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)

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.

NFT Lending Strategies: How to Maximize Returns (and Minimize Risks)

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

__Charts__

The first thing you will see on the Analytics homepage is a collections chart that allows you to select and compare up to 5 collections at once across weekly volume, floor price and average price. To change the selections simply click on the collection names in the table below the chart or use the (x) next to collection labels on the chart.

Every sale reveals more information as you hover on specific dots and you can change the time period using the nav below the chart to see timescales from 1 hour to 1 month.

![Screen Shot 2022-11-14 at 20.56.35](//images.ctfassets.net/lhkcghnr8ql4/7pBUlx2PNQXJunnDd1b0Sj/d43bd137de1ad0960dafc3a6fcd228dd/Screen_Shot_2022-11-14_at_20.57.46.png)

Another chart that can help contextualize sales and floor data is our individual NFT appraisal history chart. Every NFT we appraise gets reappraised every hour and we chart those data points for your comparison in the pricing history section of the NFT page.

![Screen Shot 2022-11-14 at 20.58.00](//images.ctfassets.net/lhkcghnr8ql4/7umha3SsnQiRjbWEkOObN4/c7ac3c6687e67ffee63fccdb516c366b/Screen_Shot_2022-11-14_at_20.58.00.png)

__Finding Deals__

One of the most valuable tools we have built into the core of our app is hourly appraisals of more than 270,000 of the top NFTs across more than 240 collections. We are adding more all the time and continue to refine our models every day.

Each NFT’s appraisal is updated hourly and we present the appraisal on each NFT page under the preview image and in the pricing history chart on the right.

![Screen Shot 2022-11-14 at 20.58.08](//images.ctfassets.net/lhkcghnr8ql4/JOgAZws6PUEUjWf0o27yj/28c8547d574f7f6d03ccd0011f00601e/Screen_Shot_2022-11-14_at_20.58.08.png)

If the NFT is currently listed on a marketplace, an over/underpriced indicator will appear on the top of the NFT page (like the example above). You can investigate these appraisal/listing differentials on individual NFT pages or look at entire collections and rank them by this difference on the Collection page in the Explore table at the bottom.

![Screen Shot 2022-11-14 at 20.58.20](//images.ctfassets.net/lhkcghnr8ql4/6WVSkisVRSnJcd47ULT1WY/664d372af8762c5d92d5dcff871e19ec/Screen_Shot_2022-11-14_at_20.58.20.png)

The main Explore table on the Analytics Homepage can also display global listings for NFTs on various marketplaces and compare them to the respective appraisals in real-time as they are listed.

![Screen Shot 2022-11-14 at 20.58.29](//images.ctfassets.net/lhkcghnr8ql4/3xoU28W1F6lxSDYB7g6LNC/b1e0b9eabad33a086eb654a699b9c756/Screen_Shot_2022-11-14_at_20.58.29.png)

![Screen Shot 2022-11-14 at 20.58.38](//images.ctfassets.net/lhkcghnr8ql4/7dzHMTRA6tzPHIP3Kxg0hU/554b6326884ff85009a0026e9ff0e6f4/Screen_Shot_2022-11-14_at_20.58.38.png)

We will continue to dial in more efficient and effective ways to expose under/overpriced listings and would appreciate any feedback from the community about features you would love to see or ways we can make the deal finding process more valuable.

__Trait Level Analysis & Search__

Another key area of interest in any NFT collector’s journey involves attributes or traits of particular NFTs and recognizing how the rarities and cultural affinities play into the value of individual trait mixes. Every NFT page has individual attributes/traits broken out by their rarities and if you click on any trait you are brought to our powerful search tool that exposes pricing and market information surrounding particular traits and combinations of traits.

![Screen Shot 2022-11-14 at 20.58.49](//images.ctfassets.net/lhkcghnr8ql4/7Bl4yW0zAntRfsULhNvpq2/f740aed79dc1e23df2185b31c394737b/Screen_Shot_2022-11-14_at_20.58.49.png)

![Screen Shot 2022-11-14 at 20.58.57](//images.ctfassets.net/lhkcghnr8ql4/6QncGpZHRrCTwoBBdhgUut/40d374bf7586b21e4a191349e8c6d5c4/Screen_Shot_2022-11-14_at_20.58.57.png)

We are adding new components to make search and NFT discovery even more powerful and (you guessed it) would appreciate any feedback from you about ways to improve and provide more powerful search and discovery tools.

__Collector Pages__

One of the most interesting parts of collecting NFTs is being able to see all the different collectors’ collections, compare them to each other (and our own), and discovering new NFTs through inspection of others’ wallets. To see your own collection page simply click on your wallet address in the top right.

![Screen Shot 2022-11-14 at 20.59.08](//images.ctfassets.net/lhkcghnr8ql4/24vowyoUOtYRhIrXmMGc8P/25c15e4ec2e5e5481cfc1d0b2a5b91d1/Screen_Shot_2022-11-14_at_20.59.21.png)

Throughout the app, anywhere you see a wallet address, you can click the address to inspect that collector’s page. General Info section and Transaction History on NFT pages in addition to rollover on any of the NFTs in the Top Selling NFTs section of the homepage and collection pages are great places to start.

![Screen Shot 2022-11-14 at 20.59.29](//images.ctfassets.net/lhkcghnr8ql4/2HPxQHHYqmjDrqsrUW0gY5/464b62ca5114540fe446087aadc3eadb/Screen_Shot_2022-11-14_at_20.59.29.png)

![Screen Shot 2022-11-14 at 20.59.37](//images.ctfassets.net/lhkcghnr8ql4/5sM2t7bHweMBAe0NCkYEQM/f5814ad38dbae143c6d6404ea7b6cc2e/Screen_Shot_2022-11-14_at_20.59.37.png)

![Screen Shot 2022-11-14 at 20.59.43](//images.ctfassets.net/lhkcghnr8ql4/32nvxIllYe9qfRqQ9miyxi/bd8534b6f6485df807125ef22992b59a/Screen_Shot_2022-11-14_at_20.59.43.png)

Please help us make Upshot the best analytics platform in the space by giving us any feedback (positive or negative) through the form on the website or pop into Discord and let us know what you think.

This is just the first in a series of new releases that we hope will make Upshot the home for DeFi x NFTs. Along with making it easier than ever for people to explore NFT data and real-time appraisals, we’re also excited to be working with partners to integrate the Upshot API into their apps.

Real-time NFT price-feeds will enable a number of benefits for NFT marketplaces and DeFi protocols, give people insights into what their assets are worth, and unlock a range of exotic new primitives at the intersection of DeFi and NFTs.

__Features we are working on implementing very soon:__

- Indexing and appraising more key collections
- Enhanced wallet profiling and customization
- Cohort and Social Analysis
- Experimental DeFi applications
- Marketplace tools & integrations

Stay tuned, this is just the beginning!

If you’re a first time user of Upshot Analytics Beta, we wanted to point out a few ways to get maximum value from the tools and hopefully enhance your experience getting to know the product. There are four major areas of focus in this quick intro: charts, finding deals, trait level analysis search/discovery, and collector pages.

Getting Started with Upshot Analytics

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.