How Do Fractional NFTs Work and Why Should We Know About Them?

These days NFTs need no introduction, as they’ve been the subject of innumerable media headlines in recent years.

There was a stark divide in people’s reactions when this phenomenon first emerged. While some couldn’t wrap their heads around the fact that digital art can be worth millions of dollars and didn’t give much credit to this trend, others jumped aboard almost immediately.

The truth is that NFTs are not very affordable, and that is why many give up trying to obtain a precious piece of art or a rare collectible. Just take a look at average prices per single token on popular NFT marketplaces: on OpenSea it is $938.99, SuperRare — $7,940, and CryptoPunks — $123,690. Meanwhile, fractional NFTs (F-NFTs) offer higher liquidity and lower entry barriers to a wide range of investors.

Clearly, technology is evolving and opening up new opportunities for us. You can now split NFTs and buy and own fractions of the much sought-after tokens. Let’s dive deeper into this novelty, find out how it works, analyze its pros and cons, and get to know it inside out.

Overview of NFTs and their limitations

NFTs, or non-fungible tokens, are essentially digital certificates that prove your ownership of a physical or digital asset.

The majority of NFTs are based on the ERC-721 token standard created by the Ethereum team. Applying this standard means that each token will be unique and non-interchangeable.

Despite their effectiveness and popularity, ERC-721 tokens come with a liquidity problem. While non-fungibility is definitely a benefit to NFT holders, such a system can lead to a market in which it is difficult to offload assets.

Rareness and uniqueness raise prices. However, no one can be sure that people will always be willing to spend large amounts of money on NFTs. If you buy an expensive NFT, it doesn’t mean there will be lines of people ready to pay an even higher price.

This happened to Jack Dorsey’s NFT. In March 2021, the Twitter co-founder put his first tweet up for sale: it was purchased by the entrepreneur Sina Estavi for $2.9 million. A year later, the buyer decided to resell this token. Initially, Sina Estavi was asking for $48 million, but as of April 29, 2022, the highest bid was 10,3 ETH, which on that day was equivalent to $30,086.

It is hard to predict if this tweet NFT will rise to the level its owner would like it to do. But the liquidity problem is quite obvious here. On the other hand, if an expensive NFT like this is split into multiple fractions, liquidity would be higher as more people could afford it.

If you are interested in the industries most affected by NFTs then watch the video where our business analyst outlines NFT use cases across the spheres.

What are fractional NFTs and how do they work?

Fractional NFTs (F-NFTs), which are also referred to as fractionalized NFTs, are NFTs that represent pieces of one large NFT and can be sold individually. If you buy an F-NFT, you become the owner of a small portion of the NFT and its value.

Besides famous artworks that are usually worth thousands and millions of dollars, assets like real estate, cars, and yachts can likewise be sold as NFTs. Such high-value tokens are fairly illiquid and unaffordable for a majority of people. So it is here where fractionalized NFTs come into play.

The process of NFT fractionalization goes as follows:

1. An NFT is minted as an ERC-721 token and locked in a smart contract

2. The NFT issuer decides how many parts to split the NFT into and outlines its price and metadata

3. The smart contract divides the ERC-721 token into a predetermined number of interchangeable ERC-20 tokens

4. ERC-20 tokens now represent fractions of the original NFT and can be put up for sale at a fixed price

5. Buyers purchase F-NFTs and can sell them on secondary markets without affecting the value of the original token

It’s worth noting that the NFT can be split into as many parts as the NFT owner wants, be it 10, 1000 or even a billion.

Although ERC-721 and ERC-20 are token standards created by Ethereum, NFT fractionalization is not tied to this blockchain only. It is possible to do it on any blockchain that works with smart contracts and supports NFT minting. These include popular blockchains such as Solana, Polygon, and Cardano.

What is the current size of the fractional NFT market?

As of April 26, 2022, the total market capitalization of fractionalized NFTs is $86.4 million. If the popularity of F-NFTs keeps growing and more enthusiasts come and surf this wave, the market will continue to expand.

The fractional NFT market has grown significantly in 2021 thanks to the release of several viral tokens, with the world-famous Doge meme being one of them.

An NFT with a puzzled dog named Kabosu was originally sold for $4 million, but then its buyer PleasrDAO decided to split the NFT and sell it in 1,57 billion pieces. According to DappRadar, this NFT’s market cap is currently around $59,02 million.

Etherrock #72 is also one of the top three most popular and expensive NFTs to have been fractionalized. The overall value of all the tokens combined is about $5,49 million. What’s interesting about this literally rock-solid NFT is that it is split into 12,95 billion tokens, which means one piece costs less than a dollar and anyone can afford to buy.

Fractional NFTs vs regular NFTs vs editions: what’s the difference?

The difference between regular NFTs and fractional NFTs is simple: a regular NFT is a complete token and a fractional NFT is a piece of that token. Imagine a company with a collection of shares, where the company owner is the NFT creator who retains the copyright to their work, and the stakeholders have ownership rights to fractional NFTs.

F-NFTs also mean something different to NFTs that are issued in several editions. When fractionalizing an NFT, your buyers can get pieces of one large puzzle. Meanwhile, when you offer an NFT in several editions, you own the original NFT along with those several other editions, which all have some slight modifications.

For example, suppose you have created an illustration of a crawling tiger with a blue background. This is your original work. If you decide to change the color scheme of your work, you can sell this modified image as an edition of your original NFT. As a rule, the price of the original version will be higher.

F-NFTs, though, are not different versions of the same NFT, but portions of the entire picture.

What are the key benefits of NFT fractionalization?

The world needs fractional NFTs for several reasons: they provide better liquidity, make investments more affordable and democratic, help assess NFT market value, and enable DeFi integration.

Let’s consider each of these advantages in detail.

• Higher liquidity

Traditionally illiquid assets, such as real estate, luxury goods, and high-class art, can now be turned into NFTs and fractionalized in order to boost their liquidity.

When an NFT is split into multiple ERC-20 tokens and sold individually, it also attracts the attention of a lot more people. Thus your asset becomes a subject of discussion among the community and gets sold out quicker.

• More democratic and affordable investments

Fractional NFTs lower the barrier to entry for new investors and in general open up opportunities for investors of all levels and bank balances. Even if their possibilities are limited and they are new to the NFT world, they can still safely join in with the trend and invest in valuable tokens, backed by real assets.

• Quicker and easier NFT price estimation

Yes, F-NFTs can help asset owners quickly assess the market value of their digital tokens. They can start by fractionalizing their NFT and selling small fractions first. Once buyers begin purchasing them or offering their own prices, the NFT owner will know the overall price of their whole token.

• More monetization opportunities

As an artist or asset owner, you can easily monetize your assets by selling them in tokenized fractions. If you are a business owner running your own NFT marketplace, the introduction of fractional NFTs will bring you financial benefits too as it will help attract more investors to your platform.

• Easier integration with DeFi solutions

Since F-NFTs are underpinned by ERC-20 tokens, they can be used in DeFi. For example, many ERC-20 tokens can be traded on DEXs or used in staking and yield farming.

What about the benefits for NFT buyers, besides the fact that they can afford to become investors even with limited funds? Well, they can also diversify their portfolio and expand their collections of NFTs. They can buy fractional NFTs that represent pieces of different artworks or assets. With time, some of these F-NFTs may grow in price and then the buyer will reap the financial rewards.

Are there any risks and security concerns associated with fractional NFTs?

From a technological point of view, the security of F-NFTs depends on the smart contracts that they are locked in. If an NFT marketplace developer has written smart contracts adeptly, and successfully passed the smart contract audit, there is nothing to worry about.

In most cases, NFTs get stolen not because of vulnerabilities in the blockchain or smart contracts, but because users haven’t taken protective measures: they haven’t set up 2FA, or they stored their password online, or they shared their screen during a video call. You can find out about the security measures you need to take by reading our article.

What about other risks? Let’s check them out.

Market volatility

It’s no secret that cryptocurrencies, along with NFTs and F-NFTs, are highly volatile. While there is a chance that you will earn yourself a lot if the token price rises, it is also possible that the price will drop and you will lose money.

Before diving into the NFT market, it will be important to understand how it works and check that the chosen NFT is genuine and the project is not a scam. You can do your own research, or you can choose to use special tools like CheckNFT.iO to verify NFT authenticity.

Buyout option

This issue represents a risk and an opportunity at the same time. Why is this so? Take a look at the following example.

Let’s say that one NFT worth $10,000 is split into 10 pieces, $1,000 each. A buyer acquires one fractional NFT and becomes the owner of 10% of the whole token. If this buyer decides that they want to own the entire token, they can send the remaining $9,000 to the protocol and thus trigger the auction.

The auction will run for a fixed period of time during which other token holders will need to place bids for their fractions, i.e. offer more than $1,000 for one token. If they don’t do so, the buyer will receive the complete NFT and others will get their $1,000 back. True, they don’t lose their money, but they do lose fractional NFT ownership.

Meanwhile, if token holders outbid the buyer, this means that the NFT is worth more than the original price. They will get to keep their fractional NFTs and raise the overall value of the whole NFT.

So, on the one hand, the buyout option poses the risk of losing control over the asset, while on the other hand it makes it possible to raise the price for the NFT, which is a big plus for investors.

Regulatory issues

NFTs are giving lawyers and governments real headaches. The problem is that the regulatory framework for NFTs has not been developed yet and it is still not decided whether NFTs should be treated as commodities, securities, or intellectual property. As for fractionalized NFTs, it is an even harder question.

Generally, The U.S. Securities and Exchange Commission (SEC) uses the Howey test to decide if something is a security. An asset falls under the authority of an agency if investors put up money to finance a company with the intention of further profiting from the efforts of the organization’s management.

As for NFTs, some SEC commissioners expressed an opinion that in some cases NFTs could meet that standard. In December, 2021, SEC commissioner Hester Peirce said,

“Given the breadth of the NFT landscape, certain pieces of it might fall within our jurisdiction. People need to be thinking about potential places where NFTs might run into the securities regulatory regime.”

However, the issue is still unresolved, so it is strongly recommended that companies and investors planning to participate in the NFT movement and explore the possibilities behind fractional NFTs should seek competent legal advice beforehand.

What industries do fractional NFTs fit in?

Fractional NFTs, just like traditional NFTs, have their origins in the art world.  This is because works of digital art are easy to tokenize, sell, and collect. However, the popularity of F-NFTs doesn’t end there. Let’s take a closer look at how fractional art ownership works and check out several other industries where fractional NFTs have made their mark as well.

F-NFTs in art

Buying fractional art NFTs means getting collective ownership of iconic (in other words, pricey) digital artworks. Although expensive NFTs created by famous artists usually find their buyers quite quickly, for most people the financial possibilities are still limited.

It is very likely that when the NFT market cools down, fractional NFTs will become more popular. This is because people will be trying to avoid expensive and risky investments, and they’ll see that fractional tokens do not require a large outlay.

F-NFTs in real estate

The first interaction between the real estate industry and blockchain technology was real estate tokenization. It was evolving technology that led to the introduction of NFTs in this sphere. Fast forward, and it is clear that things are going even further: NFTs backed by property can now be fractionalized.

Fractional real estate NFTs allow multiple investors to share the ownership of one property. Although F-NFTs have not yet become widespread in this sector, the situation may soon change. Firstly, their use will lower the entry barrier for small and medium investors. Secondly, there is of course the much-talked-about metaverse where you can buy digital properties. These two use cases will popularize F-NFTs in real estate.

F-NFTs in the metaverse

NFTs and the metaverse are two inseparable concepts: NFTs represent assets that can be bought, sold and collected in the metaverse.

Assets that can be purchased in the metaverse include plots of land, stores, shopping malls, clothing, accessories, and even unique appearance traits for avatars. As is pretty much the case in real life, the most expensive asset is real estate. Digital land and commercial buildings cost a fortune, so these NFTs can be split into many F-NFTs.

F-NFTs in gaming

Play-to-earn crypto games are on the up at the moment. They involve winning and purchasing in-game items such as rare cards, skins, coins, swords, avatars and so on. These can be sold as fractional NFTs.

One of the most popular crypto games, Axie Infinity, has started testing this idea. The game offers NFT fractional ownership of several super-rare Axies.

What are the most popular fractional NFT marketplaces?

Although fractional NFT marketplaces are not as fashionable as regular ones yet, it’s an area that is currently going places. Here we will consider a few of the most popular platforms that offer investment in F-NFTs.

Fractional.art

Fractional.art is an Ethereum-based decentralized platform that allows its users to mint, buy, and sell fractionalized NFTs. Launched in July 2021, this marketplace is already a success story: just a month after release, in August 2021, the company raised $7.9 million in seed funding.

Many famous collections are presented on Fractional.art. Users can buy fractionalized CryptoPunks, Cool Cats, Bored Ape Yacht Club’s pics, Pudgy Penguins, and many other on-trend NFTs.

Dibbs

Dibbs is a fractional NFT marketplace that uses Ethereum, WAX, and Flow blockchains to perform transactions. The platform is created chiefly for sports fans as it mints and sells physical sports trading cards.

There are collections of cards from iconic athletes that cost from $200 to thousands of dollars. For example, on February 10, 2022, Dibbs dropped one of the best Aaron Rodgers Rookie cards with the football player’s autograph. Going by the name of 2005 Playoff Contenders #101 Aaron Rodgers Autograph PSA 10, the whole NFT cost $39,000 and was completely sold out.

Otis

Otis is a pioneer in fractional ownership and investments in NFTs and collectibles. The platform was launched in 2019 and, in March, 2022 was acquired by Public, a stock trading platform.

Otis is a place where everyone can find digital goods of interest. The website offers a wide range of items: from sneakers and sports memorabilia to collectibles, comics, and NFTs. For example, you can purchase fractions of Grimes NFT Collection, CryptoPunks, and Meebits as well as physical things such as the first edition of the Harry Potter and the Philosopher’s Stone book, Banksy’s “Police Car”, and Jordan 1 Metallic Red sneakers.

What are the top fractionalized NFT assets to date?

Fractionalized or regular, these NFTs are appearing everywhere. Meet the universally-loved Doge meme, weird but fascinating CryptoPunks, spellbinding Grimes’ NFT art, and out-of-this-world Mutant Cats.

Doge meme token

The Doge meme first became popular back in 2013. It features the Shiba Inu dog, Kabosu, that was rescue-adopted by Japanese kindergarten teacher Atsuko Sato. Taking pictures of her beloved pet, the woman hardly thought that her dog would become internationally famous.

Also in 2013, software engineers Billy Markus and Jackson Palmer created dogecoin as a joke because they wanted to make fun of Bitcoin speculation at the time. Well, perhaps the prank went too far!

Now, almost a decade later, an NFT of the Doge meme has sold for $4 million. Following the purchase, the token owner decided to fractionalize this NFT, so they split the meme into almost 17 million $DOG tokens.

CryptoPunks

No list of top NFTs can be complete without CryptoPunks. These avatars have broken multiple records in terms of NFT value, which makes them perfect candidates for fractionalization.

Usually, CryptoPunks cost thousands and millions of dollars, but now even if you have only $10 you can become an NFT investor. You will find these avatars on Fractional.Art and Otis.

Grimes’ Newborn 1 & 3

Canadian musician Grimes fractionalized two of her famous NFTs — Newborn 1 & 3 — that are generally valued around $6,400. She auctioned fractions of these tokens on the Otis marketplace. NFT enthusiasts could purchase shares for $10 each.

Mutant Cats

Ethereum-powered Mutant Cats are a collection of 9,999 artworks with cats that acquired mutations from some mysterious disease. Each cat’s appearance is different: one cat’s fur turned into bubbles, another cat’s fur is melting, one has got needles coming out of its skin, another has a skeleton shining with neon lights.

As of April 28, 2022, there are 6,212 mutants out of 9,999 staked, which is 62.1% of the overall collection. The floor price per one cat is 0.145 ETH.

Is it a good idea to invest in fractional NFTs?

Investing in fractional NFTs is definitely less risky than buying whole pieces of art. Another factor in favor of F-NFTs is that they help unlock liquidity for NFT creators — artists, musicians, real estate owners, or even sneaker brands — and they are very beneficial for NFT marketplace owners as well.

Therefore, investments in F-NFTs are accessible, affordable, and profitable for both newcomers and experienced NFT enthusiasts.

New NFT buyers can start their investing journey with small purchases in order to learn about the market and see how NFTs work. Meanwhile, those who’ve been in the NFT space for a while can significantly diversify their NFT portfolio with new unique tokens. They can also choose to invest in F-NFTs if they are not absolutely sure that their investments will pay off.

However, you still need to consider all the risks associated with fractional NFTs, especially when it comes to legal issues. We recommend that you seek legal advice before making any investment decisions.

And remember this classic investment wisdom: never invest money that you can’t afford to lose.

Thoughts on the future of fractional NFTs

The concept of asset fractionalization is not new, but it entered the NFT space not so very long ago. It has already attracted a lot of attention from investors of all sizes because it has made usually expensive tokens much more accessible.

Accessibility and lower prices are not the only benefits provided by fractional NFTs. They also help make it easier to set the price for NFTs and to unlock new monetization opportunities; they can also be integrated with DeFi platforms.

At the same time, it is still not clear how NFTs and F-NFTs are to be regulated. What’s more, there are signs that the NFT market has started cooling. So it seems there are two possible scenarios ahead:

1. If development companies create more F-NFT marketplaces and more NFT creators decide to offer fractionalized NFTs, the phenomenon will gain in popularity.
2. If the situation remains as it is now, F-NFTs are unlikely to go any further, but they will not disappear completely.

If you want to contribute to the development of the NFT space and have a great idea for implementing fractional or regular NFTs in your field, we can guide you on your journey. Our blockchain developers have launched over 80 blockchain projects, including cutting-edge NFT marketplaces and NFT provenance solutions. Contact us today, and we will do everything we can to turn your ideas into profitable reality.