NFT lending market faces chain liquidation crisis! Is it the best time to buy blue-chip NFTs like BAYC, Doodles?

According to data from Dune Analytics, the trading volume of the NFT market has gradually shrunk since the beginning of the year, with monthly trading volume declining for three consecutive months, and prices of many blue-chip projects are not as strong as before.

In addition, many NFT lending markets launched in the past six months, such as BendDAO and NFTfi, have enabled NFTs to add leverage, increase capital efficiency, and other functions. However, in a declining market, this has led to further risks for the overall market.

BendDAO Liquidation Mechanism

There are currently 32,267 ETH ($59,048,610) worth of NFTs being used as collateral for loans on BendDAO alone

For the first time ever, a lot of these are at serious peril of liquidation

A thread on the single biggest risk to the NFT market that nobody is talking about

— Cirrus (@CirrusNFT) August 17, 2022

According to analyst Cirrus' Twitter post, the NFT lending market on BendDAO has a total of 32,267 ETH, approximately $59 million worth of NFTs used as collateral for loans, but a large portion of them are facing a liquidation crisis.

So, how did this crisis come about? We need to first understand BendDAO's collateral loan mechanism.

BendDAO is the first NFT liquidity protocol based on a bonding curve pool. Depositors can provide ETH on the platform to earn interest, while NFT holders can use their NFTs as collateral to borrow ETH from the lending pool. The NFT loan-to-value ratio is around 30%-40%.

For example, if the current floor price of BAYC is 100 ETH, the holder can borrow around 30-40 ETH on BendDAO, with a loan interest rate of about 15-25%.

However, not all NFT projects can be used as collateral. Only 7 blue-chip projects are supported. When the prices of these NFTs continue to drop, borrowers will face liquidation risks.

In the example mentioned above, when the floor price of BAYC drops to 44 ETH, the Health Factor will fall below 1, triggering the liquidation protection mechanism.

The Health Factor calculation formula = Floor Price * Liquidation Threshold / Loan + Interest; Health Factor calculation process = 44 * 90% / 40 + Interest < 1

In this scenario, if the borrower does not repay in time, the NFT used as collateral will enter a 48-hour auction process, and the highest bidder will become the new owner.

Blue-Chip NFTs Face Potential Mass Liquidation

Cirrus issued a warning through the post as they found many NFTs on BendDAO facing liquidation risks, i.e., Health Factor < 1.2, triggering liquidation if the floor price drops by another 17%.

This includes 54 BAYC, 30 MAYC, 33 CloneX, and 12 Doodles.

According to BendDAO's liquidation mechanism, anyone can act as a liquidator for NFTs, with the initial bid only needing to be higher than 95% of the floor price and above the total debt amount.

Based on the current auction market, all bids for NFTs are below the floor price. If executed, it may further reduce the floor price, triggering the next wave of liquidation, ultimately causing a spiral decline in prices.

"To me, a spiral liquidation is only a matter of time, not if it will happen. NFT trading volume is at an annual low, and there is simply not enough liquidity in the market to absorb all liquidations without causing significant impacts on floor prices." Cirrus said.

Furthermore, according to Dune Analytics' data, 2.75% of BAYC and 1.58% of MAYC are used as collateral on BendDAO alone. If we include other NFT lending markets, the proportion of collateralization will be even higher, making them the highest among all blue-chip projects.

Cirrus, as a BAYC holder, is concerned about this phenomenon, but also sees it as a potential opportunity to buy BAYC and MAYC at their best times.