Fractional nonfungible tokens (F-NFTs) are dominating conversations across the tech sphere. They are the latest innovation in the NFT space that stands to revolutionize NFTs’ fundamental architecture and open up new frontiers for investors.
Anyone who has been following NFT trends will know that NFTs often make headlines for their insane valuations. The prices of popular NFTs can run into millions, making them prohibitively expensive for the average buyer. The need to solve this problem has led to the emergence of F-NFTs.
From the perspective of profitability, having a small piece of a popular yet expensive NFT is much better than acquiring full ownership of several insignificant ones at the same price.
The idea of F-NFTs is fast gaining steam. Their introduction is being globally perceived as a transformative move that would push the boundaries of what is possible within the realm of digital asset ownership.
- What is a fractional NFT?
- Use cases of fractional NFTs
- How do fractional NFTs work?
- Is fractionalization necessary for NFTs?
- The benefits of fractionalizing NFTs
- The biggest challenge facing F-NFTs: Reconstitution
What is a fractional NFT?
A F-NFT, also referred to as a fractionalized NFT, is an NFT that has been broken down into fractions to be sold individually.
The Doge NFT sale is a real-world example of NFT fractionalization. In June 2021, the Doge meme, an NFT, was sold for a whopping $4 million. PleasrDAO, who purchased the NFT, later offered fractional ownerships of the NFT in $DOG tokens that fans could purchase for as low as $1.
Although the inspiration behind F-NFTs is artwork, art is not the only area where F-NFTs find use.
Use cases of fractional NFTs
F-NFTs and gaming
Most play-to-earn crypto games allow you to buy, sell, and own various in-game items, some of which are NFTs. Such multiplayer games can use F-NFTs to allow players to come together and buy and sell expensive in-game assets by investing in their fractionalized shares. Axie Infinity, an NFT-based online video game, is already testing the feasibility of F-NFT trading by selling fractionalized ownerships of ultra-rare Axies, one of its most popular in-game NFT assets.
F-NFTs and the metaverse
With the idea of the metaverse entering the mainstream, we can expect a massive influx of investments into metaverse-related projects. Companies like Decentraland and Sandbox have already made a foray into this domain.
F-NFTs can be used to allow groups of investors, conglomerates, and even individuals to come together and buy virtual land and other similar digital assets within the virtual world.
F-NFTs and real estate
NFTs can significantly speed up the process of property buying by replacing intermediaries with smart contracts to enable simple and safe transfer of ownership. Converting a real estate property into an NFT also has other critical benefits such as instantaneous ownership settlement and a simplified overall transaction process. Further, because the ownership and rights history can be recorded directly on a blockchain, transaction details’ verification is usually fast and easy.
F-NFTs are similar to NFTs in that they allow for the purchase and sale of properties without the involvement of an intermediary. The only difference is that F-NFTs allow multiple parties, and not just one, to share the property’s ownership. Although F-NFTs are not yet an integral part of the real estate industry, it is easy to foresee that their use will make investing in real estate easier and more affordable in future.
How do fractional NFTs work?
Because most NFTs use Ethereum’s ERC-721 standard, we will try to understand fractionalization taking the example of an ERC-721 NFT.
To break this NFT into fractions, it must first be locked in a smart contract, which will split the ERC-721 token into multiple ERC-20 tokens as per the instructions the NFT owner has given. The owner specifies everything, from the number of ERC-20 tokens to be created, to their prices, to the metadata to be used, to any other property they deem important. Each fraction or ERC-20 token created represents partial ownership of the NFT. The fractions can then be put up for sale at a fixed price for a particular time or until they get sold out.
Let us look at an example to understand the working of F-NFTs. We all know that The Scream by Norwegian artist Edvard Munch is one of the most iconic artworks ever created. In fact, when it was put up for sale in 2011 at a Sotheby’s auction, Leon Black, a New York financier, bought it for almost $120 million. Imagine an NFT representing this artwork. It is easy to imagine that its price will run into the millions and hence will fit the budgets of only a handful of wealthy investors. However, if this exorbitantly priced NFT could be fractionalized into, say, 10,000 ERC-20 tokens, then one could invest in the artwork by paying as low as $12,000 per fraction. Thus, fractionalization makes rare and expensive NFTs affordable and more attractive to even small- and mid-size investors.
It is important to remember that fractionalized NFTs do not only work on the Ethereum blockchain. Fractionalization is possible on any blockchain network that supports smart contracts and NFTs. Networks such as Polygon, Solana, and Cardano can all facilitate F-NFT ownership transfers.
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Is fractionalization necessary for NFTs?
With NFTs becoming more popular by the day, the cost associated with owning one is quickly increasing. It is only through fractionalization that expensive NFTs can be made affordable with ownership democratization. The results of fractionalization are fascinating. First, it ensures affordability. Second, if one of the fractional owners decides to sell their fraction at a lower price, this would not affect the value of the fractions other stakeholders hold. Third, even if an NFT’s bidding price increases in an auction, it will still attract buyers willing to pay lower prices for fractionalized ownerships.
The benefits of fractionalizing NFTs
Efficient price discovery
F-NFTs allow for efficient price discovery for NFTs. Price discovery is the process by which a market determines the right price for an asset.
Usually, it is difficult to price newly created NFTs and NFTs having little or no transaction history. Fractionalization makes NFT pricing easy by allowing an NFT to be divided into multiple parts, which can then be released in the market to be bid on. This helps estimate the price of an NFT based on its market demand.
Thus, F-NFTs are a quick way to estimate the market value of unique and rare NFTs. Additionally, when the price of an NFT increases, the value of its fractions also goes up. However, an NFT can also suddenly lose value, as is often the case with cryptocurrencies, and the fractions’ values will also simultaneously drop in such a case.
NFTs derive value from their rarity. However, this also makes them less liquid than many other tradable digital assets. F-NFTs bring liquidity to the NFT market by allowing smaller investors to own assets collectively. Fractionalization is the easiest and most effective way to sell expensive NFTs quickly. Hence, if you own an exorbitantly priced NFT and are having difficulty finding buyers for it, you can fractionalize it into as many parts as necessary to ensure a desired level of affordability. Fractionalization has not only made NFTs more appealing to investors but has also effectively solved the problem of liquidity associated with this asset class.
An NFT owner who divides their asset into fractions receives a curator fee from their chosen NFT marketplace. Although the owner can set and update the amount of this fee, it is subject to a maximum price limit to prevent reckless pricing.
The biggest challenge facing F-NFTs: Reconstitution
F-NFTs, like everything else in the world, present challenges. These are associated with the reconstitution of NFTs. Let us delve a little deeper to understand this.
Although selling a high-potential, extremely unique, or rare NFT in fractions is commercially profitable for the owner, problems arise when they fail to get all the fractions of the NFT back together. Let us understand the problem with an example. If you have a cake and sell one-fourth of it, you can still use the remaining three-fourths for consumption or sale. Similarly, if you decide to sell 25% of your business, the remaining 75% will still be profitable for you. In most such cases, the fractions of a “whole” are not dependent on one another as far as their utility is concerned. However, NFT fractions are different. It is much more convenient to own and trade an NFT in entirety rather than in fractions. The entire asset is yours; you can sell it whenever you want or put it to its intended use. However, if you own a fraction of, say, an in-game asset, you might not be able to use it against its intended purpose in the game.
The only way to reconstitute the NFT would be to buy all the sold fractions back from their respective owners. However, if they refuse to sell them back to you or you lose their private keys, you will be left with no other way to reconstitute the NFT. Is there a solution to this problem? Yes. Now there are fractionalization protocols in place that make the reconstitution of NFTs possible via buyout auctions.
What is a buyout auction?
A buyout auction is similar to a regular auction; the only difference is that it involves trading F-NFTs instead of physical assets. When an NFT owner fractionalizes their asset, they set a reserve price for the complete asset. The reserve price is the minimum price they want for the NFT when it is auctioned. Any interested buyer will have to bid an amount equal to or higher than this price to acquire ownership of the NFT.
Current fraction holders can keep their fractional ownerships if they want to. However, they will have to beat the potential buyer by outbidding the potential buyer’s bid amount. If they fail to do so, then all individual fractions will automatically come together and reconstitute the NFT to be transferred to the buyer. The buyout option allows for price discovery, which helps increase the NFT’s overall value in the market.
Although the idea of fractionalizing NFTs is still in its infancy, it seems like it will be the next big thing in the growing blockchain industry. NFT fractionalization allows for greater liquidity, which opens the market to a much wider diversity of investors and almost guarantees that F-NFTs will power the next digital asset monetization wave. Further, as NFT continues to grow in popularity and demand, we can expect to see many more interesting developments in this domain.
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