: This feature eliminates time-consuming bid-and-ask negotiations, allowing users immediate access to a variety of loan terms offered by expert strategists.
- __Competitive yields and loan terms__: Astaria fosters a competitive environment where strategists compete for capital, ensuring beneficial market rates for both liquidity providers and borrowers.
- __No forced liquidations__: Borrowers are only subject to liquidation if their loan expires with outstanding debt. This eliminates forced liquidations due to market price fluctuations, offering additional security for borrowers amidst market volatility.

#### Benefits for Borrowers 
For borrowers, the Astaria vault system presents a unique combination of flexibility, immediacy, and value. By holding their NFTs as collateral, borrowers gain immediate access to liquidity in an instant and permissionless protocol. This design enables NFT holders to unlock the financial potential of their assets immediately, without the hurdles often associated with traditional peer-to-peer systems. Even as the NFT is locked as collateral, borrowers can still tap into its utility. 

Astaria's FlashActions feature allows temporary unlocking of the NFT to perform predefined actions, such as collecting Uniswap fees or claiming airdrops, all while ensuring the NFT is returned within the same block. Additionally, Astaria enables borrowers to take multiple loans against the same NFT, up to five times, provided the maximum potential debt does not exceed the strategist-set limit. This multifaceted borrowing process, complete with the possibility of refinancing, offers borrowers an unprecedented level of freedom and control over their digital assets.

#### Benefits for Liquidity Providers 
On the other side of the coin, liquidity providers reap significant benefits from participating in Upshot’s vault on Astaria. When they contribute capital to PublicVaults, they receive yield-bearing ERC-4626 VaultTokens, thereby earning interest on their provided funds. This model presents an attractive proposition for liquidity providers, enabling them to earn from their capital while contributing to a DeFi ecosystem. The epoch-based operational system of PublicVaults also provides liquidity providers with a sense of stability, as withdrawals need to be signaled at least one epoch in advance.

### Loan Mechanics on Astaria 
Loan mechanics on the Astaria platform are shaped by the fine-tuned parameters defined by strategists, offering flexibility and precision in the lending process. Here's a quick overview of these parameters:

- __Loan Amount__: The loan amount, denominated in the ERC20 token used by the Vault.
- __Duration__: The loan duration in seconds.
- __Interest Rate__: The interest rate of the loan. All rates on the Astaria protocol are in simple interest and non-compounding.
- __Maximum Potential Debt__: This is the highest possible debt that can be accrued against an NFT considering all existing loans. It's a vital factor when strategizing multiple loans against the same collateral.
- __Liquidation Initial Ask__: The requested starting price of the Dutch auction if the collateral is sent to liquidation. Note that the initial auction price is set by the most senior lien in the lien stack.

These mechanics contribute to the versatility of Astaria's lending platform, allowing users to have diverse and strategic engagement with NFTs. For more in-depth information about these mechanics and how they function within the larger Astaria ecosystem, we encourage you to visit Astaria's loan term [documentation](https://docs.astaria.xyz/docs/protocol-mechanics/loanterms). 

## Upshot’s Vault Management Strategy 
At Upshot, our lending strategy is designed to minimize risk for the lender while maximizing value for the borrower. To accomplish this, we leverage Upshot's industry-leading appraisals, recovery rate models, default probability estimates, and our proprietary risk management framework. This ensemble of models and analyses ensures that our lending strategies provide fair, accurate terms, and a healthy yield, all while mitigating the risk exposure for our liquidity providers and ourselves.

From selecting high-quality NFT collections to considering future collateral value when determining loan amounts, each element of our strategy is tailored to provide optimal benefits for all stakeholders. Borrowers can take advantage of our flexible lending process where our quant team fetches all the loan terms, which are then fed into the Astaria SDK. This system allows us to offer borrowers the most current and relevant lending terms, frequently updated every 30 minutes, and lenders the opportunity to stake in our vault. 

We have also added a "kill-switch" feature that quickly responds to significant market events, further ensuring the protection of our liquidity providers. As we embark on this journey with Astaria, we remain committed to continuously improving and refining our lending strategies, based on market trends and user feedback

### Upshot’s Vault 
Upshot's initial offering will feature one unified vault, presenting several advantages:

- __Simplicity__: A single NFT lending vault simplifies management and operations, making it easier for users to understand the lending process.
- __Greater liquidity__: Consolidating NFTs from various owners increases overall market liquidity, facilitating borrower access and enabling lenders to earn interest.
- __Reduced risk__: Pooling NFTs from multiple owners spreads default risk across a broader pool of borrowers, reducing loss risk for individual lenders in case of a default.

This setup will be reviewed and potentially revised based on user feedback and demand, with plans to launch additional vaults over time to cater to varied risk profiles and lending strategies.

### Supported Collections (As of May 25, 2023) 
As of the initial launch, Upshot will support the following collections as part of our initial vault: 

- Azuki
- BAYC
- Beanz Official
- Chromie Squiggles
- CloneX
- CryptoDickbutts
- Doodles
- MAYC
- Milady
- Moonbirds
- Pudgy Penguins

We look forward to expanding our collection and vault offerings in the coming months.

### Upshot’s Methodology 
Upshot’s strategy embraces "conservative NFT lending," with terms designed to minimize lender risk while still providing value to the borrower. Core elements of our strategy include:

- __Collateral__: Borrowers provide an NFT as collateral for the loan, selected from high-quality collections with a history of stable or appreciating value.
- __Loan amount__: The amount is a function of the future collateral value, less a margin for forecasting uncertainty, offering adequate protection to the lender in case of default.
- __Loan duration__: The duration is based on the highest future recovery value over a 30-day time horizon, ensuring maximum recovery value in the event of a default.
- __Interest rate__: The rate compensates the lender for the risk involved in lending the NFTs, such as default risk and illiquidity risk.
- __Leverage__: Our initial strategy does not permit second or third lien loans.

Please note that this design is flexible, and adjustments will be made based on feedback regarding parameters such as loan amount and interest rate. 

### Our Risk Mitigation Framework
In our commitment to maximize value and mitigate risk for Astaria Vault participants, Upshot utilizes a sophisticated Portfolio Optimization framework, deeply rooted in Modern Portfolio Theory (MPT). MPT emphasizes the power of diversification, aiming to create an optimal asset allocation with superior risk-adjusted returns through careful optimization strategies.

Upshot's approach to portfolio optimization is methodical and data-driven. We begin with a collection's time-series data, utilizing daily floor prices and our in-house generated appraisals to construct robust time series. From these data points, we calculate risk and return approximations, employing different modeling methods such as mean, exponentially weighted average, or machine learning-based algorithms like Auto-regressors and GARCH.

After determining return and risk approximations, we move to portfolio selection. We employ optimization solvers to determine collection weights, thereby constructing a portfolio that meets investors' objectives within set constraints. Upon establishing collection weights, we then proceed with our capital allocation strategy.

Recognizing the limitations of traditional MPT techniques, particularly in the dynamic and sometimes unpredictable NFT market, we've integrated alternative portfolio construction methods. These include minimum spanning tree (MST) and centrality-based methods from Graph Theory, which offer a more nuanced approach to diversification and have shown promising results in terms of out-of-sample performance. This innovative strategy not only ensures that our portfolio is robust against market fluctuations, but it is also highly scalable.

## Conclusion 
This partnership between Upshot and Astaria presents a promising new horizon NFT financialization. To learn more about Upshot and our strategic approach, visit our [website](https://upshot.xyz/). For a closer look at how we're utilizing our robust machine learning capabilities with Astaria's on-chain NFT lending platform, check out our [Astaria-Upshot vault](https://astaria.xyz/lend/vaults/0xe5149d099b992e3dc897f3f4c88824eac2a6a59d). If you're interested in diving deeper into Astaria's protocol or need help navigating the platform, you can find comprehensive guides and helpful details in Astaria's [documentation](https://docs.astaria.xyz/). 

We invite you to embark on this journey with us as we redefine the boundaries of ownership in the world of NFTs. This partnership with Astaria allows individuals to navigate an expansive range of unique use cases for their jpegs, unlocking unprecedented ways of engaging with NFTs. Together, we are transforming the concept of asset ownership, breaking down barriers and bridging the gap between the world of DeFi and NFTs. Join us in this exciting new chapter as we unlock the potential of NFTs like never before by visiting our [vault](https://astaria.xyz/lend/vaults/0xe5149d099b992e3dc897f3f4c88824eac2a6a59d).

Astaria has partnered with Upshot bringing Upshot lending strategies to their platform.

Upshot Unveils Strategic Partnership with Astaria as Inaugural Vault Strategist

## Introduction
The world of investing has been transformed by the rise of digital assets, and none more so than NFTs. These unique digital assets have captured the imagination of investors around the world, and there is now a growing demand for indexes that can track their performance.

[__Upshot Indexes__](https://app.upshot.xyz/indexes) offer a new approach, providing index methodologies and API endpoints for developers to create index products that track the performance of a basket of NFTs. This allows projects to offer exposure to a broad range of NFTs or specific segments of the market. For example, developers might use Upshot to build an NFT index that tracks the performance of blue-chip NFTs or Yuga Labs NFTs.

## The Basics of NFT Indexes and ETFs
NFT indexes allow investors to track and gain diversified exposure to the world of non-fungible tokens without the need to purchase individual NFTs. These indexes function similarly to traditional indexes by tracking a basket of assets – in this case, NFTs – that meet specific criteria such as rarity, popularity, or historical value. Key benefits of NFT index funds include ease of entry, diversification, reduced time and knowledge requirements, and improved liquidity.

To learn more about the intricacies of NFT index funds and how they compare to traditional index funds, read our in-depth blog post [__here__](https://upshot.xyz/post/introduction-to-nft-index-funds).

### Challenges of Building NFT Indexes
Creating NFT indices presents a unique set of challenges such as limited scope when tracking floor NFTs, pricing complexities, and liquidity and capacity concerns. To learn more about these challenges, please refer to our [__previous blog post__](https://upshot.xyz/post/introduction-to-nft-index-funds) on NFT indexes more generally.

#### Limited Scope When Tracking Floor NFTs
Presently, NFT index funds predominantly focus on tracking the floor prices of NFT collections. However, this approach fails to capture a complete picture of the range of outputs that are in a collection, as some collections contain highly-valuable rare NFTs that are worth significantly more than floor NFTs. Consequently, this limited scope results in an inaccurate representation of the true diversity and value potential of a collection.

#### Pricing Complexities
NFT indices typically weight-adjust their construction based on the floor price the various collections within the index. This does not take into account the collection as a whole, which would require pricing algorithms to better understand the value of the entire collection. Developing sophisticated pricing models for NFTs can be challenging due to the unique characteristics of each asset and the lack of historical data compared to traditional financial assets.

#### Liquidity and Capacity Concerns
NFTs are non-fungible, low-velocity assets. This characteristic poses challenges for NFT indexes in that oftentimes there is not sufficient capacity in the open market to rebalance the portfolio. Moreover, the acquisition and disposal of NFTs can be time-consuming and expensive, potentially hampering the fund's ability to manage its portfolio efficiently and effectively.

## Introducing the Upshot Indexes: Empowering Projects to Create More Expressive NFT Financial Infrastructure
Upshot has constructed a set of NFT index methodologies to enable other projects to build more expressive financial primitives for NFTs with our API. By providing the framework and tools necessary for designing and maintaining NFT indexes, Upshot aims to enhance the accessibility of the NFT space and open up opportunities for more meaningful capital allocations as well as more interesting financial innovations.

Leveraging our quant team’s extensive research and experience in constructing indexes for less liquid financial assets, Upshot's initial set of indexes track core sectors of the NFT space. This initial set of indexes include the Upshot Yuga Index, Upshot Art Blocks Curated Index, and Upshot PFP Index. These methodologies can be used to track the performance of specific segments of the NFT market or the broader market as a whole, with updates available on an hourly cadence.

By equipping index creators with robust and accurate pricing methodologies, Upshot empowers them to overcome common challenges like liquidity constraints, capacity issues, and the accurate valuation of assets within a collection. Through this approach, Upshot facilitates the growth of the NFT index ecosystem, making it more diverse and catering to a wide range of investor preferences and risk appetites.

### Presenting Upshot's Premier NFT Index Methodologies
Upshot is launching three initial index methodologies that cater to various NFT market segments: the Upshot Yuga Index, Upshot Art Blocks Curated Index, and Upshot PFP Index. 

#### Upshot Yuga Index
The methodology behind the Upshot Yuga Index monitors the performance of collections under the Yuga Labs umbrella, weighted by appraisal-based market cap. This methodology captures some of the most liquid NFT collections, enabling developers to offer exposure to verticals such as PFPs, metaverse, generative art, and gaming in a single index. The Upshot Yuga Index includes collections such as Bored Ape Yacht Club, Otherdeed for Otherside, Mutant Ape Yacht Club, CryptoPunks, Meebits and Bored Ape Kennel Club. 

To view more details around the methodology of the Upshot Yuga Index, visit [__here__](https://app.upshot.xyz/indexes/yuga). 

#### Upshot Art Blocks Curated Index 
The methodology behind the Upshot Art Blocks Curated Index tracks the top 20 Art Blocks Curated NFT collections, enabling developers and projects the ability to offer exposure to cutting-edge generative art. This index construction is composed of the following collections: Chromie Squiggle by Snowfro, Fidenza by Tyler Hobbs, Ringers by Dmitri Cherniak, Gazers by Matt Kane, and Archetype by Kjetil Golid among others. 

For more information on the methodology of the Upshot Art Blocks Curated Index, click [__here__](https://app.upshot.xyz/indexes/artblocks-curated).

#### Upshot PFP Index
The methodology behind the Upshot PFP Index tracks the top 20 PFP (profile picture) collections, weighted by appraisal-based market cap. This index represents a significant portion of the NFT space, with many PFP projects driving social identity, community engagement, and network value within the digital realm. The Upshot PFP Index includes collections such as CryptoPunks, Bored Ape Yacht Club, Azuki, Clone X, Pudgy Penguins, and Doodles. 

For more information on the construction of the Upshot PFP Index, click [__here__](https://app.upshot.xyz/indexes/pfp).

## Ways to Use Upshot’s NFT Index Methodologies  
#### Utilizing Upshot's NFT Index API as a Price Oracle for Perpetuals
Upshot's NFT Index API endpoint can be utilized as a powerful price oracle for the creation of NFT perpetuals. Perpetuals are a type of financial derivative that allows traders to take long or short positions on an underlying asset without an expiry date. In the context of NFTs, perpetuals can enable traders to speculate on the future price movements of NFT collections or the overall NFT market without actually owning the underlying NFTs.

The Upshot NFT Index API endpoint provides access to novel index constructions and price feeds that are crucial for calculating the index value and ensuring that the perpetual futures accurately track the performance of the underlying NFT collections. This includes information such as weighting based on appraisal-determined market caps of various NFT collections included in the index. Additionally, the API endpoint allows users to retrieve historical index prices, which can be used to analyze price trends, develop trading strategies, and assess the risk and return characteristics of the NFT market.

By leveraging the Upshot NFT Index API endpoint as a price oracle, creators of NFT perpetual futures can benefit from a robust, reliable, and up-to-date source of pricing information. This not only ensures that the perpetual futures are accurately tracking the performance of the NFT market, but also helps to establish trust and credibility among traders and investors participating in the NFT perpetuals market. 

#### Unlocking Holistic NFT Market Insights for Analysts and Researchers 
Upshot's NFT Index API is a powerful tool that enables analysts, researchers, and media organizations to gain a comprehensive understanding of the NFT market. NFT indexes offer a novel method for analysts to understand the NFT market, as they provide a holistic perspective on the rapidly evolving landscape, moving beyond the limitations of individual collections and enabling a more comprehensive analysis.

By breaking down the NFT market into different segments, such as art, gaming, and PFPs, analysts can identify trends and patterns within each category. Tracking the performance of NFT indexes over time enables the identification of market movements, emerging trends, and potential investment opportunities. Utilizing Upshot’s NFT API, analysts can generate valuable insights by creating in-depth reports, research papers, or news articles, which in turn assist investors, enthusiasts, and the general public in making informed decisions and staying up-to-date on the latest developments in the NFT market.

## Conclusion
The launch of Upshot Indexes marks an exciting new chapter in the rapidly evolving intersection of DeFi and NFTs. As the NFT market continues to mature, we can expect to see more projects leveraging these NFT indexes as a way to offer exposure to this exciting new asset class. By providing developers with robust methodologies and an easy-to-use API endpoint to build with these NFT indexes, Upshot is paving the way for a future where the financialization of NFTs unlocks new investment opportunities and enhances our understanding of this dynamic market. 

To learn more about the technical details of Upshot's offering, we invite you to explore our [__developer API documentation__](https://docs.upshot.xyz/reference). If you're ready to start building your own NFT index products, you can sign up for access to [__our developer portal__](https://developer.upshot.xyz/signin). As NFTs continue to reshape the digital asset landscape, we believe that innovative financial infrastructure, like Upshot Indexes, will play a vital role in driving the development of novel financial primitives. 

Introduction article to Upshot Indexes: A New Era of NFT Exposure.

Introducing Upshot Indexes: A New Era of NFT Exposure

Index funds are an indirect way to get exposure to an entire market without having to put in the work to pick the underlying assets individually. Today, various types of index funds exist, including equity indexes, bond indexes,  commodity indexes–and NFT index funds–that cater to diverse investment needs and preferences.

An NFT index fund is a vehicle that tracks an index of NFTs, typically from similar collections (e.g. [Yuga Labs](https://www.yuga.com/)), traits (e.g. hoodie CryptoPunks), or prestige (e.g. Art Blocks Curated). This post will explore how NFT indexes work, what they enable, the challenges uniquely faced by NFT indexes, and how those challenges can be overcome 

## What is an NFT Index?

An NFT index contains a list of hand-picked NFTs whose overall value is determined using capitalization-weighted, equal-weighted, or price-weighted methods.

An NFT index’s basic objective is to provide investors with insight into an NFT’s performance in the [DeFi](https://www.coindesk.com/learn/what-is-defi/) market. It does this by acting as a benchmark or reference point for investors to track the movement of NFTs in the market and make trading decisions using their deductions.

As typical within the volatile crypto and [NFT markets](https://upshot.xyz/post/nft-markets-are-maturing), NFT indexes are regularly adjusted to match NFTs’ supply. So while these indexes may offer investors an opportunity to make better trading decisions, they can be volatile as their composition changes to reflect the adjustments in the market.

## What is an NFT Index Fund?

NFTs represent a new frontier of digital assets, art, and internet culture. Composed of unique digital items that cannot be replicated or replaced, NFT index funds provide a novel way for investors to gain diversified exposure to the new asset class of non-fungible tokens without having to research and pick the individual NFTs themselves.

An NFT index fund works similarly to traditional index funds in that it tracks a basket of assets–in this case, NFTs. To do this, the index fund manager will select NFT collections that qualify for the index based on specific criteria, such as [rarity](https://upshot.xyz/post/nft-rarity-tools), popularity, or historical value. 

For example, the NFT index fund manager may track a basket of Yuga Labs NFTs, which include Bored Ape Yacht Club, Mutant Ape Yacht Club, Bored Ape Kennel Club, and [Otherside NFTs](https://www.coindesk.com/layer2/2022/05/02/otherside-and-the-future-of-nft-consolidation/). They will also consistently monitor the collections for various risks, as set forth by the index guidelines.

The index fund manager will also determine how often each index is rebalanced, generally monthly, quarterly, or bi-annually. This rebalancing process involves adjusting the weight of each collection within the index, typically based on factors like their floor price, appraised value, or overall market capitalization.

### NFT Index Funds vs Traditional Index Funds

Like NFT index funds, traditional index funds are investment vehicles that offer profit-making opportunities through investing in assets. However, their operational strategy differs greatly. One major difference between both is that NFT index funds invest in NFTs while traditional index funds invest in [traditional financial assets](https://www.mdpi.com/1099-4300/24/11/1565) such as stocks, bonds, or commodities.

An NFT index fund allows investors to gain exposure to a diversified portfolio of NFTs. It tracks and invests in a basket of equities that align with a specific index.

On the other hand, a traditional index fund is a type of mutual fund or exchange-traded fund (ETF) where a portfolio is constructed to match or track the components of a financial market index. Essentially, traditional index funds aim to replicate the performance of a specific market index.

Additionally, traditional funds are typically considered a more passive type of fund management. Where NFT index funds feature fund managers who consistently monitor the collections for various risks and trade using the information discovered, index fund managers curate portfolios that match and mirror the movement of securities of a particular index. 

## How Traditional index funds work

Index funds are typically considered a more passive type of fund management. As opposed to hedge fund managers who actively try to stock pick and time the market with buys and sells, index fund managers build up a portfolio of holdings to mirror the securities of a particular index. The idea is that the investment profile of the index matches the performance of a whole, broad segment of the market. 

For example, index fund investors can buy funds that focus on companies with small, medium or large capital values, or they can buy funds that focus on sectors such as technology or energy. While these more specific index funds may be less diversified than the broadest market index, they are still more diversified than if someone were to buy individual stocks within a sector. 

### Traditional Index Fund Example

There are numerous traditional index funds designed to track various market indexes. Some popularly known examples include:

#### S&P 500
In the United States, the [S&P 500 Index](https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview) is one of the most popular indices. The S&P 500 Index, or Standard & Poor's 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes such as liquidity, financial stability, and a history of profitability. 

As a result, the S&P 500 Index offers a comprehensive representation of the U.S. stock market's health. The S&P 500 index is regarded as one of the best gauges of prominent American equities' performance.

#### Dow Jones Industrial Average (DJIA)
Also known as the Dow 30, the [Dow Jones Industrial Average](https://www.dowjones.com) (DJIA) is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange (NYSE) and Nasdaq. The Dow includes companies like Nike, Salesforce, Goldman Sachs, Visa, Coca-Cola, and IBM.

The DJIA is also designed to serve as a proxy for the health of the broader U.S. economy. Often referred to simply as the Dow, the DJIA is one of the most-watched stock market indexes in the world. Although the Dow encompasses a variety of businesses, each can be characterized as a blue-chip company that consistently generates stable earnings.

## NFT Index Funds to Know

NFT index funds are rapidly revolutionizing the NFT market and challenging the traditional index structure as a whole. By offering investors the exposure and insight they need in the NFT market, these asset classes provide the possibility of making a profit off NFTs without necessarily having to research and invest in individual NFTs.

Although NFT index funds are an innovation, they are becoming a staple in the NFT market and now play a crucial role in managing NFT investment complexities. While there may be a limited option of NFT index funds available in the market today, this will change in the coming years as NFT index funds become more implemented and embraced. However, some important NFT index funds every investor should know include:

### 1. Upshot Index
![upshot logo2](//images.ctfassets.net/lhkcghnr8ql4/3SrLPrMZWqZRw9lvxVxLWb/52cd65ee1b8819c01dbf51e7bebccfe6/upshot_logo2.png)

The [Upshot Index](https://upshot.xyz/post/introduction-upshot-indexes) enables developers to build financial infrastructures that allow investors to track the performance of the broader NFT market. It offers a new approach to index methodologies by providing investors with the framework and tools they need to create and maintain NFT indexes that will be used to track the performance of a basket of NFTs. 

For example, the Upshot Index can be used to create NFT indexes that track the performance of blue-chip NFTs. Developers can create expressive financial infrastructures that challenge the complexities that plague NFT indexes such as liquidity problems and capacity limitations. 

While Upshot will not be issuing these indexes as investable products directly, the company is actively exploring partnerships with financial institutions and developers to create ETFs, perpetuals, and other investment products based on the Upshot Indexes. As the NFT market continues to grow and evolve, Upshot plans to expand its index offerings to capture emerging trends and opportunities in the space.

For more information about Upshot and Upshot Indexes, please visit [https://upshot.xyz/](https://upshot.xyz/)

### 2. Bitwise Blue-Chip NFT Index Fund

![Bitwise](//images.ctfassets.net/lhkcghnr8ql4/4Mns5A5iwhvv5MKYJyIKl8/c93ddd9ce6e376507cfa420574e2b26d/Bitwise.png)

The [Bitwise Blue-Chip NFT Collections Index](https://bitwiseinvestments.com/crypto-funds/nft) was developed to [track blue-chip NFT collections](https://static.bitwiseinvestments.com/FundDocs/nftFund/Bitwise-Blue-Chip-NFT-Index-Fund-Investment-Case.pdf?_ga=2.248036487.1099504939.1648648633-923459484.1648479033) in the Arts and Collectibles sector. It screens and selects collections using criteria such as the minimum number of assets in its collection, liquidity, and category, and ranks the selected collections based on floor market capitalization. 

Some of the most popular index constituents in the Bitwise Blue-Chip NFT Index Fund include Crypto Punks, Bored Ape Yacht Club, Mutant Ape Yacht Club, Azuki, [Chromie Squiggles](https://upshot.xyz/post/buying-guide-chromie-squiggles), and Clone X. The assets are rebalanced quarterly.

__Where to Buy:__ The Bitwise Blue-Chip NFT Index Fund is not a publicly traded fund. It’s available to accredited investors for private placement subscription with a $25,000 minimum investment and will provide monthly redemptions after an initial lock-up period of 6 months.

### 3. Bitwise Metaverse NFT Index
![Bitwise](//images.ctfassets.net/lhkcghnr8ql4/4Mns5A5iwhvv5MKYJyIKl8/c93ddd9ce6e376507cfa420574e2b26d/Bitwise.png)

The [Bitwise Metaverse NFT index](https://bitwiseinvestments.com/crypto-funds/ball-multicoin-bitwise-metaverse-index-fund) is a new asset class launched by Bitwise and  Matthew Ball, CEO of Epyllion and the former global head of strategy for Amazon Studios. This index will include up to 40 metaverse-related crypto assets, their weighting, and a corresponding fund tracking the performance of the index. 

The crypto assets will be chosen using factors such as custody, liquidity, technological, and regulatory risk. 

__Where to Buy:__ The index fund is offered through Bitwise.

## Benefits of NFT Index Funds
![NFT Index Funds](//images.ctfassets.net/lhkcghnr8ql4/2eMvae9vKisAAqEP5a0S10/ffac846ed9c9162bd36164f151714668/NFT_Index_Funds.png)

### Ease of Use

With the rapid growth of the NFT market, NFT index funds offer a familiar and easy way for investors to gain exposure to the burgeoning market of digital assets in a manner that is very similar to how TradFi investors already operate. By leveraging the expertise of index fund managers, potential investors can enter the complex world of NFTs with greater confidence and reduced barriers to entry.

### Portfolio Diversification

The average investor does not have the capital to buy a breadth of NFTs to represent all of the various blue-chip NFT collections out there. With floor prices of blue-chip NFTs rapidly climbing, even one NFT purchase can eat up the majority of dry powder for an individual investor. NFT indices are a great way to gain broad exposure with a smaller amount of capital. 

Investors can enjoy the benefits of owning a diverse portfolio of NFTs, reducing the risk associated with concentrating investments in just a few assets. 

### Lower Time and Knowledge Requirements 

The [NFT market](https://upshot.xyz/post/nft-markets-are-maturing) moves lighting fast—collections can take off or dump within a weekend of news. It is exhausting for the average NFT participant to keep up with the major sources of news, especially when much of the information lives on Twitter or private Discord servers. 

Similar to how average TradFi investors are not listening to every public company earnings call, NFT indices allow people to participate in a broad manner without having to understand every detail. This not only saves time and energy, but also helps mitigate the risk of making financial decisions based on incomplete or inaccurate information.

### Liquidity 

One of the challenges NFT investors face is the lack of liquidity in the market, as buying and selling individual NFTs can sometimes be difficult due to their unique nature and varying demand. NFT index funds can help address this issue by providing investors with an investment vehicle that is easier to trade in and out of compared to individual NFTs. 

The pooled nature of index funds typically allows for greater liquidity, making it more convenient for investors to adjust their positions as needed.

## Complexities of Building NFT Indices 
![NFT Indices](//images.ctfassets.net/lhkcghnr8ql4/1hxz7gNXFerwXZWIAbaE6N/987f3a0480c210384df5bef1ac55d1d0/NFT_Indices.png)

### Some Only Track Floor NFTs

Today, the NFT index funds that do exist typically only track floor prices. [Floor NFTs](https://chain.link/education-hub/what-is-an-nft-floor-price) are not indicative of the entire collection, especially when some collections have grails (or rare NFTs) that are worth several orders of magnitude more than the floor NFT. The limited scope of floor NFTs does not accurately reflect the true diversity and potential value within a collection, which can lead to suboptimal investment performance.

### Pricing 

NFT indices typically weight-adjust their portfolios based on the floor price of a collection. This does not take into account the collection as a whole, which would require pricing algorithms to better understand the value of the entire collection. Developing sophisticated [pricing models for NFTs](https://upshot.xyz/post/how-upshots-ml-models-work) can be challenging due to the unique characteristics of each asset and the lack of historical data compared to traditional financial assets.

### Liquidity and Capacity Issues 

NFTs are non-fungible assets that often have low velocity. Given that each asset is unique, they change hands much less frequently than traditional [ERC-20 tokens](https://ethereum.org/en/developers/docs/standards/tokens/erc-20/) or stocks. It is difficult for an NFT fund to curate an index and have the right capacity on the open market to rebalance it as needed. 

Additionally, the process of acquiring and disposing of NFTs can be time-consuming and costly, which may limit the fund's ability to efficiently and effectively manage its portfolio.

## Possible Solutions to Building NFT Indices 

If you’re looking to build out an NFT index, work through these challenges with a few innovative solutions. 

### NFT Appraisals 

[NFT appraisals](https://upshot.xyz/post/how-upshots-ml-models-work) allow NFT indices to place a better basket of assets that more accurately reflect the broader collection, beyond simply adding floor assets. They can better index the higher end of the NFT market by taking into account rarity, metatraits, and historical trading patterns, among other factors. 

Developing comprehensive appraisal methodologies and leveraging advanced [ML models](https://upshot.xyz/post/how-upshots-ml-models-work) can help index fund managers more accurately assess the value of each NFT within a collection, leading to a more representative index.

### Capacity

NFT index funds may face capacity constraints due to the illiquid nature of the assets they hold. To address capacity issues, NFT index funds can implement strategies such as limiting the size of the fund, focusing on more liquid NFT collections, or utilizing derivatives and other financial instruments to gain exposure to the underlying assets without directly owning them. 

This approach can help improve the efficiency and flexibility of portfolio management while minimizing the impact of liquidity constraints. 

In traditional finance, the high-yield bond market, also known as the "junk bond" market, faces similar capacity constraints due to the illiquidity of these assets. To manage these constraints, some high-yield bond index funds employ strategies like sampling, wherein the fund invests in a representative sample of the bonds in the index, rather than holding each bond in the index. 

This sampling approach allows the fund to maintain a more manageable portfolio while still aiming to achieve a similar risk and return profile as the overall index. By adopting similar strategies, NFT index funds can address capacity constraints and provide investors with diversified exposure to the NFT market, even in the face of illiquidity challenges.

### Synthetics & Perpetuals

A synthetic asset is an asset that tracks the value of another asset, essentially mirroring its price movements without the need for direct ownership of the underlying asset. One common form of synthetic asset is a [perpetual contract, or perp](https://milkroad.com/funding/perpetual-contracts#:~:text=A%20perpetual%20contract%20is%20a,from%20the%20underlying%20crypto%20asset.), which is a type of derivative that does not have an expiration date. 

To create a synthetic asset, a pool of capital and a reliable price feed that consistently updates are required. A well-known example of a synthetic asset is DAI, which tracks the value of the US Dollar. Utilizing price feeds for an NFT index can provide investors with synthetic exposure to the index through instruments like perpetual contracts. 

This approach may help mitigate some of the capacity issues and potentially simplify the design of an investable NFT index product, making it more accessible to a wider range of investors.

## The Future of NFT Index Funds with Upshot

For several decades, traditional financial markets have offered investors the opportunity to get broad exposure to various asset classes by simply buying into a basket of goods that serve as a proxy for the market. As NFTs emerge as a novel class of digital assets, investors are increasingly eager to have vehicles that give exposure to the asset class without having to put in the time and effort to pick various jpegs individually. 

As the [NFT market continues to mature](https://upshot.xyz/post/nft-markets-are-maturing), innovative solutions to these problems will play a crucial role in addressing the complexities and challenges associated with building and managing NFT indices. By providing robust and accurate pricing methodologies, Upshot can empower index issuers to easily overcome obstacles such as liquidity constraints, capacity issues, and accurate valuation of assets within a collection. 

As a result, the development and adoption of NFT index funds will become more seamless and efficient, ultimately making the world of NFT investing more accessible and attractive to a broader range of investors. 

Ultimately, NFT indices will be an increasingly important frontier in allowing individuals to interact with the new digital renaissance. 

To leverage sophisticated tools like the Upshot Index and make more informed decisions in the NFT market, [start exploring with Upshot today](http://Upshot.xyz).


Introduction To NFT Index Funds

It’s easy to get lost in the day-to-day fluctuations of a digital community’s:

- Social media engagement
- Website traffic
- And, in the case of NFT collections, floor prices

But as we always say: __floor price alone don’t tell the full story of a digital community’s value.__

Moreover, sometimes a dip in a key metric might look concerning on the surface, but may not actually signal impending doom like many assume.

To truly understand the health of a digital community, you must look beyond the standard metrics. In this post, we’ll break down how to do an in-depth community analysis—focusing on everything from network structure to engagement trends.

We’ll use a popular NFT collection ([Azuki](https://www.azuki.com/))  as a case study to showcase these techniques. But the insights apply to assessing any online community.

Analyzing how this community responded after the launch of a new collection uncovered some counterintuitive insights. Not least of which, their asset prices dropped but their community grew larger and stronger by many measures.

But we’re getting ahead of ourselves.

First, let's look at how to analyze a community's strength.

## Conducting Network Analysis
Most real world and digital communities can be thought of as networks: sets of people connected together.

Everything from social networks to metabolic networks fit this topology. Most networks have common properties. For example, they often follow a power law distribution, where a small number of nodes are highly connected hubs, but most nodes only have a few connections.

Analysis of network structure can reveal insights about the nature of the underlying community. For example, many networks follow a power law distribution, with a few highly connected hubs and most other nodes having just a few connections.

For NFT networks, this likely represents a few whale wallets transacting with many others, while most holders only interact with a small subgroup.

## Quantifying Subgroups Through Community Detection
One key technique used in network analysis is community detection. This involves identifying densely connected clusters of nodes, with sparser connections between clusters.

Intuitively, these clusters represent subgroups within the broader network - like friend groups within a social network. In an NFT collection, detected communities likely represent groups of closely linked collectors and holders.

The cohesion of communities can be quantified using modularity. Networks with high modularity have dense connections inside communities but sparse connections between them.

So when examining an NFT collection, detecting communities and calculating their modularity provides insights into the composition and connectivity of holder subgroups––going beyond just individual wallet links and floor price.

## Analyzing the Azuki NFT Network
To analyze the Azuki NFT community, and determine the strength of their network beyond the headlines and floor prices, we looked at transaction data over a 6 week period in mid-2023. The snapshots of the collection took place just before and after their Elementals mint on June 27th.

We extracted two key datasets:

1. __Ownership data__: how many Azuki NFTs each wallet held
2. __Transaction data__: a network showing Azuki sales and transfers between wallets

![azuki image](//images.ctfassets.net/lhkcghnr8ql4/HLjvxUMTU6zteB1M6qYtM/0b09f85247ce83e37eb1bf32dfebf536/azuki_image.jpeg)

# How Ownership Transformed
Now, many Azuki holders complained that they experienced technical issues with the mint. Some were unable to mint any NFTs from the new Elementals companion collection. Other holders complained that the art for the collection looked almost identical to the original collection. An egregious error for a hefty 2 ETH mint price.

These factors led to a massive drop in floor price, and many criticizing the project.
![azuki price chart](//images.ctfassets.net/lhkcghnr8ql4/1KyLtbeJJqACKyuQkFVysE/4d278678eb353d4d79e93640d3b9336c/azuki_price_chart.jpeg)
*Image courtesy of [@mrjasonchoi](https://twitter.com/mrjasonchoi) on X.com*

But network analysis shows us that floor price, headlines, and twitter sentiment don’t tell the whole story. 

The data we analyzed showed a steady increase in unique holders––i.e., more community members––from 3,381 in the weeks preceding the mint to 4,372 just a couple weeks after the mint.

We also saw the number of wallets making transactions surged after the Elementals release, from 1,006 to over 6,500 weekly.
![Azuki ownership analysis](//images.ctfassets.net/lhkcghnr8ql4/73qTy1J9g3dwaN8NDPcVU1/81cb712fd4160eda54e6ea5cfb99ffe0/Azuki_ownership_analysis.png)

Also, analyzing the top 100 Azuki holders showed around 60% remained consistent holders before and after the release. So, despite the headlines, the "whales" were mostly staying put.

![Azuki whale analysis](//images.ctfassets.net/lhkcghnr8ql4/3Cp1tNMdrqou4jVczVYuiY/d972fd46602fd63a96161317a084072e/Azuki_whale_analysis.png)

# Insights on Azuki’s Transaction Network
In addition to ownership data, we also looked at the network of Azuki transactions between wallets each week. Studying patterns in these transactions revealed insights about the community’s structure and engagement over time.

One metric we examined was __assortativity__: the extent to which similar wallets connect to each other. High assortativity indicates wallets tend to connect to other similar wallets.

For NFTs, this could mean whales transacting with other whales, or collectors within the same community subgroup trading with each other.

To calculate assortativity, we first used community detection algorithms to identify subgroups of closely connected Azuki holders. We saw the number of communities increase over time as more new holders joined.

This image is a visual representation of the Azuki community’s connections before the Elementals launch (between June 19th and June 26th):
![Azuki community pre launch](//images.ctfassets.net/lhkcghnr8ql4/7nrgWXj4oc0sIzIfZfPfuD/fee05411e5bda44b7596e3d9bafe0471/Azuki_community_pre_launch.png)

This image is a visual representation of the network after the launch, from June 27th to July 3rd:
![azuki community post launch](//images.ctfassets.net/lhkcghnr8ql4/6TioWd0t1nepvOFxJL57tM/2d03a0b615082ab75fcbd82f5731880b/azuki_community_post_launch.png)

As you can see, the community grew significantly, and became more interconnected. This suggests a stronger, more resilient network.

We also saw shifts in the key buyers and sellers week to week. No single whale dominated - different wallets emerged as hubs each period. This was another positive indicator, which shows a diverse network not dominated by single nodes (so to speak).

__Back to the assortativity calculations:__

The lower the assortivity, the less alike each wallet is. Implying a robust, diverse community that’s part of many communities.

The assortivity dipped when Azuki Elementals launched.

![assoritivity ratings](//images.ctfassets.net/lhkcghnr8ql4/4z7xk5mxaXExH23PM0H7Js/1ba2d2f2f74f91446ba3a96f216d7e45/assoritivity_ratings.png)

In short, these network insights suggest the introduction of Elementals brought in new holders from across groups. Azuki's community was diversifying and strengthening despite price drops.

## Key Takeaways
While we focused on one specific community, these network analytics can be used to understand any digital community. Some key lessons:

- Look beyond surface metrics. Network structure better reflects engagement.
- Monitor changes around major events. This reveals if new members join or existing ones leave.
- Identify core members and influencers within detected communities. Engage these VIPs.
- Watch for new hubs emerging over time. Distributed activity is healthy.
- Consider incentivizing key members during volatility to prevent mass exodus.
- Establish network baseline metrics early on. Track how they evolve across milestones.

Of course, every community is unique. But network analysis provides a data-driven toolkit to gain actionable intelligence on your digital community’s health.


Floor price doesn't reveal the full health of a digital community. We break down techniques like network analysis, engagement trends, and community detection to gain deeper insights.

How to Quantify a Digital Community’s Strength

Despite ever-changing market conditions, the NFT lending space represents immense potential for traders, lenders, and developers.

Indeed, its propensity for transformation is part of what makes NFT lending so fruitful.

But with potential comes risk. You must have a strategy to protect yourself, your profits, and your assets.

- Lending on risky platforms with low collateralization ratios could lead to unnecessary losses for you.
- Failure to diversify your portfolio across platforms, collections, and [asset buckets](https://upshot.xyz/post/asset-buckets) could leave you overexposed.
- You might miss out on opportunities for more attractive yields.

This article provides strategic insights on evaluating lending platforms, setting prudent loan terms, diversifying NFT assets, managing liquidation risks, and more.

With these practical tips and risk management strategies, you can confidently maximize returns in NFT lending while minimizing downside risks.

We’ll start by breaking down the two main types of lending models:

__Peer-to-peer and peer-to-pool.__

## What Are the Differences Between Peer-to-Peer and Peer-to-Pool Lending?

- __Peer-to-Peer Lending__: This model facilitates direct transactions between individuals. A typical scenario involves a borrower using a platform like NFTfi or Arcade, offering an NFT as collateral to secure a loan (often in WETH or DAI), then the NFT collateral is safely stored in a vault, governed by the agreed-to terms.

- __Peer-to-Pool Lending__: This model operates a bit differently. In peer-to-pool lending, liquidity providers stake tokens into pools. Borrowers can then tap into this liquidity by placing their NFTs in vaults. BendDAO is an example of a platform that champions this lending approach.

Now that we have a cursory understanding of the different NFT lending types, let’s break down a few of the most popular lending platforms, what makes them unique, and the most common ways people earn money on them.

# Peer-to-Pool Lending
Peer-to-pool NFT lending utilizes pooled funds contributed by multiple lenders. Borrowers can access these funds by staking their NFTs as collateral into smart contract vaults.

__This provides easy liquidity without needing to sell your NFTs.__

For lenders, peer-to-pool lending offers a hands-off way to earn attractive yields. By supplying capital to lending pools, they can passively earn interest and platform fees based on pool activity.

In general, this model provides higher liquidity than direct peer-to-peer lending.

### Lending for Enhanced Yield on BendDAO
BendDAO in particular offers a lucrative proposition for lenders:

By simply depositing ETH, you can watch your investments grow as the platform lends it out to eager borrowers. But the benefits don't stop there.

Those who stake the platform’s BEND token (and possess veBEND) are entitled to an administrative fee. This fee is calculated based on the holder's [veBEND](https://docs.benddao.xyz/portal/governance/vote-escrowed-bend-vebend) balance in relation to the overall veBEND supply.

Remarkably, this [administrative fee](https://docs.benddao.xyz/portal/governance/fee-collection-and-distribution) constitutes about 30% of the total interest revenue amassed from all NFT loans. And for the cherry on top? All these fees, paid exclusively in ETH, are disbursed to veBEND token holders on a weekly cadence.

# Peer-to-Peer Lending
Peer-to-peer lending facilitates direct loans between individuals using NFTs as collateral. On platforms like NFTfi, X2Y2, and Arcade, borrowers and lenders connect directly to agree on loan terms, and the NFT acts as security if the borrower defaults.

A key advantage of peer-to-peer lending is lower fees, as there are no intermediaries taking a cut. Lenders can also potentially earn higher interest rates than on pooled lending platforms. However, liquidity on peer-to-peer platforms can be lower as loans require manual matching. There’s also higher risk without centralized oversight.

For borrowers, peer-to-peer lending unlocks liquidity from NFTs without having to sell them. They can leverage NFTs to obtain loans tailored to their needs. Likewise, lenders can earn yields on a decentralized market outside the traditional financial system.

Overall, peer-to-peer NFT lending provides a direct and decentralized way for borrowers to monetize their NFTs and for lenders to earn yields. But it comes with the risks of a nascent market lacking intermediaries or oversight.

### How People Maximize Returns with NFTfi
NFTfi, one of the most reputable peer-to-peer NFT lending platforms, supports over 150 NFT collections. The platform employs a multifaceted approach to appraise NFT collateral value, considering factors like:

1. Current floor prices
2. Project averages
3. And valuations from [NFTBank](https://nftbank.ai/)

Borrowers benefit from the platform's robust, tamper-proof permissionless smart contract infrastructure, accessing liquidity through wETH, USDC, and DAI loans. Notably, while NFTfi waives borrowing fees, lenders incur a [5% fee](https://nftfi.com/how-it-works/) on the interest accrued from successful loans.

*__1. Lending for yield__*

This strategy can be an enticing alternative to traditional liquidity provision on platforms like [Uniswap](https://uniswap.org/).

For optimal returns, lenders might diversify by proposing multiple loan offers, each crafted with a focus on risk-minimization, such as spreading offers across different collections, and structuring conservative loan terms. Prioritizing loans on liquid assets and collections—those that can be swiftly sold if necessary—might also be beneficial.

*__2. Lending to acquire__*

Proactive lenders can leverage this strategy to make offers on desired NFTs, often securing them for a cheaper price than through an open market purchase. A boon for NFT aficionados and collectors, this strategy facilitates cost-effective NFT acquisition over time. The principles of diversified loan offers and asset liquidity still remain crucial with this strategy.

# Perpetual Peer-to-Peer Lending with Blend
Blend, [Blur](https://blur.io/)’s NFT lending platform, quickly emerged as a leader in the NFT lending space. What sets Blend apart is its deviation from the norm:

It operates independently of oracles and imposes no constraints on loan durations.

This flexibility allows borrowers to maintain their positions indefinitely, either until they repay or face liquidation. The interest rates, rather than being fixed, are shaped by market dynamics.

By channeling ETH into Blend, users not only reap yields but also accumulate Lending Points on the Blur platform. These points empower lenders to make loan offers from their Blur Pool funds. The "Max Borrow" value, chosen by the lender, dictates the maximum ETH amount that can be borrowed against a single NFT, and in turn, amplifies their point earnings.

When a borrower greenlights a loan offer, their NFT is secured, and the lender's interest earnings, denominated in ETH, commence. The loan remains flexible, allowing closure at any point to retrieve the principal and interest. However, borrowers are bound by a 30-hour window to either repay or refinance their loan with a fresh offer.

### Blur Season 2
This gamified take on lending has led to much of Blur’s early success.

The $BLUR [Season 2 Airdrop](https://blur.io/airdrop) is designed to incentivize specific user behaviors, such as bidding, listing, and lending. By partaking in these activities, Blur liquidity providers can earn rewards.

Bidding has emerged as the favorite among farmers, primarily because it demands exposure solely to ETH—a relatively low-risk asset compared to NFTs. This exposure can be further hedged using short futures, theoretically rendering farming almost risk-free.

### How Lenders Are Harvesting Blur Points
Blur Points serve as a testament to a user's engagement level, determined by the length and intensity of their participation in lending, bidding, and listing activities. In the case of lending, you earn Blur Points by loaning your NFTs to other users. Note that those points are on top of the yield you earn from the loan itself.

It’s a risky, high stakes yield strategy. Which is likely what has made it so popular. Which leads us to to the next section:

## NFT Lending Risks (and How to Manage Them)
In NFT lending, the key to maximizing your returns is effective risk management. There are several important aspects to creating a risk-resilient portfolio of NFT loans.

Let’s break some of them down here:

# 1. Setting Your Lending Parameters

Risk management in NFT lending relies heavily on the configuration of lending parameters. As a lender, you’re able to define the NFT collections you’re comfortable lending against, set the loan-to-value (LTV) ratio, determine the loan duration, and establish the interest rate. By carefully calibrating these parameters, you can ensure that your lending activities align with your risk tolerance.

For example, opting for a lower LTV ratio (e.g., 50% instead of 75%) provides a safety net in case the value of the collateral NFT experiences a sharp decline. Similarly, setting a higher interest rate can offset the risks associated with lending against NFTs.

You can also mitigate your risks by choosing shorter loan durations, such as 1-6 months, rather than longer 12-month loans. Diversifying your loans across multiple borrowers, collections, and even platforms can be prudent as well.

# 2. Navigating Loan Defaults

In the event of a default, the lender takes possession of the NFT the borrower used as collateral. At this point, as a lender you have the choice to keep the NFT, potentially benefiting from future value increase, or to liquidate it to recover their funds.

The decision of whether or not to take custody of an NFT can play a large role in your success as a lender. It may be tempting to hang onto the NFT, but if the price has dropped to the point that the borrower liquidated, you might be holding a depreciating asset.

When deciding, analyze the recovery potential of your new asset by looking at the collection's growth indicators:

- Check for positive community sentiment
- Upcoming catalysts like launches or events
- Recent sales trends

Also assess the liquidity of the collection to estimate how easily the NFT could be sold. More liquid collections generally have higher recovery rates if sold post-default.

If indicators point to potential near-term appreciation, holding the NFT may be worth your while. But if the value has dropped significantly, liquidating the asset quickly may maximize recovery.

# 3. Inadequate Appraisals
Loans are made based on a shared understanding of the appraised value of the collateralized asset. When the [valuation is inaccurate](https://upshot.xyz/post/asset-buckets), lenders risk financial loss, while borrowers risk receiving less than the actual value of their NFT asset.

It's important to benchmark your platform’s valuation models by backtesting accuracy across different market environments. Models relying solely on current floor prices aren’t enough. Sufficient out-of-sample data should be used to evaluate performance.

# 4. Concentration Risks
Diversification is an essential part of risk management for NFT lending. By lending across various NFT collections and platforms, lenders can spread their risk, thereby mitigating any negative impact if the value of a specific collection plummets significantly.

It’s also important to consider systemic risks such as cascading liquidations. If many loans from the same collection share the same liquidation price, drops in value can trigger sequential liquidations, amplifying price drops, liquidations, and more.

Furthermore, lenders can employ a risk overlay based on their current portfolio of active loans. This overlay can fine-tune the loan terms by considering various factors, such as:

- Collection-level concentration
- Ownership concentration
- The number of open NFT loans in the marketplace

Lenders can even employ more sophisticated techniques like quadratic programming to find the optimal asset weights that minimize portfolio volatility.

# 5. Market Volatility
NFT prices can fluctuate immensely in short periods of time. Regularly monitoring the market and adjusting your lending parameters accordingly can be an effective risk management strategy.

In the event of a specific collection’s value dropping, lenders might consider readjusting the LTV ratio or temporarily suspending lending against that collection until the market stabilizes.

# 6. Hedging Risks
NFT lending serves as a popular method for owners to hedge their long positions in NFTs. Essentially, taking out an NFT-collateralized loan functions similarly to purchasing a put option with an upfront payment.

If the market value of the NFT dips below the loan amount, the borrower might find it beneficial to default on the loan and surrender the NFT, thereby effectively utilizing it as a hedging tool.

However, NFT lending isn’t the sole strategy for risk mitigation. Financial instruments like perps and options offer alternative risk hedging avenues.

For example, borrowers concerned about a potential decline in [Bored Ape NFTs](https://app.upshot.xyz/indexes/yuga) could short $APE futures to counterbalance their long exposure. This provides downside protection if Ape prices decline, offsetting the impact of potential defaults on loans collateralized by the NFTs. Utilizing derivative instruments on correlated assets allows lenders to hedge risks beyond portfolio diversification.

## Future Prospects of NFT-Backed Lending
NFT-backed loans have emerged as a transformative tool, enabling asset owners to unlock liquidity in the NFT market and have been the go-to source for downside protection of NFTs. However, the journey isn’t without its challenges. Recent declines in NFT prices have cast shadows over the robustness of many NFT x DeFi protocols, as evidenced by dwindling user engagement.

There's a tendency among market participants to downplay the probability of adverse future events. Such an oversight can culminate in significant losses. It's imperative for investors to adopt a forward-thinking approach to risk management.

Despite the hurdles, the monetization and securitization of NFTs, a domain still in its nascent stages, brims with immense promise.

Learn strategies to maximize returns and minimize risks in NFT lending by understanding key differences between peer-to-peer and peer-to-pool models, setting prudent loan terms, diversifying, and more.