The key to understanding fractionalized NFT is to know the meaning, how it works, and the advantages as well as challenges. Fractionalized NFT is a form of NTF where an NTF slips into smaller pieces so that owners can have a fraction of ownership over the original token. All this lowers the barrier to entry for high-value NFTs since these fractions are cheaper than the whole. Also, an owner can fractionalize an NFT even if they are not the original creator of it. Many of the fractionalization platforms offer “NFT curator fees” to the owners, representing a share in the trading value of the fractions.

How do fractional NFTs work?

Since most NFTs are based on Ethereum’s ERC-721 standard, we will try to understand fractionalization by taking the example of an ERC-721 NFT.

For breaking this NFT into fractions, first of all, it needs to be locked inside a smart contract, which will divide the ERC-721 token into a set of ERC-20 tokens according to the instructions that have been given by the NFT owner. Everything is specified by the owner, be it the number of ERC-20 tokens to create, prices for those tokens, metadata to use, and other properties they deem important. Each fraction or ERC-20 token created represents partial ownership of the NFT. Then, fractions can be put into sale for a fixed price during some time or up until they get sold.

For example, there is an art that costs millions; now, suppose an NFT represents this art. One would quickly imagine that its price would run into millions, thus fitting the budgets of only a handful of rich investors. Of course, if this extravagantly priced NFT were to be fractionized into ERC-20 tokens of, say, 10,000 units, one would have been able to invest in the artwork by paying just $12,000 per fraction. In that sense, fractionalization creates accessibility to very rare and expensive NFTs and makes them more attractive, even for small- and medium-size investors.

It is important to emphasize that the approach of fractionalized NFTs does not work only on the Ethereum blockchain but on any blockchain network that does support smart contracts and NFTs. Networks like Polygon, Solana, and Cardano can also enable F-NFT ownership transfers.

Advantages of Fractional NFTs

Fractionization can increase an NFT’s value by making it more liquid-that is, easier to buy and sell in parts. Following are some of the key advantages of NFT fractionalization:

• Increased Accessibility and Affordability for Investors: High-value NFTs, such as those whose prices reach upwards of $100,000, become beyond the reach of many buyers. But when an NFT is fractionalized into 1,000 shares at $100 each, this opens participation to a much broader range of investors. It democratises valuable NFTs.
• Increased Liquidity for Owners of NFT: Market liquidity is essentially a measure of how easily one can sell or buy an asset. Traditional NFTs have low liquidity since often only a few investors can afford to buy such highly valued assets. Since an expensive NFT is easier to trade in fractional parts, it has greater liquidity, and the owners of NFTs are able to sell with higher efficiency.
• Value Appreciation: Fractionalization of an NFT can potentially increase its value because it would be more liquid, available, and visible. Among the many advantages listed above, fractionalization increases price discovery-make the market have a better estimate of the value of an NFT. Most of the fractionalization smart contracts have the ability for a buyback auction, which can be utilized by anyone to buy all the fractions and take back full ownership of an NFT. If in such a case the fractions have accrued value, then that could result in an overall increase in the market value of the NFT.

Challenges and Limitations of Fractional NFTs

Fractionalized NFTs have similar challenges faced by traditional NFTs and other forms of digital assets, especially in security. Indeed, there is a loophole malicious actors may use to try to fool investors that they are buying legitimate shares of a hot NFT. Such malicious actors can issue fungible tokens with names which may suggest their relationship to a particular NFT and then mislead inexperienced buyers.

Another serious issue that is at stake is the issue of regulatory uncertainty. The concept of fractional NFTs embodies the aspect of collective investment in them, making them perhaps viewed as unregistered securities. SEC Commissioner Hester Peirce, known as a supporter of digital assets, has herself warned that fractionalization of NFTs may reconstitute them as securities for legal purposes, thus bringing them under additional regulations.

Fractionalization can also undermine the control of the original asset owner. This is because, in the event of the owner wanting to sell the original NFT, they may be need to hold a buyback auction wherein they risk losing ownership in case someone outbids them.

Fractional NFTs create exciting possibilities for creators and owners of NFTs. Such a model would spur demand for otherwise static tokens and increase exposure for artists, musicians, and other creators of NFTs. In bear markets, fractionalization will give investors an avenue to buy assets with less risk, thus improving the stability in the ecosystem. However, concerns around their regulatory status are potentially limiting development in this route as a mainstream asset class.

Future of Fractional NFTs

Its future does not lie in some of the use cases it finds itself in currently. Some fascinating developments are at the doorstep of our times that will redefine our interaction with digital ownership. For example, Dynamic NFTs would automatically change fractional ownership under certain conditions.

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