According to S&P Global, the U.S. leveraged finance market topped USD 3 trillion in size for the first time ever in 2023. Even though billions of dollars of loans are in the DeFi system, never before has there been a mechanism like Open Dollar's Non-Fungible Vaults (NFVs), where each vault not only holds the collateral but is also responsible for the debt, enabling the trading of the vault itself – essentially the equivalent of selling a loan.

NFVs are a new primitive for Liquid Staking Tokens (LSTs), as it provides new methods to manage these assets along with their associated leveraged positions, thereby unlocking a number of new possibilities. In this article, we’re breaking down why Open Dollar’s NFVs are a game-changer for DeFi.

Liquidation Protection for CDPs

Leverage is a tool widely used by investors to amplify their investment outcomes, particularly for collateralized debt positions (CDPs). However, leverage is a double-edged sword; it not only increases returns but also escalates the risk of liquidation. When the market moves unfavorably, leveraged positions are more prone to liquidation, which can lead to significant losses for investors. This is where Open Dollar's Non-Fungible Vaults (NFVs) offer a novel solution for avoiding liquidation.

Unlike traditional CDPs that are permanently tied to the wallets that opened the position and are illiquid, NFVs in Open Dollar are NFTs that enable the sale or transfer of the position. In essence, when a user opts to trade an NFV, they are not just transferring assets; they are transferring the entire position, including the deposited collateral, its potential rewards, outstanding debt, and associated risks. In the LST market, where users often seek to maximize their returns with leverage, NFVs offer the flexibility to mitigate the risk of liquidation or fees associated with closing a position.

By allowing the trade of the entire position (collateral and debt), NFVs enable users to exit their leveraged positions before market conditions deteriorate to the point of liquidation. With CDPs on other protocols, users have only two options for avoiding liquidation: add more collateral or repay  enough debt to restore the collateral ratio of their vault to a safe level.

Adding more collateral or repaying debt requires the user to have the additional capital immediately available to do so. In adverse market conditions, this may require the sale of other assets prematurely, or keeping funds idle for this scenario which reduces capital efficiency.

DeFi Loan Marketplace

In traditional finance, loans and debt instruments are commonly traded, allowing investors to buy and sell debt which often includes bundled loans or individual loan parts. However, the traditional market typically lacks the transparency and accessibility found in DeFi platforms. This multi-trillion dollar market is reflective of the demand and opportunities presented by facilitating the trading of loans, but there is currently no parallel in DeFi despite its growing popularity and market capitalization.

While NFVs can be sold through standard NFT marketplaces, Open Dollar will introduce a specialized marketplace to facilitate the trading of NFVs that can be compared to the secondary loan marketplace in traditional finance. Trading NFVs through this specialized NFT marketplace not only provides a new avenue for investment in LSTs but also enables advanced features such as automations, while introducing a level of liquidity in the market for debt instruments that was previously unavailable in DeFi. With these advanced strategies to manage debt and collateral, users gain more control over their financial positions.

Loan Valuation in DeFi

In line with the ethos of DeFi, NFVs enhance transparency in loan valuation, particularly valuable to the already-complex LST market. By using NFVs to represent loans, the value of the loan is directly tied to the value of the underlying collateral minus the outstanding debt. This straightforward method makes understanding and assessing the value of loans more accessible to all users, not just financial experts.

Open Dollar cares about standardization and user-friendliness because it’s crucial to broader participation and understanding for LSTs and DeFi in general. Our method aims to help users make more informed investment decisions by removing the complexity and opaqueness that so often acts as a barrier to entry. In doing this, the NFV marketplace combines key DeFi principles like transparency and clarity with elements of TradFi necessary for greater adoption, like sophistication and structure.

Vault Automations

NFVs support the integration of real-time monitoring and automated responses to market fluctuations, allowing users to minimize or avoid the risk of liquidation, which is especially useful for leveraged investments. For instance, if the value of the collateral in a vault nears a threshold where liquidation might occur, the system can prompt users to take action, such as adding more collateral or reducing the debt.

Users could also enable an automatic sale of their NFV on the marketplace, allowing for a real-time safety net that doesn’t require manual intervention. This kind of proactive approach to risk management not only protects the users' investments but also contributes to the overall stability of the Open Dollar platform.

NFVs in the DeFi Landscape

Unlike many traditional DeFi platforms, which focus on straightforward lending and borrowing mechanics, Open Dollar merges the worlds of NFTs, lending, and risk management into a cohesive ecosystem to meet the specific needs of the LST market.

Other DeFi platforms may offer similar lending and borrowing services, but the way Open Dollar encapsulates entire complex financial positions within NFVs enables new features and a level of security currently absent in the DeFi loan landscape. This approach not only enhances liquidity and flexibility for users but also introduces a level of sophistication in how debt and collateral are handled.

Looking forward, NFVs could pave the way for new trends in the DeFi sector, potentially influencing how other platforms approach loan and asset management. We also hope the blending of NFTs with CDPs may spur further innovations in asset tokenization, trading, and increase user confidence for those who want to improve their capital efficiency but are otherwise discouraged by the consequences of liquidation.

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Open Dollar is a DeFi lending protocol built on Arbitrum for borrowing against liquid staking tokens while earning staking rewards and providing CDP liquidity with Non-Fungible Vaults (NFVs).

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