Liquidity Providers or Market Makers are responsible for providing liquidity to buyers and sellers in a financial market so users can trade assets without affecting their prices. They help determine the price of assets and regulate the crypto or NFT market.
The uniqueness of NFTs makes them illiquid as it may take quite some time to find buyers. A particular NFT may be popular with certain collectors and not the others. Collectors are usually inclined to a particular type of asset they want to buy. For example, a collector may prefer a punk with a cigar, while another may prefer a punk with a cap. How do you find buyers for 9999 unique items on the blockchain?
NFTs may have recorded impressive growth figures in 2021. Nonetheless, liquidity and pricing difficulty hinder it from fully becoming mainstream. The nascent industry is generally driven by impulse buying, hype, and exuberance. The final price paid for an NFT is often based on the buyer’s subjective preferences rather than the interplay of demand and supply.
Cryptos, unlike NFTs, can be easily swapped on the marketplace as their prices are defined, and they have more utility and demand. However, NFTs face the challenge of inaccurate price determination and valuation.
The difficulty in establishing the prices of NFTs is often influenced by their low transaction volume and extreme price changes. Price fluctuation, whether manipulated or otherwise, is commonplace in the NFT marketplace, and they contribute to the illiquidity of NFTs.
This article will try to make a case for market-making as a valuable service for NFTs, taking cognisance of their liquidity and price determination problems. You will also learn about our algorithmic solution at Flovtec.
These benefits strengthen the argument for Market-Making in NFT.
Market makers can;
● Facilitate the massive adoption of NFTs in DeFi,
● Help more people embrace NFT,and
● Enable a more accurate determination of prices.
Let's elaborate on some of these benefits.
The provision of liquidity for NFTs is not exactly an uncharted course; companies like solvent protocol, NFTX, and Charged particles are already market-making and exploring more opportunities to make NFTs mainstream in DeFi. Let’s explore some of them.
The solvent protocol is the first liquidity platform for NFTs on Solana. Their objective is to facilitate trading and a better pricing discovery model for NFTs.
Users deposit their NFTs into a specific bucket and get droplets in return; for example, Geckos can have their droplets as $Gecks.
Droplets are just like any fungible token; you can stake, swap, and trade for any crypto on Solana. In the future, users can redeem NFTs of a particular bucket. The platform plans to integrate the rarity of NFTs into the number of droplets issued; for now, every NFT gets a standard 100 droplets and will pay 2 droplets as a mining fee.
When swapping droplets for other tokens, the AMM will determine the price according to the demand and supply in its liquidity pool. The solvent protocol helps with the price discovery of NFTs, making them more efficient than NFT marketplaces, where a single NFT often manipulates the floor prices of other NFTs in a project.
Solvent gains liquidity by allowing users to liquidate their NFTs and use the droplets gained to add liquidity to the pool in exchange for liquidity rewards in the form of $SVT tokens (the governance token for Solvent). According to the latest statistics, the Solvent protocol has $2,652,507 in total value locked on theplatform.
NFTX, built by a DAO and powered by Infura, is another project that provides liquidity for NFT. NFTX model is similar to the Solvent protocol and converts non-fungible tokens to fungible ones. Users can trade NFT collectibles such as Crypto punks and Crypto kitties on the platform.
For example, a user submits PUNK NFTs and gets PUNK ERC-20; he can provide liquidity on the Balancer PUNK-core pool to earn fees. Daily fees reported on balancer pools have reached a highof .75%. The balancer is a decentralised exchange and trading platform on Ethereum.
Other opportunities for Market makers in NFT includes NFT derivative and loans. AMM-based floor prices are used to determine the value of an asset to be used as collateral for loans.
Other projects providing liquidity for NFTs include Aavegotchi and Etna network. Some do not just provide liquidity; they also make it possible for other liquidity providers to participate.
NFTs recorded a boom in 2021, with DApp radar reporting that NFT trading volume exceeded $23 billion last year alone. The motive for trading that large volume remains unclear. The possibility of connecting with an artist or brand is a great objective for acquiring an NFT, but there is more to it than meets the eye.
More people will embrace NFTs if the tokens become more liquid; like Cryptos, they can easily be swapped or flipped for better returns. An NFT, just like digital art, is a means to store value. NFT buyers are not necessarily fans; some collectors are already investors in the crypto space.
As more people embrace NFTs, they will eventually become mainstream, so people will not necessarily have to scramble to find a buyer on the marketplace or become stuck with a digital art they do not want anymore. If NFTs become more liquid, with an easy entry/exit of the market, it is logical that more people will want to own an NFT.
Market makers utilise AMM to establish prices, but in the NFT market, Floor, average, and median prices are often used to value NFTs. The problem is that the floor prices in the marketplace are generally flawed. Floor prices are not determined objectively; instead, they use characteristics such as rarity, utility, popularity, and trend.
Price determination in the NFT market is quite difficult as some characteristics are usually unique to individual buyers. For example, a crypto punk with a cigarette and red eyes can be valuable to cannabis enthusiasts and not to non-smokers.
Floor prices are often manipulated. To determine the actual worth of an NFT, one may have to check the transaction volume and compare the floor price of a particular NFT with other NFTs in a project. The trading volume gives a better idea of how many buyers are buying at that price. For example, if a project is listed at 3 ETH, but the trading volume is very low, it may suggest that the NFT isn’t worth 3 ETH.
Also, when there are very few NFTs available on the market, sellers may intelligently hike the prices or even sell to their wallets to raise the floor price of an NFT; this can be referred to as wash trading. There was a reported case of wash trading involving crypto punks in 2021.
Flovtec, a leading Crypto liquidity platform, has developed a proprietary algorithm for the market-making of NFTs. Our algorithm is based on a statistical model that counts the attributes of an NFT, rarity, market dynamics and price action of other NFT projects.
Flovtec’s model uses the floor price to get a stationary time series. The price of a stationary time series of categorical data is statistically evaluated using multivariate regression, generalized linear models, random forests, and neural networks.
Liquidity Providers have a big role to play in the burgeoning NFT industry. One would expect NFTs to gain massive adoption once the issue of liquidity and price determination is eventually put to bed. Then more opportunities like NFT loans, derivatives, and Fractionalization will come alive. At Flovtec, we are working to unleash the full potential of NFTs and enable them to become mainstream.