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How to create a multifunctional fractionalized NFT?

Fractional NFT
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What is Chainlink VRF

NFTs have taken the art scene by storm and are also a major talking point in the tech sphere. The explosive sales growth that NFTs have witnessed has created a lucrative market for them worth billions.

Although NFTs are hugely popular now, they are not a new concept. NFTs came into existence in 2014 with the launch of Quantum, a non-fungible token created by Kevin McCoy and Anil Dash. It was much later, around 2020, that NFTs became a trendy topic people wanted to talk about, and their market value grew to a whopping US$250 million. Thus, from when they came into existence to the time they became widely popular, NFTs did travel a long way. Interestingly, the craze for NFTs has continued ever since, and market projections point to their bright future. According to a report by SkyQuest Technology, the global NFT market is expected to reach USD 122.43 Billion by 2028, with a CAGR of 34.10 % during the forecast period of 2022-2028.

Clearly, NFTs are a hit right now, and as per projections, they will grow bigger in the future. All this has caused NFTs to attract major investments from across industries. However, at a lower level, many still struggle to find an answer to the question, “How to invest in NFTs?” Well, it is easy! You can invest in an NFT in two ways: buying a whole NFT or a fraction of it based on availability and your budget.

Expensive NFTs are often broken down into smaller fractions to make them more accessible to the masses. This article revolves around these fractionalized NFTs that can be traded in the same manner as non-fungible tokens. As you read on, you will not just understand what fractionalized NFTs in web3 are but also how to create one. However, before diving any deeper, let us touch upon the basics.

What are NFTs?

A non-fungible token (NFT) is a record on a blockchain linked to a digital or physical asset. To understand what that means, we must first understand what “fungible” is.

A “fungible” item is replaceable with a similar item bearing the same value; that means every fungible item has the same utility and intrinsic value. An example of this would be a $10 bill that can be used to replace any other $10 bill—you can swap your $10 bill with your friend’s without actually causing its value to dip. However, if you have a $10 bill that some celebrity has signed or that has a unique serial number like all eights, it could be worth up to $1,000 or even more. Why so? Because a mere celebrity autograph can make a regular $10 bill rare, special, and hence, non-fungible.

Now, let’s come to what a token is. In the world of cryptos, “token” refers to a digitally issued certificate of authenticity recorded on a blockchain. The blockchain, also known as a distributed ledger, is a permanent record of transactions. Blockchain records are immutable, i.e., they cannot be changed or modified. And it is this immutability that makes NFTs valuable. When a unique certificate is issued against a digital product proving its authenticity and originality, it becomes far more valuable than other similar items.

Think of an artwork. Isn’t the value of an original painting always higher than visually similar prints or copies? Yes, but why so? Because while prints are infinitely reusable, there is only one original, which is non-fungible. Possessing an NFT means possessing an asset’s certificate of originality. So, NFTs are a great investment because rare and original items are always valued highly.

What are fractionalized NFTs?

A fractionalized NFT is an NFT broken down into smaller fractions to be sold individually. Each fraction represents a portion of the NFT’s ownership, enabling multiple people to own a single token. This collective ownership of fractionalized non-fungible tokens sets them apart from regular NFTs. Fractionalization lowers the threshold for NFT purchases, enabling more people to invest in these unique tokens. Fractionalized NFTs work just like shares of a company or shared ownership of a property.

When an NFT is fractionalized, the original NFT is locked up in a vault, and a limited supply of fungible tokens representing fractions of the NFT’s ownership is issued. Interested buyers can then invest in these individual fractions of the NFT and claim shared ownership over it.

How to fractionalize an NFT?

ERC-721 and ERC-1155 are two of the most popular token standards for creating NFTs on Ethereum, and both can create unique non-fungible tokens. However, to create altcoins or other homogenized tokens, the ERC-20 standard is used.

The process of fractionalization involves generating multiple fungible tokens out of a single non-fungible token. And to create multiple ERC-20 (fungible) tokens from an ERC-721 (non-fungible) token, you just need to deploy a smart contract with relevant instructions. Anyone holding an ERC-20 token can fractionally own the associated NFT.

Traditional finance uses fractionalization to deal with high-value assets, such as vacation homes and aircraft. An investor can, thus, expose his investment portfolio to a high-value asset without necessarily owning it. This means that fractionalizing an asset reduces the investment costs and risks associated with it. NFT fractionalization offers the same benefit to NFT investors.

Now, let’s dive deeper and understand the process of NFT fractionalization in detail-

  • To fractionalize an NFT, it must first be secured in a smart contract that breaks this ERC-721 or ERC-1155 token into several smaller parts, each representing an individual ERC-20 token.

  • Each ERC-20 token represents partial ownership of the NFT. After the owner of the NFT sells it, holders of the ERC-20 tokens can redeem their tokens for their share of the money received from the sale.

  • From deciding on the number of ERC-20 tokens to be created to fixing each token’s price, the owner of the NFT makes all major decisions regarding the fractionalization process.

  • An open sale is then organized for the fractional shares at a fixed price for a set period or until they are sold out.

Understanding the process of NFT fractionalization by examining the working of Fractional.art, a popular fractionalized NFT marketplace

Fractional.art, also popularly known as Fractional, is the leader in fractional marketplaces. It is a decentralized protocol that enables NFT holders to fractionalize tokens individually or on a pooled basis.

As the first step of the fractionalization process, an NFT owner needs to lock their token up in something called a “vault.” To create a vault, the user needs the following information: ERC721VaultFactory#mintname

Vaults, powered by audited smart contracts, take custody of users’ NFTs and lock them up until further action is taken. You can lock a single token or a collection of tokens in your vault.

The next step involves setting the parameters of fractionalization for your token(s), such as deciding the number of fractional shares to be issued. Once done, you must transfer the custody of the NFT(s) to the vault, which, in turn, will give you 100% fractional shares of the locked-up NFT(s).

name 
symbol
token  (NFT or NFT basket address)
id  (NFT id)
listPrice (the initial NFT price)

Vaults, powered by audited smart contracts, take custody of users’ NFTs and lock them up until further action is taken. You can lock a single token or a collection of tokens in your vault.

The next step involves setting the parameters of fractionalization for your token(s), such as deciding the number of fractional shares to be issued. Once done, you must transfer the custody of the NFT(s) to the vault, which, in turn, will give you 100% fractional shares of the locked-up NFT(s).

Fractional NFT

Fractional.art also has certain rights reserved for buyers; for instance, they can vote on the reserve price of the token(s) they have invested in. They can use their fractional shares as they please: gift them or split/share their ownership with friends. They can also airdrop them to members of their preferred NFT communities. Fractionalized NFTs can also be used to add liquidity to a decentralized exchange such as Uniswap or SushiSwap.

The reserve price is nothing but the minimum bid required to initiate an auction for a token’s sale. Bids lower than the reserve value are not taken into consideration. The party that makes the highest bid at the auction is given complete ownership of the token. The proceeds from the token’s sale are then distributed among the fraction owners on a pro-rata basis. Since the ERC-20 tokens created at the time of fractionalization now hold no value, they are burned by the protocol.

The following definitions will help you understand how marketplaces for fractionalized NFTs, like Fractional.art work.

Implied valuation

It is the price an NFT is currently valued at. It can be used as a reference to determine your “entry price.” If the implied valuation is equal to or lower than what you believe the NFT is worth, it is a good time to invest in that NFT.

Collectible supply

The shares of a fractionalized NFT that are available for purchase are referred to as collectible supply. If the collectible supply is at zero percent, it implies that no fraction of that NFT is now available for purchase.

Reserve price

The reserve price is the amount required to launch an auction for a fractional NFT. Each fractional owner of the NFT can vote to set the reserve price, after which a weighted average of the votes is used to calculate the reserve price for the NFT. Since auctions only begin when the reserve price is set, you may consider it the lowest price an NFT could sell for.

Buyout

A buyout occurs when an external party deposits an amount higher than or equal to the reserve price, which initiates an auction. When the auction ends, the NFT is withdrawn, and the fractional owners exchange their tokens for cryptos earned from the sale.

Can NFTs be restored after being fractionalized?

The answer to this question is, “Yes!” Fractionalization of an NFT is a reversible process; that is, the fractionalized NFT can be put back together to form the whole. Every F-NFT smart contract has a buyout option. This buyout option powers each NFT shard holder with the capability to buy all the fractions of an NFT to unlock its original version.

To trigger the buyout option, shard holders must transfer a certain amount of ERC-20 tokens back to the smart contract. A repurchase auction will be held within a set time after the trigger. Other NFT shard holders have a time limit to make a decision. Once that time is over, all the fractions of the NFT will automatically be transferred to the smart contract, and the entire NFT will be granted to the buyer.

The benefits of fractionalized NFTs in web3

NFTs allow you to own unique items, which is one of their biggest selling points. However, this element of exclusive ownership is also one of the major reasons behind their constantly increasing prices. Fractional NFTs are intended to address this problem and offer other important benefits, such as:

Democratization

Rising NFT prices have pushed many interested buyers out of the market. And this is particularly the case with highly in-demand non-fungible tokens. The fractionalization of an NFT enables a wider range of interested buyers to access it, who can then buy shares of their favorite NFTs, either as an investment or for gifting to others.

Price discovery

It is not easy to determine the correct price for an NFT, especially when it comes without any transaction history. After fractionalizing an NFT, its parts are released to be bid on by multiple investors, which helps determine its best price based on market demand.

Greater liquidity

Due to their high price, expensive NFTs often remain on the marketplace for longer before being sold. The fractionalization process breaks such NFTs into tiny affordable fractions to be bought on secondary markets by multiple investors. It reduces the risks associated with NFT investment, and even expensive NFTs tend to sell out quickly.

Better for creators

While all the above points are about the buyer’s experience, NFT fractionalization is also extremely rewarding for creators as they can reap the rewards of greater exposure in the highly liquid F-NFT market.

All kinds of NFTs can be fractionalized, and this has caused a lot of people to fractionalize their NFTs to ensure faster sales. So many NFTs have so far been fractionalized that creating an exhaustive list of all the titles isn’t possible. The list below only comprises the top fractionalized non-fungible tokens available on the market.

CryptoPunks

CryptoPunks are among the most expensive NFTs available for purchase, with some of them selling for millions. Despite their high price, they are extremely popular. Interestingly, they became even more appealing to investors after being fractionalized in 2021. Currently, fifty CryptoPunks exist in the fractionalized form, with 250,000 million ERC-20 tokens created out of them. These fractions were originally sold for US$0.05 per unit and are now priced at US$0.07779 for each fractional share.

Mutant Cats

Mutant Cats is a collection of 9,999 artworks that have been algorithmically created in the style of CryptoPunks. You can visit the OpenSea marketplace and purchase either a complete NFT from the collection or a fraction of it. It is worth noting that with the purchase of any Mutant Cats NFT, you also receive voting rights within the ecosystem. What more? You can stake your shares for $fish tokens.

Grimes’s popular NFT art pieces

Grimes is among the most established artists to immensely benefit from the fractional NFT trend. According to reports, she has earned US$6 million for her artwork. Her recent creations, Newborn 1 & 3, have been fractionalized at Otis, one of the top NFT marketplaces.

Doge meme token

The popular Doge meme non-fungible token sold for US$4,000,000, and the owner fractionalized it into nearly 17 billion $DOG tokens after purchase. 20% of the supply created was sold on the MISO marketplace to 1,796 buyers for close to US$45million. The rest went to Uniswap or Sushiswap.

Multifunctional fractionalized NFTs’ real-world use cases

Fractionalized NFTs are a great means to provide exposure to the NFT market. But that is not the only role fractionalized NFTs play; they have numerous real-world use cases that make them even more valuable. Let us explore some industry-level use cases of fractionalized NFTs to understand their real-world applications better.

Gameplay using fractionalized NFTs

Play-to-earn games, unlike other types of crypto games, allow players to earn, buy, sell, and even gift in-game digital assets. The majority of these assets are in the form of non-fungible tokens. Multiplayer games like Star Atlas and Axie Infinity, which feature NFTs, use this technology to enable players to come together and purchase more expensive items.

Axie Infinity selling its ultra-rare Axies (an in-game NFT asset) in fractions is just one example of how games are embracing this new trend. In the case of Axie Infinity, members of the community fractionalized Axies and sold them via Niftex, a marketplace for fractionalized NFTs.

The metaverse and fractionalized NFTs

The metaverse is fast gaining popularity among investors. A significant amount of money is being pumped into this fast-growing virtual universe, thanks to the efforts of brands like Facebook, Decentraland and Sandbox.

NFTs have already made acquiring virtual real estate and other digital assets in the metaverse easy. And since non-fungible tokens are based on smart contracts, they make ownership management a breeze by handling payment distributions, royalties, and the transfer of legal ownership rights. Interestingly, with the advent of fractionalized NFTs, buying and selling digital assets within the metaverse has become even more convenient. Users can now buy/sell NFTs that have been split into several pieces, each piece representing partial ownership of an asset.

Real estate and fractionalized NFTs

Fractionalized NFTs don’t just benefit investors looking to buy spaces in the metaverse but also those interested in real-world real estate properties.

Real estate investments often provide significant returns within a short period. However, in this day and age, you need a lot of upfront capital to purchase any property, which means that only a handful of people can invest in the real estate sector. This is a problem NFT fractionalization is looking to resolve by putting fractional shares of real estate NFTs on sale, making real estate investment affordable.

Fractionalized NFTs and the art space

Art pieces by popular artists are often sold at high prices. However, artists who are not well-known struggle to make a living selling their art. NFTs have played a great role in helping such artists make a living by selling exclusive rights over their creations. The good news is that the picture is getting better with the emergence of fractionalized NFTs. Now, even small investors can invest in expensive art, and creators can reap great rewards when their creations are sold.

The role of fractionalized NFTs in music

Musicians are using fractionalized NFTs to uncover hidden value in the NFT space. This is a win-win for both artists and their fans. Now, many artists have started selling royalty shares to their fans by offering each one of them the right to receive a percentage of all royalties from all future sales of their albums. Torey Lanez, in fact, released his NFT digital album directly to fans by selling out 1 million digital units in less than one minute.

Interestingly, another new fractionalized NFT trend is coming up where almost all royalties from a music album directly go to the fans who invest in the album’s NFT.

Fractionalized NFTs as collectibles

Collectibles are essentially prized possessions. Talking about NFTs, they have always been a popular collectible, having a huge market. Fractionalized NFTs have only made buying NFTs as collectibles easier for NFT enthusiasts. The CyberPunks fractional NFTs, for instance, were a great commercial success. Had CryptoPunks not been fractionalized, the average investor would not have been able to invest in them, considering their high price.

Domain name fractionalized NFTs in web3

In the past couple of years, domain names such as .crypto and .eth have been a huge success in the web3 space. Fractionalizing domain name NFTs and putting them out for sale could also be a lucrative business.

Endnote

Fractionalized NFTs have pushed the boundaries of what is possible within the NFT world. They have boosted the NFT market by making NFT investment more attractive to small- and medium-scale investors. Hence, whether to invest in art, music or real estate, fractionalized NFTs are a smart choice.

It is also worth noting that the cost of digital assets is constantly skyrocketing, which has caused many new creators and investors to become a part of the NFT movement. But because of their high price tags, many NFTs fail to find buyers. Fractionalized NFTs have solved this problem by making NFTs affordable without forcing creators to cut down on the price.

Clearly, fractionalized NFTs are a revolutionary concept in the rapidly evolving and ever-changing world of NFTs. Instead of allowing only a handful of people to own and manage valuable digital assets, fractionalized NFTs offer a way for the whole community to benefit. This is exactly the ethos behind web3 development, where every project is created with the community in mind.

If you want an NFT or NFT marketplace created, contact LeewayHertz right away. We will turn your dream project into reality with our extensive expertise and experience in web3 development.

Listen to the article
What is Chainlink VRF

Author’s Bio

Akash Takyar

Akash Takyar
CEO LeewayHertz
Akash Takyar is the founder and CEO at LeewayHertz. The experience of building over 100+ platforms for startups and enterprises allows Akash to rapidly architect and design solutions that are scalable and beautiful.
Akash’s ability to build enterprise-grade technology solutions has attracted over 30 Fortune 500 companies, including Siemens, 3M, P&G and Hershey’s.
Akash is an early adopter of new technology, a passionate technology enthusiast, and an investor in AI and IoT startups.

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