With the increased attention towards NFTs (non-fungible tokens), we have further seen token prices surge exponentially. On occasion, NFTs representing artwork have sold for millions and millions of dollars. Moreover, avatars from famous collections are becoming relatively pricey. This increase in demand and price escalation makes it prohibitively expensive to purchase NFTs. The high price tags result in significant entry barriers to the market, as not everyone can afford to acquire NFTs. One way of solving this issue is through the process of fractionalization, which is where fractional NFTs enter the picture.
So, what are fractional NFTs? Fractional NFTs are non-fungible tokens that have been fractionalized into several smaller pieces, which the name reflects. However, what exactly does this mean? This essentially means taking an NFT and splitting the non-fungible token into several fungible tokens representing a stake in the original asset.
The fractionalization process is done using smart contracts. A contract creates a specified number of fungible tokens that are interconnected with the indivisible original. Each part — or fraction — provides the holders with a percentage of ownership of the original NFT. It is later possible to trade the fungible tokens representing a stake in the fractional NFT on an exchange or marketplace at a fraction of the cost.
How Do Fractional NFTs Work?
In its bare-bone state, an NFT is a token that implements a particular standard. Before the process of fractionalizing an NFT, the tokens must first be locked in a smart contract. Smart contracts are programs on a blockchain that can automatically execute functions when someone fulfills the predetermined conditions.
Once the original NFT is locked in the smart contract and the predetermined rules are met, the contract splits the token into smaller fractions — represented by fungible tokens — based on the instructions specified in the smart contract. The number of pieces is specified by the NFT’s owner, along with the price, metadata, and other properties of the newly created fractions.
Each of the fractions, or tokens, then represents partial ownership of the entire original NFT and can be put up for sale over a set period or until they are sold out. The number of fractions can vary depending on the owner of the original NFT. As such, it’s possible to divide an NFT into 1,000, 10,000, or even 10 million individual shares. All shares or fragments can then be sold on secondary markets, and it won’t directly influence the value of the original NFT.
Benefits of F-NFTs
Fractional NFTs help democratize the NFT space as it allows for a gateway for smaller investors to participate in the market.
The increase in popularity has driven up the prices of NFTs, making it difficult for people to enter the space. However, it’s possible to tear down these high entry barriers by using fractionalization. This suggests that fractional NFTs open up the market for a broader range of people and provide further access to the blockchain industry.
2. Increased Liquidity
The issues of accessibility aren’t only affecting potential buyers of NFTs but can also influence owners of expensive tokens. As accessibility issues limit the market, it reduces the number of potential buyers and the amount of liquidity. This further suggests that the more expensive a non-fungible token is, the harder it will be to sell the asset. However, by fractionalizing the NFT, it becomes possible for several smaller investors to purchase fractions of the NFT immediately. Fractionalization, therefore, expands the market and is one way of addressing problems with liquidity.
3. Price Discovery
People generally trade more expensive NFTs less since the market of pretty expensive tokens is relatively smaller. The lack of transactions makes it difficult to pinpoint the exact market value of an NFT due to inadequate data. So, by fractionalizing the token, it becomes less expensive. As a result, it allows more people to trade and bid on the fractionalized asset making it easier to find an NFT’s actual value.
In conclusion, Fractional NFTs are NFTs that have been divided into smaller fractions using smart contracts. We can refer to this process as “fractionalization”. Moreover, it provides the NFT realm with more accessibility as it makes it possible for more than one person to own a stake in an NFT.
Fractional NFTs provide loads of benefits such as democratization, increased liquidity, and price discovery. As such, they have the potential to influence several aspects of the entire market positively. For example, F-NFTs make it possible for smaller investors to purchase more sought-after NFTs; meanwhile, it also provides a larger market for potential sellers.