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NFTs, or non-fungible tokens, have become all the rage in the crypto space lately. NFTs make the tokenization of a range of assets super easy, and it’s no wonder their popularity is only growing with every passing day. However, NFTs do come with a liquidity problem.
Since the rareness and uniqueness of NFTs naturally raise their values, they are not very affordable to most. And even if you do manage to buy an NFT, there’s no guarantee anyone will be willing to buy it from you at a higher price. For instance, when Twitter co-founder Jack Dorsey put his first tweet up for sale as an NFT back in March 2021, it was bought by the entrepreneur Sina Estavi for $2.9 million. However, recently when Sina Estavi looked to resell the NFT for $48 million, it didn’t get a very enthusiastic response.
So whole NFTs are becoming increasingly hard to acquire, and many newcomers to the market even consider completely giving up on buying a rare collectible. But evolving technology in the blockchain space may already have a solution for the liquidity issue: NFTs can now be split into smaller fractions and sold separately. How would this work? Let’s find out!
What Are Fractional NFTs?
As the name suggests, a fractional NFT is just a whole NFT split into smaller pieces. This allows a number of buyers to have partial ownership of an NFT, and naturally, the prices are lower than that of whole NFTs.
How is an NFT fractionalized?
NFTs are usually created following the ERC-721 token standard regulated by the Ethereum blockchain, but the ERC-1155 standard is also followed sometimes. Now, these two standards are used to generate non-fungible tokens only- unique ones that can not be replaced by another.
On the other hand, the ERC-20 standard is used to create fungible tokens. They are interchangeable, and therefore each unit has the same value and utilities. So, how an NFT is fractionalized is that a smart contract is used to generate several ERC-20 tokens linked to an indivisible ERC-721 NFT. Now anyone who owns one of these ERC-20 tokens can have a fraction of the NFT linked with it.
Fractional NFTs can also be turned back into a complete NFTs. How? Well, the smart contract used to fractionalize an NFT should have a buyout option that lets a fractional NFT holder purchase all the fractions created and unlock the actual NFT as a whole. The buyout option can be triggered by transferring a certain number of the fractioned ERC-20 tokens back into the smart contract. This should initiate a buyback auction of sorts, running for a set window of time. If the other fractional NFT owners choose to sell their shares, the buyer to start the buyout gets full ownership of the NFT.
What Are The Benefits Of Fractional NFTs?
The many benefits of fractional NFTs would include:
- The democratization of NFTs: As mentioned before, most rare collectibles traded in the form of NFTs come with prices unaffordable to the general populace. So smaller investors and newcomers are barred from entering the NFT space at all. When an expensive NFT is fractionalized, though, the costs are brought down, and the assets become accessible to a larger pool of investors.
- Improved Liquidity for Non-Fungible Tokens: Again, since fractional NFTs make previously inaccessible assets available to smaller investors, fractional NFTs have the potential to enhance market liquidity for NFTs.
- Better Price Evaluation of an NFT: For one of the more expensive NFTs with very little to no transaction history, it gets difficult to determine its real value. However, once fractions of these NFTs get traded around a lot more, buyers can determine the original NFT’s actual value with more ease.
- Access to the Wider NFT Community: Once fractional NFTs are created, more buyers can access the broader NFT community. Depending on the NFT platform where a buyer gets their fractional NFT from, they can earn exclusive benefits like staking rights and governance, voting rights, and even receive rewards for their contribution.
- Better Visibility for Creators: Digital creators of NFTs can have better exposure online and may be able to reach a broader audience in an NFT marketspace with enhanced liquidity.
- Easily Integrated with DeFi Applications: Since fractional NFTs are ERC-20 tokens, they can be used in DeFi with better ease than ERC-721 tokens. Fractional NFTs can potentially be traded on decentralized exchanges for crypto and used in functions like staking and yield farming.
Are There Any Drawbacks to Fractional NFTs?
Keep in mind that the usual volatility of crypto may cause the price of your fractional NFTs to drop and lose money at a particular point in time. Plus, since fractional NFTs are reliant on smart contracts that create them, their security is guaranteed by the quality of the smart contracts’ code. Glitches in smart contracts, therefore, may also be a cause for concern.
Despite the quibbles, however, investing in fractional NFTs is definitely less of a risk than buying whole NFTs. Investments in fractional NFTs are undeniably more accessible and profitable for both seasoned NFT investors and newcomers. While veterans can diversify their portfolios by investing in a variety of projects, new NFT buyers can test the waters more freely with fractional NFTs.
As always, do remember to do your research before investing in fractional NFTs.Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.