Explained: What Are Fractional NFTs (F-NFTs), Their Importance And How Do They Work

NFTs, or non-fungible tokens, signify a new, transparent, decentralized era of asset ownership. The assured exclusive ownership of NFTs is one of its primary distinguishing characteristics. An NFT is essentially a unique token of which copying or faking cannot take place.

However, the NFT holders’ ability to use their assets is severely constraining by this exclusivity. Due to this, industry innovators have pushed the limits of what is feasible for NFTs. Thus, opening up possibilities for fractional ownership.

Crypto investors can own a portion of a large pie due to fractionalization. There are little to no risks. The idea is comparable to having stock in a corporation. Small- and mid-tier investors can now own NFTs instead of merely whales with large bank balances.

A Fractional NFT: What Is It?

An NFT divided into smaller fractions is known as a fractional NFT. This arrangement enables many parties to claim ownership of various portions of the same NFT. A smart contract that creates a predetermined number of tokens tied to the indivisible original fractionalizes the NFT. These fractional tokens, which can be sold or exchanged on secondary marketplaces, grant each holder a portion of ownership in an NFT.

NFTs, also known as non-fungible tokens, are indivisible ERC-721 tokens produced by a smart contract on the Ethereum network. The tokens are the ideal medium for individualized intellectual property tracing since they are indivisible and impossible to duplicate.

Thanks to numerous NFT project auctions that broke records, NFT asset values soared in 2021. These virtual assets range widely and include virtual real estate, in-game objects, digital art, and many more.

Also read: What Are Music NFTs? How Are They Changing Music Industry?

Gaining Access to F-NFT Ownership

NFTs are becoming a more and more well-liked asset class. Some collections have grown to be so valuable that purchasing a single NFT has become unaffordable. The NFT collections that are worthwhile to collect can still be fairly expensive, even though not all of them have achieved the fame of Beeple’s artwork or the cartoon ape avatars from Bored Ape Yacht Club. Additionally, the fact that NFTs are unique tokens makes it challenging to purchase them on cryptocurrency markets due to a lack of liquidity.

Fractionalization is a potential solution to all of these issues because of the high hurdles to entry. The accessibility of NFT can increase for investors by dividing financial resources into smaller portions. Due to the increased market liquidity, this is advantageous for both investors and NFTs in general. Fractional NFTs flood the market with many inexpensive tokens that offer a share of well-known NFTs.

In essence, purchasers with restricted financial resources can purchase fractional NFTs for a small portion of the market value. Due to this, different investors can each acquire a portion of the same asset.

Assets with Fractionation

The concept of asset ownership in portions is not new. The idea has been successfully implied to a wide range of physical assets, including stock, designer goods, and luxury assets like yachts and private planes, in industries ranging from real estate to fashion.

Also read: What is NFT Staking? Pros and Cons of NFT Staking.

Fractionalization is a popular method for groups of people to affordably buy holiday homes in the real estate sector. Owners who purchase fractional ownership of property receive a deed that represents their part, unlike timeshare owners who are only guaranteed a certain period at a property each year.

All the gains and losses that come with owning property are assumed by fractional owners. Depending on how much of the asset each co-owner owns, they each receive a proportionate share of the revenue, usage rights, and access to the shared property. The value of individual shares will increase if the vacation home’s overall worth increases over a decade. Of course, that also implies that if the value of the property declines, the value of the shares will do the same.

What’s the Process of NFT Fractionalization?

An NFT is essentially just a token that adheres to the ERC-721 standard for Ethereum. The NFT must first be locked in a smart contract, which is just a blockchain-based program that is programmed to run once certain criteria are satisfied before it can be fractionalized.

Following the NFT owner’s instructions, the smart contract divides the ERC-721 token into various fractions in the form of ERC-20 tokens. The owner specifies how many ERC-20 tokens will be produced, their price, their metadata, and other characteristics. The NFT is represented by each fraction, or ERC-20 token, as having a portion of ownership. The fractions are then offered for sale for a predetermined amount of time or until they are all gone for a set price.

Also read: How To Store NFTs Assets Online & Offline; Quick Guide for Beginners

The fact that NFTs and fractionalized NFTs aren’t merely available on the Ethereum blockchain should not be overlooked. Any blockchain network that supports smart contracts and NFTs can implement fractionalization. Alternative networks that support smart contracts that enable the generation and transfer of NFTs are Polygon (MATIC), Cardano (ADA), and Solana (SOL). Fast transaction speeds and gas fee-free usage are other advantages of these networks.

What Distinguishes F-NFTs from Traditional NFTs?

Fractionalized NFTs, also known as F-NFTs, are fractions or percentage ownership of a whole NFT. An NFT is a whole, whereas F-NFTs are merely fractions of the entire, hence there is a clear distinction between the two.

It’s crucial to note that the fractionalization process can be undone, turning F-NFTs back into whole NFTs. A buyout option is often included in the smart contract that fractionalizes an NFT, enabling an F-NFT investor to acquire all of the fractions and unlock the original NFT.

By returning a predetermined quantity of ERC-20 tokens from a collection to the smart contract, an F-NFT holder can start the buyout option. This will start a buyback auction that will last for a predetermined amount of time. This provides time for the other F-NFT holders to decide. The fractions are automatically returned to the smart contract and the buyer acquires complete ownership of the NFT if the buyout is successful during that time.

Why Is the Need for Fractional NFTs?

F-NFTs are required for the following three primary reasons:

Democratization: Smaller investors may not be able to participate in some NFTs due to their expensive costs. A costly NFT can be made more affordable and available to a wider group of investors by fractionalizing it. It’s also crucial to remember that when the price of an NFT rises, all of its fractions’ values rise accordingly. The worth of all the fractions will decrease as well if their value abruptly plummets, which happens frequently in the cryptocurrency market.

Also read: Explain NFT Whitelist. How Do You Join An NFT Whitelist?

Price discovery: Fractionalized NFTs can offer mechanisms for determining the price at which a specific NFT is valued. The open market is where the fractionalized ERC-20 tokens are traded, thus their prices can help give.

More liquidity: One of the most distinguishing characteristics of NFTs is that they are unique tokens that cannot be duplicated or divided. Due to their rarity, few wealthy investors have access to NFTs, especially those that are valued. Due to the ease with which ERC-20 tokens may be exchanged in secondary marketplaces, F-NFTs alleviate this lack of liquidity. Numerous investors might be more eager to snap up fractions of an NFT right away at a lower price than they would be to wait weeks or months for one NFT to sell, so addressing market liquidity difficulties.

Are They a Smart Investment?

Without a question, fractional NFTs are a wise investment. They are improving inclusiveness and participation in the burgeoning NFT market while also assisting in releasing liquidity for NFTs. They increase the NFT market’s new potential by democratizing, increasing liquidity, and establishing prices.

However, fractionalized NFTs are not risk-free because they experience the same problems that affect NFTs in general, including publicity rights, contracts, and intellectual property rights. F-NFTs are more likely to create concerns with financial regulators because their creation could be considered unauthorized initial coin offerings, even though the sale and acquisition of full NFTs as digital collectibles may not pose issues with securities laws (ICOs).

Hester Peirce, an SEC commissioner, expressed concern that the organization would see fractional NFTs as securities at the Security Token Summit 2021. However, no official legal or regulatory standards on NFTs have yet been published by the SEC (US Securities and Exchange Commission).

The laws governing NFTs and F-NFTs will change as the market for these assets expands. Investors and business owners in NFT-related initiatives should be aware of any potential legal difficulties for the time being.