Fractionalised NFTs - Making Non-Fungible Tokens Affordable
NFTs are reforming the crypto space in a truly unprecedented fashion and have come to firmly establish themselves within the ecosystem. This is because non-fungible tokens are able to forward intricate value preservation infrastructures and are effectively redesigning the concept of uniqueness and scarcity in the digital asset framework.
It should thus come as no surprise that NFTs have enjoyed such parabolic momentum in the markets and have sparked such high interest levels across many investors, institutions and crypto VCs.
Furthermore, the recent craze that we have witnessed surrounding NFTs could have indeed been fuelled by the fact that NFTs empower investors, asset holders and digital artists with a new format of blockchain-enabled ownership. In fact, these unique digital assets provide owners with proof of authenticity relating to pretty much anything one can think of.
Be it digital art, music, real estate or even precious metals, NFTs allow anyone to immortalise an asset on the blockchain through its distributed ledger system. Moreover, the ability to store valuables on-chain as non-fungible tokens is proving particularly beneficial for artists and collectors as it creates a new, permissionless, disintermediated environment for them to trade and exchange their art pieces.
While it is true that NFTs are spawning a new market, captivating the imagination of many and allowing more artists and creators to realise their potential, non-fungible tokens still remain a rather exclusive, niche and somewhat enclosed environment.
Their uniqueness and scarcity have been their main focus and selling point but, despite their incredible success, there is a general lack of liquidity in the non-fungible token market. This is because the NFT market is limiting access to the broader audience, which includes retail investors and small collectors, as the majority of high-end NFT artworks are too expensive and quite frankly off-limits for most investors in the space.
Thus, to ensure more liquidity and give investors the opportunity to gain more exposure to NFTs, many artists, creators and NFT issuers are beginning to experiment with a new non-fungibility model, the Fractionalised NFT. Up to this point, the majority of applications and use cases for NFTs have been pretty much linked to the realm of digital art, collectibles and gaming. But, what if Fractionalised NFTs could be the ultimate solution to democratising investment in not only the digital asset space, but in the entirety of the financial system?
Introduction To NFTs
An NFT is a type of cryptographic token that represents a unique, non-fungible asset and constitutes a tokenised version of a digital or real-world asset. NFTs function as verifiable proofs of authenticity and ownership in a blockchain network. Furthermore, they are non-interchangeable with one another and introduce a new proposition of scarcity in the digital asset world.
The term ‘fungibility’ refers to the property of an asset whose individual units are basically identical and interchangeable with one another. For instance, in order to act as a medium of exchange, all fiat currencies are fungible, meaning that each individual unit must be interchangeable with any other equivalent individual unit. A $1 bill is interchangeable with any other genuine $1 bill.
NFTs can be utilised by decentralised applications (dApps) to allow for the creation and ownership of unique digital collectibles and items. While an NFT can be openly traded in marketplaces such as OpenSea or Binance NFT, it is important to note that the value contained within it is and will always be unique to the asset itself.
Various frameworks have been created to facilitate the issuance of NFTs, with the most prominent being the ERC-721 token standard for the issuance of non-fungible tokens on the liquidity-rich Ethereum blockchain. A more recent and improved standard is ERC-1155, which enables a single contract to contain both fungible and non-fungible tokens.
The majority of NFTs are associated with ERC-721 tokens and they are tracked on the blockchain to provide proof of ownership. Smart contracts store the exclusive data structures that differentiate the NFT from all other tokens, essentially making it unique.
When an NFT is exchanged between owners, it can be traced back to the original smart contract address on which it was minted, allowing buyers and sellers to verify the authenticity of the NFT and prevent fraud and forgery. The introduction of these NFT token standards allows a higher level of interoperability between networks, artists and investors, and enables the seamless transfer of these unique digital assets from one dApp to another.
However, there are some drawbacks to the widespread adoption of NFTs. This is because these ERC-721 tokens are not interchangeable with other ERC-721s, making the trading process more complex and the markets less liquid. Moreover, because of the high barrier of entry, most investors don’t have the funds to participate in the market of rare NFTs.
These constraints have most definitely inhibited NFTs from gaining the exposure and liquidity necessary to develop into an efficient and sustainable digital asset ecosystem, and have stunted the potential growth of its market overall. A new NFT model, the Fractionalised NFT, could indeed be the solution to some of these limitations.
About Fractionalised NFTs
NFT fractionalisation represents a new concept in the digital asset space and, because of its innovative proposition, it is most likely set to revolutionise the underlying architecture of non-fungible tokens as well as potentially open up new horizons in the world of investing.
When an NFT undergoes its fractionalisation process, it is first locked in a smart contract. The smart contract then splits the ERC-721 NFT into multiple fractions in the form of ERC-20 tokens, with each fraction representing partial ownership of the NFT.
Shareholders will possess a fraction of the NFT, essentially a percentage of the original ERC-721 asset, equal to the value of their ERC-20 tokens divided by the total number of ERC-20s minted when the NFT was initially locked in the smart contract. Fractions are typically put up for sale at a fixed price for a specific period of time, or until they sell out completely.
Fractionalised NFTs are of particular appeal as they offer a variety of interesting benefits to their issuers and holders. For instance, imagine a scenario in which we could fractionalise say Leonardo da Vinci’s (go Italy!) universally recognised ‘Mona Lisa’. Let’s now suppose that the, of course, priceless painting was valued at $1 billion and was represented on-chain as an ERC-721 asset. Given the incredibly high price of the art piece, only a small number of investors could afford to bid for it.
If, however, a smart contract were to fractionalise the Mona Lisa NFT into multiple fractions, each fraction would then represent fungible ERC-20 tokens. This, in turn, would allow every fraction owner to utilise their ERC-20 tokens to buy, sell or auction off their share of the NFT.
NFT Fractionalisation Incentives
Among the many benefits that come with NFT fractionalisation, there are several reasons why an NFT owner might want to fractionalise their asset. In fact, there are three major benefits to NFT fractionalisation, with these being:
- Price Discovery
- Asset Liquidity
- Democratisation Of Investment
Price discovery mechanisms determine how much a specific NFT should cost. In order to do this, the worth of an NFT is generally established by using three different metrics: Past Sales, Auction and Fractionalisation.
The Past Sales mechanism utilises historical data to generate a price estimate for the NFT, and is typically used on the open market where there are many other similar, interchangeable products for sale. Applying this method to estimate the price of NFTs isn’t necessarily the most efficient as, more often than not, there quite literally isn’t enough historical data on the asset to formulate a fair evaluation.
The Auction mechanism reveals people’s willingness to pay for a specific NFT asset, and is used to gauge a rough price estimate. The Auction mechanism takes value from the bidder who is willing to pay the highest price for the asset, and this usually constitutes a great evaluation process as well as an excellent way to come up with an estimate for NFTs, since collectors hold their own different valuations.
As previously mentioned, the Fractionalisation mechanism entails taking an NFT, locking it into a smart contract that then divides it into multiple fractions of fungible ERC-20 tokens, rendering these tokens openly tradable on the market. This process produces a price estimate for each ERC-20 token, which then allows for an overall evaluation of the underlying ERC-721 NFT itself.
More Asset Liquidity
NFTs are inherently distinguished by the fact that they possess unique, one-of-a-kind characteristics. Their non-fungibility and scarcity have always been their main focus as well as their most important selling point. However, one of the most pressing issues when it comes to NFTs and NFT trading is the generally illiquid market that encapsulates them. In fact, illiquidity in the space remains a point of concern among NFT artists, creators and investors, as it is clear that the NFT market is limiting access to its selection of rare and most valuable NFTs.
Indeed, with some NFTs going for millions of dollars, it is not surprising that only a few investors globally can afford to place their bids for them and get their hands on some of the most top-notch NFTs out there.
This naturally causes asset illiquidity due to the fact that just a handful of investors are willing to buy these NFTs. NFT fractionalisation, however, was created and designed to address and solve the lack of liquidity that exists in secondary markets.
When an NFT is fractionalised, the ERC-20 tokens representing each NFT fraction could be traded on decentralised and centralised exchanges, thus increasing the asset liquidity of the NFT itself. Instead of an artist waiting weeks for their NFT artwork to sell, numerous investors may buy NFT fractions immediately at a reduced price, which effectively addresses some NFT illiquidity issues.
More often than not, the prices in NFT marketplaces inhibit smaller investors and collectors from participating in NFT auctions, leaving only a few investors capable of purchasing the most expensive NFT pieces. Breaking up a high-end, expensive NFT into multiple fractions lowers the barrier of entry and ownership costs, and essentially allows more investors to gain exposure to the market of prestigious NFTs. Furthermore, it is important to note that if the price of the entire ERC-721 NFT increases, so will the price of the individual fractions of ERC-20 tokens.
Overall, thanks to their design, fractionalised NFTs can essentially boost the liquidity of the NFT market by fragmenting the base NFT asset into multiple, natively liquid components, and can also open up more investment opportunities for smaller collectors, democratising access to the previously exclusive NFT environment.
NFT fractions have a variety of different applications in both the real world and the digital asset sphere. Indeed, bringing price discovery, liquidity and democratisation to the NFT environment opens up some exciting opportunities in the space, especially in Decentralised Finance (DeFi).
This is because fractionalised NFTs could potentially be leveraged in real estate investing, digital art, augmented reality (AR), gaming, fantasy sports, and more. With regards to Fractionalised NFTs in the real estate business, projects such as LABS Group, for instance, have already started experimenting with the concept of NFT fractionalisation in cross-border real estate investment.
In fact, the project allows participants to invest in multiple properties around the world through the Ethereum they hold in their Metamask wallet. When users decide to invest in property via LABS Group, the project will automatically redirect them to their selection of real estate fractionalised NFTs that can then be purchased and staked on the platform to earn rewards.
In the gaming sphere, there are a few groups pioneering the new NFT fractionalisation trend, with the first being Niftex. Niftex is a blockchain-based startup that is working on its own NFT sharding technology, whereby NFTs are essentially fractionalised into ‘shards’ which can be purchased in an IPO-like format.
From there, a liquid market is created for the NFT shards using the Uniswap protocol, allowing investors and holders to buy and sell the shards like they would with any other crypto asset. The basic idea with Niftex is to increase NFT liquidity via sharding, and to essentially allow holders to accrue enough shards to gain access to the original NFT. Niftex has witnessed some major early wins with the Axie Infinity community where ultra-rare Axies, the gaming platform’s NFT assets, owned by community members have been fractionalised and sold via the Niftex platform.
Another interesting project looking to pioneer the fractionalised NFT trend is Fractional. Fractional is a decentralised protocol enabling NFT owners to mint tokenised fractional ownership of their NFTs as ERC-20s, with each fraction acting as governance on the underlying ERC-721 asset.
The goal of the Fractional protocol is to facilitate the process of buying and holding a certain percentage of an NFT. In essence, the Fractional mechanism enables users who have been previously priced out of specific high-end NFTs by renown artists, such as Beeple and his ‘Everydays’ NFT for instance, to purchase a piece of their artwork. This furthermore allows the NFT holder to see some liquidity for their asset arise almost immediately, as opposed to having to wait for weeks or even months on-end for a buyer to appear.
In addition, because of the governance perks inherent in the ERC-20 token fractions, fraction holders also have the ability to vote on the reserve price of the entire NFT asset. This reserve price is the price in ETH required to be bid by a third party who is willing to purchase the NFT through auction. At the completion of the auction, all fraction holders will be able to cash in their fractions for ETH.
Fractionalised NFTs In DeFi
Some DeFi protocols such as Aave and Compound allow users to borrow capital by pledging their crypto assets as collateral. The borrowed funds come from lenders who deposit their assets in the DeFi protocol in return for some form of reward, mostly staking rewards. Typically, the collateral pledged by the borrowers is in the form of popular cryptocurrencies like Ethereum or USDT. At present, the realm of DeFi collateralisation is gradually entering the NFT space, with some new, exciting projects offering collateralised loans on NFTs and fractionalised NFTs.
Perhaps one of the most relevant DeFi-NFT collateralisation projects is NFTfi, a decentralised protocol allowing users to put up their NFT assets as collateral to borrow capital or offer loans to other users on their NFTs. The NFTfi protocol is currently experimenting with the proposition of DeFi-centric loans based on fractionalised NFTs as well, whereby users can pledge their ERC-20 fractions of an ERC-721 NFT asset as collateral to borrow cryptos like ETH or USDT.
Charged Particles is a decentralised protocol that is fundamentally restructuring the DeFi-NFT ecosystem, by allowing users to wrap their native NFT assets with interest-bearing tokens. Charged Particles enables NFT holders to deposit their ERC-721 or tokenised NFT fractions into its dApp, which then wraps the NFT with interested-bearing tokens through its integration with DeFi protocol Aave. This constitutes a true representation of the growing demand for NFTs in the DeFi sphere, and is also symbolic of the shared, hybrid infrastructure that is developing between DeFi and NFTs.
Fractionalised NFTs For Pre-IDO Liquidity
At this stage, it should be clear that NFT fractionalisation is posing a great number of benefits to holders, issuers, artists and investors. However, one of the most intriguing use cases for fractionalised NFTs is perhaps their ability to provide pre-Initial DEX Offering, or pre-IDO, liquidity for projects launching in the DeFi space.
Among the few projects looking to pioneer the DeFi-NFT pre-IDO liquidity environment is Genesis Shards, a decentralised protocol that wraps illiquid pre-IDO tokens into NFTs. The value proposition of fractionalised NFTs in the pre-launch token market is actually pretty relevant, as it enables a project’s pre-IDO tokens to gain some form of price discovery and economic exposure even before the IDO is held.
Typically, the only way investors can access pre-IDO tokens is through over-the-counter (OTC) deals and transactions, however, these trades are usually pretty unreliable, come with some inherent risks and require a substantial amount of initial capital.
Fractionalised NFTs, on the flip side, can be leveraged to create a liquid pre-launch market by wrapping pre-IDO tokens into NFT fractions made up of tradable ERC-20 tokens. This allows projects such as Genesis Shards to effectively bring price discovery, liquidity and democratisation to pre-IDO tokens via fractionalised NFTs.
These pre-IDO NFT fractions can be either traded on NFT marketplaces such as OpenSea, for instance, or can be held until the project holds its IDO, after which NFT holders can swap their NFTs for the project’s IDO tokens.
It is thus clear that the functionalities of fractionalised NFTs stretch above and beyond the realm of digital art and gaming, as they are slowly but surely coming to merge with the DeFi ecosystem in a manner that was yet to be seen in crypto. In fact, thanks to projects such as LABS Group, Niftex, Axie Infinity, NFTfi, Charged Particles and Genesis Shards, NFT fractionalisation is progressively becoming more of an established proposition in the space, and it can develop, expand and realise its use cases in a purely decentralised, permissionless and disintermediated fashion.
NFTs have come to firmly establish themselves within the digital asset space, and they are fuelling an enticing ecosystem of diverse artistic, gaming-oriented and DeFi cross-over utilities. NFTs are inherently distinguished by the fact that they possess unique, one-of-a-kind characteristics. Their non-fungibility and scarcity have always been their main focus as well as their most important selling point. However, one of the most pressing issues when it comes to NFTs and NFT trading is the generally illiquid market that encapsulates them.
Fractionalised NFTs, on the other hand, allow artists and investors to gain access to greater liquidity, as the NFT is broken down into multiple fractions of ERC-20 tokens that can be sold or redeployed in other DeFi protocols. By fractionalising an NFT, the asset holder can enjoy a variety of attractive benefits, which include NFT price discovery, more asset liquidity and democratisation of investment.
Indeed, bringing price discovery, liquidity and democratisation to the NFT environment opens up some exciting opportunities in the space, especially in Decentralised Finance (DeFi). There is most definitely a use case for fractionalised NFTs in the world of digital art, augmented reality, gaming, fantasy sports and, most importantly, pre-IDO liquidity.
With reference to this last note, fractionalised NFTs can be leveraged to create a liquidity-rich pre-IDO market, in which NFTs can essentially become DeFi options as well as the financial vehicles necessary to solve the illiquidity endemic in the pre-launch environment.
While the development of the NFT ecosystem is still rather young, that of fractionalised NFTs is perhaps even younger but, in due course, NFT fractionalisation is most likely destined to disrupt not only the world of fine art and gaming, but potentially even that of Decentralised Finance and investing as a whole.
Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.