Borrowing against your NFTs, an interview with Arcade.xyz co-founder Robert Masiello

NFTs are going through a rapid evolution as we exit what I call the early early adopter phase. If the first phase was about creating, holding and trading non fungible assets, the second will be about enabling different ways to leverage those assets. One of the emerging use cases is to facilitate lending using NFTs as collateral. One company leading the charge is Arcade.xyz - I spoke with Robert Masiello, Co-Founder to learn more.

The following has been edited for clarity and length.

Tell me about the genesis of Arcade. What led you to start the company?

This is my second startup. My first was an analytics company that was focused on crypto. We essentially built a Bitcoin mining optimization algorithm that we sold to a private equity company.

Fast forward a few years later. My current co-founder Gabe called me one day and asked if I’d looked into NFTs. Gabe’s family owned a chain of pawn shops in Texas. We started talking about the capital inefficiencies of NFT assets. Right now a lot of those assets are art, collectibles, and social avatars, and because they’re non-fungible, there’s not a lot of liquidity behind them. It was obvious to us that there was a market to build out a lending platform, because that’s the most straightforward way to get capital efficiency out of otherwise idle assets. That’s how we got on this journey of building Arcade.

Can you describe the product? What are you building?

Arcade is essentially a loan marketplace. It’s a non-custodial platform that lets people come with their NFTs and take out liquidity against them — to use them as collateral on loans.

As a borrower, you can say: I’m willing to pledge this for X amount of time, I’m looking to borrow a certain amount of money against it, and I’m willing to repay a certain interest rate. It gets put up on the marketplace, and then we have lenders that browse the marketplace and fulfill the loan. Everything happens on-chain. We as a company don’t maintain custody of any assets. We’ve essentially just built an Ethereum smart contract protocol that allows people to trustlessly interact with each other.

If you’re the borrower and pay back your loan in time, you can reclaim your collateral. On the flip side, if you don’t pay back your loan in time, the lender can use their claim note to retrieve the collateral as well. We as a platform take a fee on top of this.

Borrowing and lending has been at the heart of financial services since financial services first started. What are some of the new challenges you face doing this with NFTs?

The challenges are really about the assets themselves and come down to pricing. If you look at pretty much any other asset class out there, you have decades or even centuries of data to price out these assets. Real estate, cars, art. NFTs are so nascent that there really is no Kelley Blue Book for them. That becomes a challenge from a negotiation standpoint because the borrower and lender may not necessarily agree on the loan to value, or the overall value of the asset. We’re trying to create a platform that lets people come to consensus around loan terms much more quickly. 

The space as a whole is trying to figure out that price discovery challenge. There’s a concept in the NFT space called the “floor price” of a NFT. A lot of NFTs are part of bigger collections, like the Bored Ape Yacht Club collection, and the floor price is the cheapest price that you can buy, for instance, a Bored Ape token. People use that as the reference price for what any Bored Ape should be. 

In our mind, the floor price isn’t a great reference to use for NFTs because it assumes that your asset is the cheapest, worst one available. If you own a higher tier Bored Ape, your asset is going to be worth much more than the floor price. We’re trying to get the space as a whole to move beyond the idea of floor price, because it’s just not the best data point we have.

I imagine that with pricing being such a challenge, you have to be on the lookout for wash trading or market manipulation of some of these NFTs. I’d have to think that’s a challenge for borrowers as well, to know what something is really worth.

There are simple ways to clean up what a floor price would be. You can use a time-weighted average price over the floor price, which should smooth out some wash trading. We have some more sophisticated ways of pricing using machine learning and data science to find the true floor. Where’s the greatest pocket of assets, and what are they listed at? It becomes more tricky for assets that aren’t part of a collection, or are one of one art.

Eliminating wash trading from the pricing model is critical. You’ve seen examples of wash trading to inflate the price of an NFT, where people buy and sell back and forth to artificially raise the current value.

Looking more broadly at the NFT space, we’re going through this very early adopter phase. What do you think it will take to bring the market out of that phase and into the mainstream?

It’s very similar to what’s happening in crypto in general. The UI/UX we’ve set for crypto has been archaic and challenging. It still is to a large extent, though there are great companies like Coinbase and FTX, or fintech companies like Robinhood and Stash, that are trying to help people to invest in crypto.

For NFTs specifically, it’s two things. It’s access to NFTs without a crypto native experience — being able to buy NFTs with FIAT currencies. Platforms like Robinhood are well positioned to do this. 

It’s also the content creators. The content has to continue to appeal to audiences that aren’t already deeply entrenched in online communities and crypto in general. You’re starting to see this happen a bit with legacy content creators like Disney, DC Comics, and Marvel. They’ve coupled the content their audiences already know with UI/UX experiences that are simple and not cumbersome. That gives NFTs a great chance to have greater penetration among wider audiences.

Do you think the future is central custody NFTs, rather than self-custody NFTs?

I think the majority of users will enter the space via a custody solution. Hopefully those more centralized platforms will create an off-ramp for people to take their assets out of custody and do a self-custody solution.

I think what you’ll see, though, is that the vast majority of value in NFTs will exist in self-custody solutions. Probably 95% of NFTs will be held in centralized platforms like Coinbase or FTX, but the actual valuable NFTs will be held by an upper echelon of users, that 5%. They’ll always want to self-custody their assets for fear of centralization.

NFTs are going through different trends. There’s the NFTs as artwork trend, and now the NFTs as utility tokens trend. What are some of the trends that you’re seeing?

NFTs right now are all about content, like I said earlier, whether it’s as simple as a picture or more of an experience. These are the really early experiments into NFTs. What we’re really interested in, in the long run, are more Web3 native experiences using NFTs, like utilities that provide access to DAOs or financial instruments.

I think that for the foreseeable future, the experiential, content-related NFT will remain the most popular. I think sophisticated financial products being tokenized as NFTs is a ways off. NFTs that are in-game assets — for instance, a sword or a shield — are an interesting concept. We haven’t seen it played out too much yet in meaningful ways, but we’re starting to see some early indications around those types of NFTs. 

The categories of NFTs will just continue to expand. We spend so much of our lives looking at screens, it makes sense that we’ll continue to invest our time, money, and value in assets that are digitally native.

This is your second crypto business. What are some of the challenges you face as you scale your business? What advice do you have for people building in this space?

I think the challenge in terms of scaling is staying connected to the communities that you’re building toward. Users are incredibly fluid in this space. They will seek out the best, newest experiences, and you have to keep making sure you’re delivering what they’re looking for because they will move on. The idea of a really sticky user is not as prevalent in Web3 as in a Web2 ecosystem.

For people starting to build in this space, my biggest piece of advice is to be really diligent about picking who you work with early on. It’s incredible what you can do with people who are knowledgeable, and you can really get lost without a guide. If you haven’t built in this space, partner with people who have a lot of experience.

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About Me

Hi, I’m Andrew Chang - I created the Web3 Roundup to share what I’m learning in this space. I’ve spent my career at the forefront of the technology industry in areas such as crypto/blockchain (Former COO @ Paxos, co-founding partner of Liberty City Ventures), video and adtech. I learn by meeting with founders, investors and other thought leaders and approach Web3 with the same enthusiasm – and skepticism – I had about crypto/blockchain technologies 10 years ago. 

You can connect with me on LinkedIn or Twitter (@DigitalDrex)