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Many owners of precious Bored Ape Yacht Club (BAYC) and CryptoPunks nonfungible tokens (NFTs), who used them as collateral to take out loans in Ether (ETH), have failed to repay their debts. The situation could lead up to the NFT sector’s first massive liquidation event.

BAYC “death spiral” incoming?

DoubleQ, the founder of Web3 launchpad Double Studio, says lending service BendDAO could liquidate up to $55 million worth of NFTs to recover its loans, fearing the so-called “health factor” of these debts could fall below 1.

Notably, an NFT collection’s floor price is important in determining the health factor. BendDAO offers 30%–40% of the NFT’s floor price as loans. But the protocol sells the NFT if its floor price falls too close to the amount borrowed—a liquidation threshold, as explained below.

BendDAO’s NFT liquidation protocol. Source: Official Website

Meanwhile, the floor price of BAYC has fallen from 153.7 ETH in May to 69.69 ETH in August—a nearly 55% plunge in three months. Simultaneously, the health factor of at least 20 loans with BAYC as collateral has fallen to 1.1 as of Aug. 19, data on BendDAO shows.

Borrowers have 48 hours to repay the loan or their NFT collateral will be liquidated. According to doubleQ, these liquidations could lead to “a death spiral for the BAYC ecosystem and NFT market as a whole,” given BendDAO’s exposure to other NFT projects, including CryptoPunks and Doodles.

“OpenSea volume is at the lowest point ever in the last 12 months,” the analyst warned, adding:

“There’s simply not enough volume to save these liquidations.. It’s inevitable.”

BendDAO NFT holdings distribution. Source: doubleQ

OpenSea is the leading NFT marketplace by volume.

To buy the dip or not?

Nevertheless, doubleQ believes the incoming BAYC liquidation could offer an opportunity to buy the NFTs at cheaper rates.

On the other hand, Naimish Sanghvi, CEO of India-based crypto news outlet Coin Crunch, wonders if there would be any buyers due to a lack of arbitrage opportunities. 

“Your bid has to be more than 95% of the floor value and higher than the debt amount,” explained Sanghvi, noting that there could no room for making money from arbitrage between these values.

“The auctions don’t begin until the first bid is placed, so there may be several NFTs in limbo at a given point in time if the prices are unfavorable. And that should scare the Liquidity providers.”

This scenario would have BendDAO wait for borrowers to repay their loans—or to wait for the re-emergence of liquidators after a market recovery—to subside its “temporary floating loss.”

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.