Major Challenges

ERC20 Shorting Mechanism

Money market is long been used by users to realize short positions. A user who wants to short BTC could go to any money market platform and use his assets collateral to borrow BTC then sell it in the market. If BTC price goes down as speculated, he can easily buy back the BTC he sold (plus interest) at a lower cost then repay it towards his loan, while keeping the difference between the proceeds from selling the BTC and the cost to buy it back as profit. See example below.

Challenge #1: Fungibility

ERC20 by definition is fungible, which means there is no difference between shorting BTC coming from different sources, whether they are mined, borrowed, purchased etc. However, NFTs by nature are non-fungibile. The concept of “shorting a general NFT” does not exist. When we apply the conventional ERC20 shorting mechanism to NFT, it is inevitable that whichever NFT the user borrows and sells short, it entails not only the general market exposure of the collection value movements, but also idiosyncratic exposure of the market conception on the unique rarity profile of the shorted NFT itself that is not generally applicable to other NFTs within the collection. To put it in context, shorting NFT more closely resembles shorting a house, while shorting ERC20 does with shorting stocks/bonds. Such idiosyncratic exposure is generally unwanted in the context of shorting NFT, as majority of the short sellers bet on the general trend of a collection to go down rather than that on any specific NFT within a collection.

Challenge #2: Liquidity

Due to Challenge #1 described above, this conventional shorting mechanism would work very inefficiently for NFT due to its poor liquidity. If user Jane uses her USDT as collateral and borrows an NFT, sells it in the open market and observes the market going low in general and wants to cash in on her “profit” - she may find herself in a deadlock that the now owner, user Henry, of that specific NFT would not sell it back to Jane at market price or any price she is willing to offer. Essentially the non-fungibility of any specific NFT dictates the extremely poor liquidity therein, making the ERC20 type of shorting scheme extremely inefficient to work in the NFT context.

Para Space designed the following NFT shorting mechanism for NFT that kills the above two birds with one stone.