Would You Accept an NFT as Loan Collateral? Some Lenders Already Have.

Can non-fungible tokens (NFTs) disrupt the lending market? And should credit unions, which are showing heightened interest in cryptocurrency, be entering this space as well?

Article courtesy of Ray Birch, CUToday.info

Lou Grilli, senior innovation strategist at PSCU, believes many credit unions will eventually answer “yes” to both questions, noting NFTs are already playing a part in the lending marketplace.

Feature NFTs use This

An NFT is a non-interchangeable unit of data stored on a blockchain, a form of digital ledger, which can be sold and traded, representing ownership of digital files such as photos, videos, and audio.

“So, an NFT could show you are the owner of a collectible, digital art, a song, a book, a video, or something more tangible, like tickets to a real-life event, or the title to a boat or to real-estate,” noted Grilli. “To understand how it works, think about owning a piece of a cryptocurrency coin, such as Ethereum. Your ownership of some amount of Ethereum is represented by a token on a blockchain. NFTs are likewise tokens on a blockchain, also representing ownership of something. Today, the most common use-case is ownership of artwork, like CrypotKitties, and characters in video games, such as Axie Infinity.”

The Coming Disruptor

But Grilli predicts NFTs will see more practical applications, such as real estate transactions, auto and boat titles, and other real-life uses.

“We already saw the first NFT-based real-estate transaction in the U.S. happen right here in Florida,” said Grilli. “And the person involved in this transaction has plans for several more.”

Where credit unions will first be forced to address NFTs is in mortgage lending, said Grilli.

“NFTs will be disrupters to mortgage lending,” he predicted. “Neobanks and crypto exchanges are entering the lending market by allowing clients to collateralize their digital asset holdings, meaning their holdings are locked up and can’t be sold or traded, in exchange for a loan.”

Recently, Genesis, a cryptocurrency exchange, offered a new client a six-month $1.25-million loan with a 7.5% interest rate—the equivalent of a 15% annual rate—collateralized by 10 NFTs by well-known digital artists Pak and Fewocious, valued at $5 million, Grilli pointed out.

Grilli Lou 042020

Lou Grilli

“While this is an outsized example, there are firms like Arcade that in their first four months issued $10 million in similarly structured loans,” he said.

The New Card Perk

Grilli noted NFTs have already entered the credit card space as perks, suggesting they could disrupt those offerings, as well.

“AMEX is offering its cardholders a chance to purchase one of 14 unique digital images from a recent performance by R&B singer SZA as part of its rewards program,” Grilli said. “Amex is anticipating that NFTs will become more mainstream and will become an increasingly desirable perk for prospective customers. For credit unions, when it comes to crypto-savvy members, there will be a clear delineation of credit unions participating in the digital asset evolution—large and small—and those that are not.”

But when it comes to NFTs and payments cards, chargebacks may be a big issue, cautioned Grilli.

“Like gambling and other high-risk merchant category codes, chargebacks for NFT purchases pose a headache to issuers,” he said. “Due to the completely virtual nature of digital assets, it is even more attractive for a fraudster to use a stolen credit card number to purchase an NFT than it is to purchase a TV. Chargeback attempts due to friendly fraud, buyer’s remorse, kids using a parent’s card, occur with a much higher frequency in the digital world than in the physical world.”

Recognizing the potential for abuse in this area, Grilli noted that PayPal announced it would cap fraudulent claims about the sale of NFTs containing art, media or collectables at $10,000.

What to do Now?

What should credit unions be doing?

Grilli recommended monitoring member activity, “Ideally, using data analytics to track funds flowing. Every credit union should be tracking ACH and debit transactions to and from the major exchanges, such as Coinbase, crypto.com, Gemini, FTX, Binance, and BitFinex. Many credit unions would be surprised to see how much activity their members are already conducting in the world of digital assets. Likewise, credit unions should be looking at purchases made at the largest NFT exchanges, such as OpenSea, NFT Launchpad, crypto.com, and Rarible.”

Grilli pointed out that last summer Visa bought one of the NFT CryptoPunks for $150,000.

“Visa doesn’t consider this an investment, and the asset is not on their balance sheet,” Grilli said. “Visa believes that NFTs will play an important role in the future of retail, social media and entertainment. If this is an area of interest, start small, and have a team of enthusiasts go through the effort of buying an NFT, within a reasonable budget,” Grilli suggested.

Making it Count

Grilli believes credit unions will eventually have to make NFTs, and cryptocurrency, “count.”

“Digital assets as collateral,” he said. “Consider cryptocurrency balances, including NFT investments as part of a member’s ability to repay. Some members are starting to accrue significant balances in cryptocurrency and NFTs. When members start searching for a mortgage, they’d like their investment to be considered, I believe.”

What members don’t want to do is sell their cryptocurrency holdings, incurring a tax liability, and more importantly, abandoning the opportunity for additional gains on their investments.

“Likewise, they don’t want to sell their NFTs, given the limited market of buyers and the slower appreciation cycle,” he said.

Grilli pointed out neobanks are already working to attract new clients by recognizing crypto and NFT investments.

“They are using reasonable valuations, and then taking into account risks of loss, using these investments as part of the overall equation when underwriting a loan,” Grilli said.

As CUToday.info has reported, UNIFY Financial, Torrance, Calif., already plans to recognize cryptocurrency as collateral for a loan.

“While this may be something that not all credit unions are ready for just yet, loan officers should be following news related to the topic, discussing this with their chief compliance officer and NCUA examiner, and preparing for a future where digital assets, cryptocurrency, and NFTs comprise a growing portion of a household’s net worth,” Grilli said. “And this future looks like it might happen sooner than anyone expects.”