NFTs Are Now Collateral for Secured Loans

NFTs Are Now Collateral for Secured Loans

Even if you don’t like non-fungible tokens, you can’t get away from them because they are becoming more popular (NFT). Even though NFT sales have been slowing down recently, the total amount of money spent on them could reach over $90 billion by the end of this year. In 2021, they made a record $40 billion. Because of this, is a new type of platform for NFT players called “lenders” that is now interested in a different way.

The lender has a reason to give the borrower access to short-term money in exchange for an interest rate that is added to the loan’s principal amount. The borrower is willing to pay a high-interest rate because they need the money fast and don’t want to have to sell the asset.

How a lender is protected from a borrower not paying back the loan, which is sometimes called “default,” depends on the asset class. In a market for used cars, the lender can take back the car if the borrower doesn’t pay back the loan.

If that is the case, what laws about secured loans also apply to non-secured loans (NFTs)?

Jeff Karas is an attorney who works as an associate attorney for the Anderson Kill law firm. This part of the article came from The Node, CoinDesk’s daily summary of the most important blockchain and cryptocurrency news.

Legal protections for using an NFT as collateral are a hard topic of “perfection” of the lender’s security interest, even though this practice is simple in theory and can even be done with smart contracts. an NFT is neither a car nor “art.” Either it is a “general intangible,” which is what the UCC calls hard-to-classify collateral, or it is an “investment property,” which includes securities and other financial assets that are similar to securities.

It’s possible that crypto-focused lenders and borrowers would benefit more if a perfected NFT was sold as an investment property. To “perfect” a security interest in an investment property, you have to be in charge of that property. As part of this three-way deal, the borrower gives the lender a security interest in the NFT. But the person who borrows the NFT has to keep it in a special account (or wallet) that is run by a third party. In return, the third party agrees to do only what the lender says.

In traditional lending systems, these kinds of three-party agreements, which are sometimes called “account control agreements,” are common. Most of the time, the third party is a bank or another place that works like a bank. But in the world of bitcoin and NFT, banks are often seen as the “enemy” instead of as a trusted middleman. Since there aren’t as many banks as there used to be, any effort to make NFT lending legal would have to find other ways to fill the gap.

Several groups have already started testing NFT lending, but they do it in different ways and with different levels of actual and perceived legal protections. The NFTfi project in South Africa has been used as an example most of the time. Since the project began, it has made it possible to lend more than $212 million. 

With NFTfi, all agreements between a borrower and a lender are based on smart contracts that each party “signs.” But at first glance, it’s not clear how strict these contracts are or how they protect you legally. When NFTfi is used, neither the borrower nor a lender gets a contract that is easy to understand. This is still true even though more than 20% of loans haven’t been paid back.

In the last few months, there have been more NFT lending platforms. One example is Arcade, which just finished a Series A round of fundraising, which was led by Pantera Capital and brought in a total of $15 million. Soon, there will be more. It’s not clear how much these new platforms will care about whether or not the loans they give out are legal, no matter what they do.

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