Fractional NFTs Explained:
and Risks of Fractional NFTs
In a digital age where the value of a digital creation depends on its demand in the market, the rise of non-fungible tokens (NFTs) is inevitable.
NFT is a form of digitally secured cryptocurrency via blockchain, but it differs from regular crypto assets in their fungibility. While a crypto asset can be easily exchanged for another similar asset, an NFT cannot. Thus, NFTs guarantee exclusive ownership, making them rare, unique, and expensive.
With NFTs booming, innovators are pushing the boundaries to explore the possibilities of making NFTs more affordable. A new frontier of fractional ownership of NFTs has emerged, and the fractionalized market capitalization has already surpassed $200 Million as we speak.
What are Fractional NFTs?
Fractional NFTs are tokenized ownership of NFTs that are split and shared between multiple people. The simple act of dividing the ownership of an NFT into smaller fractions makes it possible for several people to own a high-value NFT at a low cost.
A high-value NFT asset like a luxury yacht or real estate can be too expensive for a single person to own. This is where fractional NFTs play a massive role. It allows people to invest a small sum of money to gain fractional ownership of a highly-priced asset.
How doFractional NFTs Work?
Fractionalization of NFT involves a smart contract. To illustrate how fractional ownership of an NFT is created using Ethereum’s ERC721 and ERC20 token development standards.
ERC20 standard is used to create fungible tokens
ERC721 standard is used to create non-fungible tokens
Since a fungible token can be exchanged for another asset without losing its value, a smart contract is deployed to create ERC20 tokens that are linked to the non-fungible ERC721 NFT. This means anyone who is in possession of any of these ERC20 tokens owns a percentage of the valuable and rare NFT.
The smart contract securely locks in the data that differentiates the fractional NFT from other NFTs on the blockchain. The ownership of fractional NFTs is represented by multiple fungible tokens, the supply of which is governed by the smart contract.
Understanding NFT Fractional Ownership
Fractional ownership is a revolutionary concept that has opened up new horizons in NFT investing. Fractionalizing NFTs is beneficial for both parties, NFT buyers and NFT sellers.
Why Would an NFT Owner Fractionalize Their High-value NFT?
Here are some reasons why fractionalization of NFTs makes sense for an NFT owner:
NFT fractionalization solves the liquidity issues of NFTs. High-valued NFTs do not sell quickly because only a small percentage of investors can actually afford them. When you fractionalize them, you can divide the ERC-721 token into multiple ERC-20 tokens and sell each of them individually. This not only creates a lot of interest for the asset but also addresses the liquidity issues.
Enable Price Discovery
Fractionalized NFTs help you assess the market value of your NFT quickly. To test the value of your NFT, you don’t need to sell it. All you need to do is fractionalize it and sell 10–20% of it on the market.
The original NFT owner who fractionalizes NFTs receives a curator fee annually. The NFT owner can decide the fee amount, but it has a cap set by the governance to avoid high fees.
NFT owners can easily monetize their assets through fractionalized NFTs.
Why WouldYou Buy
NFTs in Fractions?
Here are some reasons why buying fractional NFTs make sense:
As a fractionalized NFT owner, you can vote to set the reserve price for the NFT. The reserve price is the amount that someone needs to pay to initiate an auction for the entire NFT.
Fractional NFTs have allowed small and medium investors to invest in the NFT market that was previously reserved for a small segment of wealthy people.
If the entire digital asset is purchased, the Ether (ETH) from the sale is divided to all the fraction owners.
You can resell your NFT fraction whenever you want.
Risks Associated With Fractional NFTs
Fractional NFTs have increased participation and inclusion in the booming NFT space, but it has its own set of risks, including:
It is a known fact that digital currency is far more volatile compared to physical assets, and it’s more so in the case of NFTs.
Market Based on Speculation
The value of NFT is currently based on sentiments and aesthetics. It is not a solid long-term investment as the NFT market is relatively new and still standing on the pillars of speculation. For example, if you buy an NFT art and if there is no market or buyer for it, you risk spending your money on an unsellable asset.
Inefficient Security Protocols
Smart contracts are integral to NFT fractionalization. But they are many risks associated with it. Inefficient and outdated security protocols make smart contracts exploitable to experienced hackers. This means the entire network is vulnerable to threats, attacks, and security breaches.
Copyright Infringement Concerns
Before buying NFTs, you need to do your due diligence to make sure that the NFT seller is the rightful owner of the digital assets they are selling.
Since NFTs are not regulated, the investment is entirely based on trust. This means your NFT investments are not protected outside of the blockchain.
Issue of Environmental Sustainability
Ethereum blockchain is power-intensive. A transaction on blockchain consumes a significant amount of energy. With so many prevailing environmental issues, blockchain technology can pose a serious ecological sustainability issue.
Where to Buy Fractional NFTs?
Although fractional NFTs are relatively new, several vendors are already in the fractional NFT marketplace, providing you a platform to buy fractional NFTs. Some of these reliable platforms include:
A platform that allows users to co-invest in NFTs along with their friends. A relatively new concept that makes expensive NFTs more affordable for retail investors.
One of the first NFT projects that allowed users to launch fractionalized NFTs.
Anything rare is expensive. By purchasing an NFT, you own an asset that no one has. This rarity is what makes an NFT highly valuable and hence expensive. Complete ownership of high-value NFTs is next to impossible for retail or small-time investors. However, the fractionalization of NFTs has made these expensive NFTs more accessible to this segment of investors, allowing them the opportunity to earn profits in the near future.