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NFT Stack: Exploring the NFT Ecosystem

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NFTs will leverage many of the same financial primitives as DeFi, so the stack layers of both will end up looking very similar, but NFTs are more consumer-centric.

Original title: 《 The NFT Stack: Exploring The NFT Ecosystem 》

Original source: Messari

Original translation: Kyle, Babbitt

At one point, non-fungible tokens (NFTs) are just a primitive form of blockchain, just like fungible ERC-20 tokens. However, the narrative of NFTs as a category has begun to refer to a broader trend, so similar to DeFi, the term "NFT" now includes its own ecosystem.

However, NFTs will leverage many of the same financial primitives as DeFi, so the stack layers of the two will eventually look very similar, but NFTs are more consumer-centric.

Layer 1: Layer 1 Infrastructure

To date, the NFT space has been dominated by Ethereum, Flow, and to a lesser extent Wax. Most NFT applications will likely need to transition from the Ethereum mainnet to a Layer 2 solution or sidechain while relying on Ethereum as a settlement layer. The exception to this rule may be high-end digital art or blue-chip collectibles that require stronger censorship resistance.

Other base layers (Layer 1), such as Solana, are actively building out their NFT infrastructure, such as Metaplex, enabling individuals to set up their own NFT storefronts and issue NFT collectibles with customizable royalty distributions.

Layer 2: Layer2 Solutions and Sidechains

Most consumer-focused NFT applications — games, sports, virtual worlds, utility assets, etc. — have experienced turbulence on Ethereum. After building CryptoKitties and CheeseWizards, Dapper Labs decided that Ethereum would never provide the strong scalability that game studios needed, and chose to build Flow. Similarly, even projects like Sorare — which correctly identified the direction of scalability — built on sidechains like Loom that eventually shut down — failed to attempt to scale their NFTs. Unwilling to rely on other third parties, Axie Infinity went the path of building their own sidechain, Ronin, which has so far been very effective in reducing gas costs and increasing user adoption.

As an Ethereum hybrid Layer 2, Polygon's biggest advantage so far is its compatibility with Ethereum, which reduces the learning curve for users and developers. In addition, Polygon uses its tokens to incentivize bridges to its network to great effect. Notably, Polygon is setting up a new $100 million fund for gaming and non-fungible token projects, doubling down on NFTs.

Gods Unchained, developers at Immutable Labs are about to launch their Ethereum Layer 2 scaling solution, ImmutableX. This Layer 2 is built using ZK-rollups, and the Immutable team claims it is better suited for NFT-based applications.

For more details, check out Messari’s article on Ethereum Scaling Solutions‌. By now, this story should sound familiar — [insert crypto project] built a relatively successful NFT protocol, but was unable to achieve the necessary scalability on Ethereum mainnet, and chose to build its own solution [insert new blockchain].

The last high-profile NFT layer 2 solution comes from Enjin — the first platform to offer token injection with a fixed stickiness curve per token. Enjin recently raised $18 million for its NFT scaling solution, Efinity, a new blockchain built as a Polkadot parachain. As part of Efininity, Enjin, the company that pioneered the ERC 1155 token standard, is developing a new token standard called "paratokens" that will be interoperable across the Polkadot ecosystem and used to issue Efinity tokens (EFI).

While the battle for smart contracts is the battle for blockchain's DeFi applications, the upcoming battleground between Layer2s will be for NFT hegemony.

Layer 3: Vertical/Applications

While NFTs are created and transferred at the Layer 1 or Layer 2 level, the application layer is one potential interface for issuing these tokens. Virtual worlds like Decentraland and Cryptovoxels have slowly grown over time as individuals enter the world of conferences, art galleries, casinos, and upcoming use cases.

Other applications like fantasy sports have experienced wild speculation but continue to add new users. Crypto-based sports applications have been incredibly successful to date. NFT sports applications have generated over $800 million in secondary sales, and could exceed $1 billion if primary sales are taken into account.

While blockchain-based gaming as a trend has yet to fully take off — in part due to scalability issues — the space continues to grow with the release of several upcoming games including Illuvium, EmberSword, Aurory, and more.

In addition, Uniswap V3 is the first financial application to effectively utilize NFTs. Uniswap’s V3 protocol requires active management of liquidity — LPs select ranges within custom price ranges within the asset market — in the process creating individual price curves represented by NFTs. Each NFT is displayed as unique on-chain generative art based on the properties of your position.

In addition, DeFi protocols like Synthetix choose to use NFTs as members of the Spartan Committee that governs the Synthetix protocol. Each Committee NFT (SC-NFT) is unique to an individual and can be withdrawn from old members and then issued to newly elected new members of the committee.

While issuance protocols that offer the ability to create your own unique NFTs (i.e. SuperRare tokens or Zora’s zNFTs) may fit the application layer, the main benefit of the market comes from its liquidity, which is why I place these protocols in the financialization layer.

NFT issuance is a commoditable layer that multiple layers of the stack can facilitate, including:

· Layer 1 or Layer 2 blockchains and scaling solutions White label issuance protocols (e.g. Nameless is used for Veefriends)

· Marketplace protocols (e.g. Rarible)

· Individual applications (i.e. Sandbox, Uniswap, etc.)

· Front-end interfaces (e.g. Zapper)

Ultimately, these platforms will have to rely on the unique utility proposition they can offer to users. Virtual worlds can license content, and Top Shot cards will be used in the game Hardcourt of NBA Top Shot.

Layer 4: Ancillary Applications

Composability ensures that other developers can build on top of existing applications and protocols.

Decentraland and other virtual worlds will undoubtedly have a variety of applications in their ecosystems, such as the online casino Decentral Games. Additionally, Sorare has a partnership with Ubisoft, which is developing its own fantasy league, One Shot League, using existing Sorare cards. The composability of this layer means that applications or protocols that facilitate third-party application development will have the opportunity to capture more value.

Layer 5: NFT Financialization

Similar to assets in DeFi, NFTs require similar primitives such as lending, liquidity, and asset management. Additionally, while the value proposition of NFTs lies in their uniqueness, fungibility is important for increasing liquidity and the financialization of NFTs. To date, projects focused on the financialization of NFTs are trying to make non-fungible tokens as fungible (and liquid) as possible.

Most protocols that aim to increase NFT liquidity do so by creating liquidity pools where individuals can deposit similar NFTs, or by subdividing individual NFTs to encourage greater speculation.

NFT Fragmentation Projects

Fractional - Collectors create fractions of an NFT as fungible tokens that can be combined to redeem the token, or the base NFT can be purchased for a price above the reserve price.

Niftex - NFT owners create fragments of an NFT as fungible tokens. The base NFT can be reclaimed by acquiring 100% of a shard or through a special buyout clause.

NFT Liquidity Pool Projects

· NFTX – Collectors can deposit NFTs into the NFTX vault and mint fungible tokens (vTokens) that represent ownership of a random asset within the vault, or redeem a specific token from the same vault.

· NFT20 – A decentralized exchange where individuals can deposit NFTs into a pool in exchange for a fungible token (e.g. 100 Punks tokens) that is fungible for one NFT in the pool (e.g. CryptoPunk).

· Unicly – Subdivides collections of NFTs into uTokens that can be traded. Specific collections (e.g. uPunks) are locked.

NFT Assets with Yields

· Charged Particles — A protocol that allows users to deposit fungible or non-fungible tokens into NFTs. Charged Particles NFTs can be programmatically minted using aTokens that carry a yield.

· Uniswap V3 LP Positions — By providing liquidity, LPs receive fees based on three tiers per pool — 0.05%, 0.30%, and 1% — corresponding to different price ranges.

Markets

NFT issuance platforms and marketplaces currently make up one of the largest categories of NFT protocols, and are one of the more obvious market opportunities given the business model.

In this regard, NFT issuance protocols and marketplaces will compete based on the following features:

· Brand value

· Liquidity (depth and breadth of assets)

· Unique features (i.e. unique token standards, royalties, collector fees, etc.)

· Additional service offerings (e.g. partnerships)

While unique features such as royalties and collector fees could one day be commoditized and incorporated into token standards, they are currently non-standard and therefore a key value proposition for many NFT creators and companies.

In the long term, marketplaces may aim to move closer to social networks in order to keep users anchored to their platforms. Ironically, this is the opposite of social networks such as Facebook and Instagram, which started out as social networks and later developed marketplaces.

Layer 6: Aggregators

Aggregators can come in many forms. Some protocols aggregate supply, while others focus on the demand (consumer) side. In the NFT space, there are really only two major aggregators - OpenSea and Rarible. Both marketplaces aggregate supply by integrating various smart contracts and ultimately blockchains. Since Rarible only recently integrated the ability to buy and sell non-Rarible tokens on its platform, OpenSea has been the de facto aggregator in the space.

While many people view OpenSea simply as a marketplace, it also aggregates a wealth of NFT data and metadata - data about data - that can be accessed through its API and potentially used for other purposes. Both OpenSea and Rarible continue to create fully functional platforms for projects and individuals to issue non-fungible assets. As aggregators compete for growth, they will continue to expand their asset offerings across multiple blockchains.

Layer 7: Frontends and Interfaces

There are many companies vying for eyeballs and building the de facto frontend for NFTs. With collectibles and crypto art as the first breakout use cases, entrepreneurs are choosing to build galleries or interfaces for collectors to display their non-fungible assets. Wallets like Coinbase Wallet and Rainbow and platforms like Zapper and Zerion provide friendly interfaces to view NFT portfolios.

More powerful NFT analytics platforms like NFT Bank provide return on investment analysis, taxation, price estimates, and more. Multiple analytics platforms exist but do not provide an interface to view NFTs, including Nonfungible, Cryptoslam, and Nansen.

As NFTs gain wider acceptance, even protocols that don’t issue NFTs will likely build interfaces for users to view, share, and interact with NFTs. Audius, a decentralized music streaming platform, launched Audius Collectibles, where artists with silver accounts—those who hold more than $100 in AUDIO tokens—can display NFTs on their profile pages. This type of model incorporates the native platform token and provides artists with another way to showcase their artwork, albums, or any asset they tokenize.

Similarly, apps like Showtime and Nifty are building social networks for users to share and like NFT collections and interact with other collectors. Eventually, displaying NFTs on a profile or social network may become universal across platforms.

Final Thoughts

Over the past 12 months, the NFT landscape has evolved from a small ecosystem with hundreds of millions in sales to a multi-chain ecosystem where individual projects like Axie Infinity have surpassed $1 billion in sales. OpenSea had $24 million in sales for all of 2020, and by August 2021, sales exceeded $1 billion. Unlike the DeFi ecosystem, NFTs are highly consumer-oriented and compelling. As DeFi continues to build the financial rails of the future, NFTs will periodically enter the cultural zeitgeist.