Anyone who has been following the NFT craze knows their main feature is their guaranteed exclusive ownership. With NFTs booming, there is no shortage of headlines covering what they are, not to mention their crazy valuation even as the mainstream adopts the idea.
As new waves of NFTs emerge almost every day, innovators in the space continue to push the boundaries of what is possible in NFTs. Adding to the fun and simplicity that most NFT innovations espouse, a new frontier of fractional ownership of NFTs is emerging.
It seems NFT collectors are coming to terms with the fact that it is not a bad idea to own a fraction of a big pie as opposed to full ownership of a smaller one.
In this article, we will learn what fractional NFTs are, how it works, and how it is changing the way people own NFTs.
NFT Fractionalization Explained
One of the first questions in any discussion about fractional non-fungible tokens or F-NFT would revolve around its definition. Interestingly, you can understand fractional non-fungible tokens with a basic idea regarding the fractionalization of assets. Fractionalization basically implies that you can own a share of the big NFT pie. It is more or less the same as holding shares of a company. As a result, fractionalization serves as an innovative answer for opening up NFTs to small-scale and medium-tier investors.
With the basic idea of fractionalization of assets, let us reflect on “What are fractional NFTs?” and the answer for understanding their role in the burgeoning NFT ecosystem. Fractional NFTs are not different from the regular NFTs in their technical design. However, the striking difference with fractional non-fungible tokens is the division of the NFT into smaller pieces or fractions.
The smaller fractions of the NFT allow any individual to hold a share in the ownership of the same NFT alongside many others. One of the primary highlights of fractionalized non-fungible tokens refers to smart contracts, which help in creating a specific quantity of ownership tokens associated with the original NFT. Fractional tokens offer a share in the ownership of the NFT to every token holder. Interestingly, anyone can exchange or trade their fractional tokens on different secondary marketplaces.
How Do Fractionalized NFTs work?
Fractionalized NFTs are the new sensation and they are enabled by smart contracts.
We will use Ethereum’s ERC20 and ERC721 token development standards to illustrate how fractionalized NFTs work. As a reminder, ERC721 tokens are the set standard for creating non-fungible tokens on Ethereum’s blockchain, and the ERC20 standard is used to create fungible tokens. A fungible token could be created to represent fungible items such as gold, money, or any other commodity in the physical world. A non-fungible token on the other hand can be used to represent any rare item such as a collectible game card, a trophy, or a house.
Given that a fungible token is flexible such that it can be exchanged for another of its kind without losing value, a smart contract can be deployed to generate ERC20 tokens linked to an indivisible ERC721 NFT. This way, anyone who holds any of the ERC20 tokens generated can own a percentage of the rare and valuable NFT.
This is how fractional ownership of an NFT can be created, and the smart contract can secure the data that differentiates the fractional NFT from other NFTs. This idea can also be applied on any blockchain network that supports smart contracts and NFTs such that the NFT is locked in a smart contract on the blockchain and ownership of the NFT is represented by multiple fungible tokens whose supply is governed by the smart contract.
Fractional NFTs vs. Regular NFTs
Fractional NFTs (F-NFTs) basically bring a tweak in NFTs to ensure their accessibility. The difference between the F-NFTs and regular NFTs is clearly evident in the fact that the latter are whole entities. On the other hand, fractional non-fungible tokens are just smaller shares of the original NFT.
In addition, you must also note that it is possible to reverse the fractionalization process. Therefore, you can turn the fractional non-fungible tokens into one whole NFT. How? The smart contract used for fractionalization of NFTs offers a buyout option. Any investor can use the option of purchasing all fractions to return back the original NFT.
How Do Fractional NFT Owners Benefit?
The biggest benefit for fractional NFT owners is that they get to own a percentage of a larger, and more expensive, whole NFT. Depending on the NFT and the platform where the fractional NFT was purchased, the holder may gain some local governance rights on the platform with respect to a particular fraction set.
For example, there are only 10,000 CryptoPunks NFTs in existence, and due to their expensive price tags, they have relatively few sales. In April 2021, a collection of 50 CryptoPunks was fractionalized into 250 million tokens, each representing part of the collection.
These fractional NFTs, called uPunk tokens, had a collective market cap of $12.9 million in February 2022. Holders of uPunk tokens have the option to bid on any CryptoPunk in the collection. If 50% of the 250 million vote to unlock the collection, then each of the NFTs will be awarded to their highest bidder.
Some F-NFT projects support staking, and enable holders to earn a passive income in addition to voting rights. For example, Mutant Cats is a collection of 9,999 NFT avatars which are similar to the ape avatars by Bored Ape Yacht Club, except the Mutant Cat avatars feature colorful, mutated cartoon cats. The project has fractional shares, called $FISH, which represent fractional ownership of the NFTs. Each Mutant Cat NFT holder can stake them to earn 10 $FISH per day. They also gain exclusive access to the Mutant Cat DAO community, as well as voting rights over the DAO’s assets.
Is NFT Fractionalization Necessary?
Fractional NFTs are democratizing ownership of NFTs. As the popularity of NFTs continues, the price of owning a single NFT is increasingly becoming expensive. For instance, not all NFTs can attract the level of market excitement and activity that was realized by Beeple’s collection of 5,000 NFT pieces of artwork that sold for $69 million. With fractional NFTs, democratized ownership is a possibility such that even as the bidding price of NFTs increases, market activity around that NFT remains relatively high as more people can participate at lower prices. Even if one of the owners of that NFT decides to sell, their move won’t affect the overall value held by other stakeholders.
Fractional NFTs also bring about a great deal of liquidity to the NFT marketplace. While NFTs are hot right now, their non-fungibility will ultimately lead to a lack of liquidity on most of the NFT marketplaces popping up right now. With fractional NFTs, liquidity can be sustained whereby smaller investors can participate as opposed to only having the participation of a few deep-pocketed collectors. The fungible tokens created by the smart contract to represent ownership in the NFT can be traded on other secondary platforms to further add liquidity.
Lastly, NFTs are necessary as they enable price discovery of NFTs. Price discovery is the process through which a market goes through to set the proper price of an asset.
