How Does the Lack of Liquidity for a Unique ERC-721 Token Impact Its Use in Derivatives?

A lack of liquidity means there is no ready market to buy or sell the ERC-721 token quickly without a significant price impact. This severely limits its utility as collateral for derivatives.

If the collateral needs to be liquidated to cover a debt, an illiquid NFT cannot be sold quickly or at a predictable price, jeopardizing the solvency of the derivative protocol. Therefore, illiquid NFTs are generally only suitable for highly bespoke, illiquid derivative contracts or require high over-collateralization.