What are fractional NFTs?

Introduction

The non-fungible token (NFT) market continues to grow in popularity and demand. At the same time, there are further interesting developments such as fractional NFTs.

NFTs represent a paradigm shift in asset ownership towards decentralization and transparency. One of the key features of NFTs, for example, is their guaranteed exclusive ownership. An NFT can’t be replicated or forged; it’s a one-of-a-kind token. 

However, there are limitations to what NFT holders can do with their assets. This has led innovators to push the boundaries and introduce fractional ownership.

NFTs

Before turning to fractional NFTs, we need to explore the term ‘NFT’ in more detail. Firstly, an NFT is a unique digital identifier that is recorded in a blockchain and it represents a digital asset. It is used to certify authenticity and ownership. These digital assets are found in various domains: digital art, in-game items, virtual real estate and many others.

Notably, the ownership of an NFT can be transferred by the owner. As a result, NFTs (including fractional NFTs) can be sold and traded.

More technically, NFTs are ERC-721 tokens created by an indivisible smart contract on the Ethereum blockchain. Since the tokens are indivisible and impossible to replicate, they are ideal for individual intellectual property tracing. 

NFTs experienced an impressive rise in 2021 because of many new NFT projects whose auctions achieved unprecedented success. 

Fractional NFTs

NFTs have prices in the tens or hundreds of thousands of dollars. Thus, many of the most popular collections are unaffordable for would-be collectors. NFT collectors are forced to put all their eggs in one basket by holding a limited number of high-value NFTs.

NFT fractionalization solves these problems, namely, by dividing a single high-value NFT into more affordable and tradeable pieces. In some ways, the concept is similar to dividing public company ownership into shares. 

Therefore, fractional NFTs are simply whole NFTs that have been divided into smaller fractions. This allows a number of people to claim ownership of a piece of the same NFT. The NFT is fractionalized using a smart contract that generates a number of tokens linked to the indivisible original. Accordingly, these fractional tokens give each holder ownership of a percentage of an NFT. They can then be traded or exchanged on secondary markets.

Essentially, buyers with limited funds are able to buy fractional NFTs, thereby investing a lower amount of money. This enables multiple investors to each gain partial ownership of the same asset.

Benefits of fractional NFTs

As has been noted, NFTs have greatly increased in popularity. Some collections have become so valuable that the price of owning a single NFT has become prohibitively expensive. 

Such a high barrier to enter the market limits the number of potential investors. Fractionalization, of course, is a solution to this problem. Breaking down an NFT into smaller pieces democratizes this new market, allowing interested parties with limited funds to affordably invest. This not only benefits investors, but also the NFT market in general, as it brings in new liquidity. 

Fractional NFTs inject the market with a large number of affordable tokens that offer percentage ownership of popular NFTs.

Here are some of the benefits of fractional NFTs for investors, artists and designers:

• Firstly, fractional NFTs benefit artists as they allow artistic works to be monetized more effectively.
• Secondly, investors with limited liquidity can own NFTs through fractional NFTs.
• Thirdly, NFT owners can drive interest in their assets through fractionalizing ownership.
• Fourthly, the creators of fractionalized NFTs can sell part of their NFTs without having to sell the entire object.
• Finally, an NFT owner who divides an asset into fractions receives a curator fee from the NFT marketplace. 

How it works

The fractionalization process is relatively simple. Generally speaking, you take an NFT and create a set number of shares (thousands or even billions of shares). Each one can be sold at a fixed price. These shares, i.e., fractional NFTs, can be bought and sold on secondary markets without affecting the value of the original.

An NFT is, in other words, a token that uses Ethereum’s ERC-721 standard. Before the NFT can become fractionalized, it is locked in a smart contract. 

The smart contract then splits the ERC-721 token into multiple fractions in the form of ERC-20 tokens. Next, the owner defines the number of ERC-20 tokens that will be created, their price, metadata and other properties. Each fraction, or ERC-20 token, represents partial ownership of the entire NFT. The fractional NFTs are then put up for sale at a fixed price. 

NFTs and fractionalized NFTs aren’t, however, just limited to the Ethereum blockchain. Fractionalization can work on any blockchain network that supports smart contracts and NFTs. Alternative networks such as Polygon, Cardano and Solana all support smart contracts and allow the creation and transfer of NFTs. These networks have the added benefit of fast transaction times and no gas fees.

Use cases of fractional NFTs

Gaming: most play-to-earn crypto games permit players to buy, sell and own various in-game items. Needless to say, some of these are NFTs. By investing in fractionalized shares, players can buy and sell expensive in-game items within these multiplayer games.

Metaverse: fractional NFTs allow individuals, groups, investors and companies to jointly purchase assets such as virtual land in the metaverse.

Real Estate: NFTs can significantly speed up the process of buying property by replacing intermediaries with smart contracts. This enables simple and safe transfer of ownership, as well as immediate payments.

Platforms for fractional NFTs

Fractional NFTs are still relatively novel, but you can access them using several new platforms. In general, these platforms mint custom ERC-20 tokens that represent a share of each NFT or NFT collection.

Several platforms have emerged where users can create and purchase fractionalized NFTs, for example: 

• Unicly is for investors looking to transform their NFT collection into a tradable asset with guaranteed liquidity. Investors can use the platform to tokenize NFTs and create tradable collections of any size. 
• Fractional.art is, notably, the most popular platform for buying, selling and minting fractional NFTs. You can buy a fractional piece – from one of the collection vaults – of a single NFT or an entire collection. Although it has no bidding and staking options, like Unicly, the platform offers more flexibility for developers. This is thanks to its basic and permissionless protocol design. 
• Otis is an NFT investment platform where users can invest in NFT collectibles and art. Users can also manage their NFT portfolio and participate in real-time trading via the Otis app. Investors can use the platform to acquire fractional interests in crypto assets. 

Conclusions

Fractional NFTs undoubtedly open up a myriad of possibilities. They’re helping to unlock liquidity for NFTs, while also increasing participation in the NFT space. Moreover, they expand the range of opportunities open to the NFT market by bringing liquidity and democratization.

However, there are some drawbacks. The sale and purchase of whole NFTs as digital collectibles often won’t raise issues with securities laws. Fractional NFTs, on the other hand, are more likely to raise red flags with financial regulators. This is because they are more similar to a share and therefore to a security.

As the market for NFTs and fractional NFTs continues to grow, legal rules around the assets will also evolve. Investors and owners will have to monitor this development carefully. 

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