A breakdown of why NFT enthusiasts are on high alert about BendDAO.
US$55 million worth of Bored Apes and CryptoPunks NFTs, among others, are at risk of liquidation, and it has something to do with BendDAO.
At this point, most of our readers would be familiar with the concept of a decentralized autonomous organization (DAO). But for those who need a quick refresher, DAOs are internet communities set up on the blockchain with no central governing body and where members act in the interest of the group. You can invest in and become a member through purchasing their crypto tokens. Once you are a member, you have the governing power to vote on the decisions of the organization. In some places, like Wyoming and The Republic of the Marshall Islands, DAOs are recognized as legal entities.
One such community is BendDAO, a platform where users pool their Ethereum together to give out loans for people to borrow against NFTs for a cut of the interest payments. Seems simple enough, right? But as of August this year, the DAO is running out of money, and many fear that it will soon be unable to pay back the lenders. Let us take a look at how BendDAO works, why it ended up in this position and its impact on NFT projects.
How does BendDAO work?
As we already discussed, this project allows people to get loans with their high-value NFT holdings as collateral. The loan approved would amount to about 40% of the collateralized NFT floor price. So, for instance, if you hold an NFT with a floor price of 15 ETH, you can receive a loan of up to 6 ETH. Borrowers can also liquidate (sell) their NFT holding if the floor price falls below a certain threshold.
On the lender’s side, those who put their money into BendDAO receive bendETH, which are interest-bearing tokens, with each token having the same value as an ETH token. The DAO guarantees its holders an annual percentage rate of interest of 77.54%, of which 73% is paid in ETH and 4.53% is paid in BEND, the DAO’s native token. To provide such hefty returns to the lenders, the DAO charges borrowers an interest rate of 93.96%, which, given the rising rates of Ethereum, disincentivizes the borrower from paying back their loans.
If a borrower is unable to repay their loan, then their NFT will be auctioned off at a price higher than the debt owed by the borrower and at a minimum of around 95% of the collection’s floor price. The DAO also gives borrowers a 48-hour window to rescue their NFTs from being liquidated. During this period, any bid made would be kept locked up, according to a tweet by @punk9059 (NFTStatistics.eth), the director of research at PROOF Collective, a private community of NFT collectors. This represents a risk for bidders, especially when it comes to debts of a very high amount. At present, 15,000 ETH has been lent out by the BendDAO, but the contract’s reserves dropped from about 10,000 ETH to less than 5 ETH over the past weekend due to a bank run.
So, what is the problem?
The answer to this comes straight from the BendDAO team in their statement, “…we underestimated how illiquid NFTs could be in a bear market when setting the initial parameters.” They are in a situation where the borrowers aren’t paying back their loans and the NFTs being auctioned off aren’t being bought because of the high prices that have been set. These high prices, which are meant to cover the debt of the borrower, are sometimes far too much for people to lock up their ETH holdings for. Particularly considering the fact that the floor prices of said NFTs could end up falling in between the 48-hour lock-in period.
Another issue with the way BendDAO works is that it doesn’t want to take on any of the debt on itself. This means that it refuses to accept anything lower than the bid it has set so that it can pay the lenders back. However, in refusing to deal with any of the bad debt themselves, they have landed their DAO in a position where none of the NFTs are selling.
Why is this a concern for NFT projects?
What makes this situation even more precarious is that a lot of popular NFT projects, such as Bored Apes, CryptoPunks, Azuki and Clone X, have their values tied to these auctions. Since no one is willing to bid at the current rates, naturally, BendDAO will have to reduce the selling price. This drags down the value of the NFTs (and the projects they are a part of) lower and lower.
For instance, the floor price of Bored Apes Yacht Club reached an all-time high of 146 ETH in April this year, but it came crashing down to 66.9 ETH as of August 24, soon after BendDAO’s debt crisis surfaced. While this might seem completely unrelated, it all adds up when you consider that there are around 272 Bored Apes being collateralized on BendDAO, which make up 2.72% of the entire collection.
BendDAO’s next steps
BendDAO has decided to bring down the liquidation threshold, making it 85% for now and then gradually lowering it to 70% by September 20. It also plans to reduce the liquidation protection window from 48 hours to just four hours, which should ideally reduce the lock-in period for bidders would come down as well. The interest rates have also been pulled down to 20%.
For now, the NFT community at large can only wait and see how these changes affect NFT projects. But given the popularity and the strength of the communities behind these NFTs, it is unlikely that they will go away any time soon.
- Are DAOs Legal Entities and What Types of DAOs Exist in 2022?
- Which DAO Should You Join in 2022?
- What Is a DAO and How Does It Make Money?
- Why Are Cryptopunks So Expensive?
- Why Are Bored Ape NFTs So Expensive?
Header image courtesy of BendDAO’s Twitter handle