What Are Fractional NFTs?

Decentralized Finance (DeFi) is the basis for major advances related to the new Web. Secure transactions in the blink of an eye and coins not tied to any form of government are some of the many projects willing to solve today’s society’s problems. One advance that has gained prominence in recent years has been the ability to own a single asset which cannot be replaced by another, having its authenticity verified by a smart contract. This functionality is represented by NFTs (Non-Fungible Tokens), which allows any asset to be represented by a digital certificate, and can be sold or transferred between wallets in the blockchain.
NFTs have gained more and more fame in the digital world, especially between games and works of art. However, its strong exclusivity and singularity factor usually conferred very high prices and were often over calculated in relation to the assets in question. The act of fractionating the item proportionally among several owners allowed expensive assets to be accessible to many, through the possession of smaller fragments of the asset as a whole. This is how fractional NFTs work and in this article we will see more details about how this technology works and the news it brings to the DeFi environment.

What Are Fractional NFTs?

Non-Fungible Token (NFT)

Real-world physical assets or tangible assets, such as works of art, are more common examples of products with intrinsic value that can be owned, while songs, ideas and other intangible assets can now be identified by a code, priced and sold, according to interest and demand.
In addition to pricing, validating the concept of ownership is very important when selling and/or buying something, especially when this thing is something you can’t see or touch. This has been a long-standing challenge in the digital world. How do you ensure that something belongs to you and only you? Or how do you ensure that something is unique and originally yours, to the point that you can transfer possession in exchange for value, that is, sell?
NFTs emerged as the solution to this challenge. Anything could now be linked to a code that would represent the asset, in a unique and non-fungible way. NFTs work differently from cryptocurrencies, which are fungible assets (like any other currency). In crypto, any currency of the same nature can be exchanged for another so that there is no difference between the two items. Swapping 1 BTC for 1 BTC makes no difference as both are BTC. With the NFTs, there is a uniqueness factor in relation to the item. Trading the Mona Lisa for Lady with an Ermine makes a difference, even if both works of art are women painted by Leonardo da Vinci. Likewise, it also makes a tremendous difference to trade the real Mona Lisa for a printed image of the same work or for a reproduction painted by another artist. Even if it represents the same asset, or is of the same nature, the original asset is unique and its intrinsic value is linked to that specific object. In the case of NFTs, this object is linked to a unique address code and cannot be mixed with others, whether of the same nature or not.
In addition, the concept of NFTs allowed non-palpable assets to be identified, priced, sold and owned. Imagine selling an idea, buying an original digital art or owning a rare and unique emblem of your favorite game. This has become possible. Within an economic context, everything can become an NFT. From a work of art, even memes or collectibles, everything can be linked to a certificate that guarantees its authenticity. Another interesting detail is that some projects use the NFT as a kind of VIP pass for clubs, communities, decision-making meetings, early project launches, among others. The asset, in addition to having an intrinsic value, acts as an entry pass to a benefit club that may vary from project to project.

The Popularity of NFTs and Barriers to Access

In fact, the arrival of the NFTs solved problems of asset ownership, authenticity, among others. However, faced with the new facility, new challenges have arisen. With the fame that emerged along with the concept, some projects took off and saw their values reach impressive marks. Most of the well-known projects, such as Bored Ape Yacht Club and CryptoPunks have very expensive items for small and medium investors. This factor eventually made assets inaccessible to most of the community. The restriction on affordability soon hit the creators of the NFTs. Since few had access to the project, the NFTs’ notoriety did not reach its peak and many creators had little or no exposure of the work. Although the concept won the spotlight because of the high amounts paid by celebrities in exchange for digital images, most projects were not highlighted and the concept saw its 15 minutes of fame pass very quickly.

As only the portion that had greater financial conditions could pay to own the assets and their advantages, the number of trades involving them was very low, despite the high values attributed. This context generated an impairment of low liquidity with very high prices.

And, finally, the scarce history of transactions brought a difficulty in pricing when it came to understanding what was the community’s interest in the project.

Because cryptocurrencies did not face the same challenges as fungible tokens, the solution seemed very simple: to make fungible what was not fungible. This is how the idea of fractionating NFTs came about, to meet the need to have the best of both worlds between fungible and non-fungible assets. As the name already says, the concept is based on fractioning, that is, dividing an asset that cannot be duplicated, allowing it to have multiple owners and not just one.

Fractional NFTs - Definition and Concept

As we said before, the idea revolves around dividing into smaller pieces, equal in value, which together represent an entire NFT, like slices of a large cake.
If you own an NFT and want to break it down, the process is simple and only requires you to do it through a specialized platform.
Simply put, most NFTs are built on standard Ethereum’s ERC-721 protocols (some utilize ERC-1155), which confer the characteristic that the NFT cannot be split. In contrast, cryptocurrencies are built on standard ERC-20 protocols. When entering a platform to fractionate NFTs, the NFT owner needs to create a vault, where he will keep one or more NFTs locked. Next, the vault will use smart contracts to lock this NFT and divide it into smaller pieces. The owner will be able to choose how many pieces the NFT will be divided into, in addition to deciding whether he will keep most of the parts, or sell them all, allowing an equal possession of his asset. With this, tokens will be generated in ERC-20 protocols that are linked to the vault with the main NFT. These tokens will be worth a corresponding fraction of the entire NFT, so that added together they reach the original value. However, a piece can be valued individually, also valuing the initial NFT. And finally, the new minted tokens can be sent to new owners or can be sold on the platform itself or another appropriate website.

The tokens are worth a corresponding part of the entire NFT, and together they form the entire value, however, a piece can be valued individually, while also valuing the initial NFT. In the end, anyone who pays the amount to have an F-NFT available for sale can buy it and share all the advantages included in the NFT project, as partners in a large company. An interesting detail is that the vault can be created with more than one NFT, making the owner of F-NFT own part of the entire set and not just one.

Can Fractional NFTs Be Reversed?

Just as when we share a good or a company in the real world, the first question we ask ourselves is always: Is it possible to put it all back together? As the owner of the original asset, will I be able to have it all back again? And as a buyer, can I have an NFT as a whole that has been divided into an F-NFT?
The answer is yes, you can. It is possible to use the buyout function that exists in the smart contract to reverse the fractionalization. The buyer sends the value of all fractions to the vault. At this point, a buyback auction is initiated for a pre-established period of time. During this period, the current owners of the fractions may outbid the user who initiated the auction and maintain their fractions. Therefore, the process is not 100% guaranteed.
However, if the outbid is not reached, the fractions return to the vault automatically and immediately. The owners of the fractions still receive the values corresponding to their parts.
Some users consider this factor a disadvantage of F-NFTs, as it somehow leaves the decision to own the assets in the hands of others.

Fractional NFT Platforms

As already stated in this article, the fractionalization of NFTs needs to be done on a specific platform. Many of them have other characteristics. Others are a market for users to find F-NFTs of interest. Below we have a list of some options.

Unic.ly

Source: Unic.ly Vaults

One of the platforms used is Unic.ly, which promises to combine, fractionalize and exchange NFTs in a simple and safe way. Unic.ly is a space where you can create new collections from a single NFT in your possession and supports Ethereum-based NFTs in ERC-721 and ERC-1155 protocols. Through the collections, you generate uTokens that represent the fractional parts of your NFT and make them available to other users to bid on. On the other hand, you can search for collections that are part of NFTs of interest to you and buy representative uTokens. These uTokens guarantee governance in the collection or part of it. The platform also features the UNIC governance token, which can be staked to farm more UNIC tokens.

Fractional.art

Source: Fractional.art

The Fractional.art platform is more related to NFTs linked to works of art. It is possible to link a digital wallet for better access to your NFTs through the platform. The site has a layout more like a catalog, and in it you can find several online auctions of units or sets of NFT’s and their fractions.
NFTs are sent from their wallets to a curated vault to be fractioned and subsequently verified for authenticity. After the process, the vault stores your NFT and gives to you 100% of the fractional ownership tokens, to do whatever you please with them.
The platform also serves as an exchange, allowing the purchase and sale of tokens through its crypto assets.

NFTX

Source: NFTX

The NFTX platform has the common features of buying and selling fractions of NFTs, but enters with the possibility of also exchanging between assets. In addition, it has Liquidity Pools for the tokens generated with the fractionation of NFTs. With this function, you can block part of your tokens in staking in exchange for more representative NFT tokens in NFTX vaults. This functionality clearly shows how the fractionation of NFTs solves the liquidity problem in the economy of NFTX.

Otis

Source: OTIS

Otis’ platform is slightly different from the previous ones, as it represents more comprehensive assets in the context of NFTs. In addition to artistic and cultural works, Otis also presents shares of cultural assets such as rare collectibles, trading cards, and contemporary art from the physical world. Ownership of the assets is assessed by an independent auditor and the platform assesses whether the price requested for the fractions of the asset are fair and not over calculated. In the end, sellers still net higher than working with auction houses, even with a valuation just or slightly below the fair market value, thus bringing more confidence and interest in listing their fractional NFTs on Otis.

What Is the Difference Between F-NFTs and Traditional NFTs?

The main difference between the two assets is the fractionalization. An F-NFT is a split version of an NFT that can be owned by several different owners. This is possible when locking the ERC-721 or ERC-1155 protocol in which the NFT is maintained and this is divided into several ERC-20 protocols, a kind of asset tokenization. This factor allows an increase in the accessibility of users to the project.
The advantages related to NFT, such as access to clubs and exclusivities in other projects, remain for all owners of the fractions.

Benefits

NFTs arrived on the Web3 as the possibility of making several assets non-fungible, enabling users to confer ownership and price on these assets. For these reasons, this technology eventually became a key tool for many metaverse features. However, the technology faced problems of low liquidity and high cost of some projects due to the sudden fame. With this, only a few projects became known and even other advantages of NFTs as exclusive access were ignored by most of the community that could not pay for the asset.
The fractionation of the NFTs allowed more trades to be made with smaller pieces of the traditional asset, making it immediately more accessible. With this, it became easier to identify the community’s interest in certain projects and the real value of the assets. The increase in transaction history also increased the liquidity and visibility of projects.
Even with the new improvements, some enthusiasts worry about new variables in the equation. F-NFTs depend on the security of the smart contracts they are held on, so it is always good to carefully evaluate the platform on which you trust your asset. In addition, F-NFT holders are always in a silent war with buyers. Since the buyout and outbid process can be initiated by anyone and automatically validated, the control and ownership of F-NFTs becomes a little more dependent on other network users, making it more difficult to maintain ownership of their assets if there is a great interest in it. Another factor that worries F-NFT users is the new competitiveness that arises from the increased demand generated by fungibility. Now, to sell an item of interest to buyers, you need to compete in price with other F-NFT owners of the same initial NFT.

Use cases

Artwork

Artwork should be the most common and simple field of action to understand. Art has become a fever among NFTs and today we have many examples of some that have been sold for fortunes. Fractioning them to give access to more users revolutionized the technology. NFTs also enabled digital works to be authenticated and sold as unique articles, as well as versions made with brushstrokes. The F-NFTs made possible a greater exposure of the artists, in addition to a greater appreciation of the digital work that started to be priced.

Gaming

Online games also played an important role in the dissemination of NFT technology. Not only in play to earn models, with items that work as bargaining chips and currency trading, but also in other MMORPG styles. Emblems, character skins, magic items, skill items, and others that do not influence the game economy could be sold as collector’s items to other players.

Metaverse

The metaverse has grown exponentially and projects aim higher and higher. With this, the entry of investors is increasingly necessary. The F-NFTs made it possible for projects to be linked to NFTs and then fractioned to several shareholders, with the idea of collecting funds. The possibility of joining several NFTs in the same vault facilitates the egalitarian merger of companies, projects and concepts.

Real estate

Today there are already investments from Real Estate Funds that put into practice the idea of fractionating a property so that all owners receive part of the sale and/or rental value. Although the idea is not yet in practice, it is possible to see that buying fractions of real estate investments using F-NFTs can be simpler and less bureaucratic.
Even the definitive purchase of real estate by one or multiple parties can be simplified by selling NFTs or F-NFTs. The valuation of the property could be evaluated and the entire transaction history of the former owners of the property would be recorded on the blockchain.

How Do Fractional NFT Owners Benefit?

• Partial ownership of a much more expensive asset
• Possibility of valuation
• Ease in selling the asset, considering that it has a more accessible value
• Staking (on some platforms)
• Exclusive access to the NFT community
• Voting rights (on some platforms)

Regulation and Jurisdiction

Overall, digital articles, both NFTs and F-NFTs, face jurisdictional doubts on the legal side. As an example, in real estate they have already had agendas about considering it as an investment of securities but so far no information has been disclosed about the regularization of it. It is not yet known how this type of asset will be taxed, but some community users believe that the interest of the America’s Securities and Exchange Commission (SEC) in investigating F-NFTs is a sign of the most likely possibility. Although they have not yet reached a consensus on this, it is possible that F-NFTs will be handled in the same way as company shares, bonds, or derivatives.
In terms of jurisdiction, the location could be a problem. Disputes related to transaction problems would encounter difficulties under which legal context to adopt. If an American seller sells on a UK exchange for a German buyer, what court would have jurisdiction to deal with the case under their laws? The process of reversing F-NFTs would also cause conflicts since regardless of the regulation, the process carried out in the blockchain is immutable.

Conclusion

For enthusiasts of the new world brought by blockchain technology and its features, there is always a lot to discover. With new discoveries, allowing room for improvement is always welcome and in DeFi it would be no different. Along with the possibility of transferring funds in a decentralized, secure and anonymous way, through the blockchain network, the possibility of doing the same with other types of assets is an attraction in DeFi. The exorbitant prices that some NFT projects have achieved have become a notorious barrier to this technology. The possibility of tokenizing these assets solved the pricing and liquidity problem of NFTs and F-NFTs made the technology more accessible, exposed and democratic. Even with other challenges ahead, the new modality fell into the liking of many users who saw the possibility of owning, valuing and taking advantage of interesting assets that they could not previously afford.