How NFT-Backed Loans Are Transforming the World of Small Business Financing

With traditional lenders rejecting 80% of SMB loan applications for a number of reasons – such as inadequate credit history or cash flow, limited financial information, or insufficient collateral – there’s a huge market for new lending products that embrace the transparency of blockchain technology.

NFT-backed loans are central to this, allowing lenders to look past outdated credit scoring methods to fund SMB’s in a manner that reduces risk and adds transparency to how the loan’s money is being spent. 

As part of a rapidly growing NFT industry, thought to be worth $40 billion, the convenience and flexibility of NFT-backed loans is winning over mainstream investors. In December 2021, Pantera Capital became one of the first firms to contribute $15 million to the funding of investment platform Arcade in a prime example of how this new finance is taking a foothold in the business world. 

But the world of NFT-backed loans is quickly evolving even past these popularized models. Today, we are witnessing growth outside of the world of crypto-based loans processed on decentralized finance platforms as new lending models that provide access directly to cash via NFTs now emerge. 

Let's now take a look at what exactly are NFT-backed loans, as well as how they are set to benefit both small companies and investors. 

What are NFT-backed loans?

You’ve probably heard of NFTs, the non-fungible (or unique) tokens that are secured with a smart contract on the blockchain (most popularly the Ethereum blockchain). These often consist of art pieces, collectibles, or even real estate. 

Today, there are two common ways to create NFT-backed loans. Firstly, there is a model where an NFT is used as a piece of collateral in exchange for crypto-based loans.

Secondly, there is a unique emerging model that provides access directly to cash through the blockchain, which offers added transparency among numerous other benefits for both the receiver and lender. 

In essence, these emerging NFT-backed loans, which are in essence blockchain-based loans, are new financial instruments that allow businesses to raise capital through an NFT, which acts as a bill of exchange between participants. 

Because the loan is raised through blockchain-based finance on a public ledger, loan activity becomes completely transparent, with every step of the lending process being stored and easily viewed on the blockchain, giving each lender a crystal-clear view of transactions.

Yet unlike the common assumption that NFT loans require crypto exchanges and decentralized finance (DeFi), there are emerging NFt-backed loan options that can instead be traded for cash. 

Flexible, low-risk and affordable, this new wave of funding is set to shake up the lending landscape for SMBs and investors alike, making it one of the most attractive options in the financial landscape for several reasons.

Let’s take a look at 4 major benefits of this new model of NFT-backed loans. 

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4 benefits of NFT-backed loans

The fact that NFT-backed loans provide transparency of all related transaction activities is why they are quickly becoming a major source of finance for entrepreneurs and start-ups

But this is not the only benefit: here are several other advantages that are making cash-based NFT loans the go-to option for SMBs.

1. There’s less risk because of more transparency

The blockchain technology that powers the smart contracts behind the NFT-backed loan is transparent, traceable, and flexible. 

All parties can keep track of the agreement along every step of the process, from the first pre-approved offers through to the repayment of the loan. Each member can also easily see the state of play by tracking the money flow, which reduces the misunderstandings that sometimes plagues traditional loans. 

Such transparency slashes the risk of unintentional loan usage, too; a major and understandable concern for many lenders is their natural concern about fraud and spending money on things a business does not need. This is often an important issue when funding companies far down the supply chain, where investors have to be extra careful to ensure suppliers are observing internationally upheld laws, such as anti-money laundering and labour rights regulations. 

With NFT-backed funding, they can see exactly where the borrower is spending the money through the blockchain. 

The smart contracts involved would then contain clauses that do not send the money until the shipment of goods or completion of terms is confirmed. Therefore, there is no money there until the deal is complete, and there will be no chance the NFT will be sent to the wrong hands. 

2. They’re more affordable

Applying for a business loan normally comes with several types of fees for the manual work that goes into it. When we combine costs such as the application fee, the broker commission, and the processing charge, we start to see just how expensive it can be — and that’s before even starting talking about interest. 

Instead, NFT-backed loans use an automated system that cuts out the human labor cost during the application process. There’s no need for the lender to pay underwriters, admin staff and other employees, meaning the lender can afford to charge just a small commission to borrowers.

When it comes to interest we’ve already mentioned how the transparent nature of blockchain lending and credit flow tracking reduces the risk level for lenders. Borrowers will see the benefits of this in the form of lower interest rates as lenders will feel more secure about who they’re sending the money to and what it’s being used for. 

For investors in NFT-backed lending products, this is a huge boon. 

Affordable lending options will fuel demand among borrowers who see them as a much more attractive option than traditional finance, which adds unfair lending costs to loans — and has tended to set up an unfair playing field for SMBs. 

3. They’re easier to understand 

Rather than get bogged down with the small print and technicalities of traditional finance, secure smart contracts make the terms concise and crystal-clear to all parties

The important stuff, such as buyer details and the value of the loan, are signed and sealed, but can also be quickly altered should the participants choose. 

While many mainstream NFT loans involve lucrative pieces of art as collateral, such as the digital art collector who raised $1.25 million in funding, there’s another model that strips the NFT down to a simple and traceable bill of exchange, making them even more accessible to SMBs.

These are normally cash-based NFT loans that skip the need to go through cryptocurrency exchanges and DeFi platforms, which can be daunting for SMB owners. 

Instead, the deal is made in the currency that the small business owner is comfortable with, cutting out the tech speak that often dominates the crypto world, and making the business more likely to go ahead with the loan.

4. They’re becoming more popular in trade financing

The flexible and accessible nature of NFT-backed loans means they are becoming prominent in trade-and-supply financing, helping small businesses far down the supply chain access funds that were previously out-of-reach

In the current system, lending to many SMBs located down the supply chain can be a legal nightmare that involves many separate contracts.

Tokenizing the loan payment guarantee to the lender, or the ‘ultimate buyer’, in the form of an NFT solves this problem at a stroke. Instead there’ll be a financial mechanism, sealed with a smart contract, that encourages suppliers to pass the NFT across the supply chain. Businesses can use the tokens as instant digital bills of exchange, removing many of the obstacles that plague normal trade finance in supply chains. 

Already, start-ups like Tinlake are starting to see the huge potential in this new world of finance. A smart contract-based marketplace, it allows companies to tokenize invoices into NFTs which can then be financed.

SMBs will have a traceable money flow that gives them a solid credit history, an attribute that will, in turn, engender future financing opportunities and continue to fuel a nascent NFT lending industry.  

Register with Duckfund today to find out how our unique NFT lending product is leading the way in an industry that’s attracting more institutional investment than ever before.
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