What Are Fractional NFTs? (How They Work, Pros & Cons)
A fractional NFT (non-fungible token) is a single NFT that’s been divided into smaller pieces, allowing multiple investors to gain partial ownership of it.
NFT fractionalization has made it easier for crypto art enthusiasts and investors to get hold of some of the world’s most expensive NFTs, like the iconic CryptoPunks NFTs.
Besides, we’ll introduce you to an easy way to invest in shares of physical artworks (through Masterworks).
How Do Fractional NFTs Differ from Traditional NFTs?
Simply put, a traditional NFT is the whole entity, while an F-NFT represents a portion or a fraction of the original NFT asset.
Traditional NFTs are usually owned by a single buyer or an organization representing several NFT collectors. On the other hand, F-NFTs are collectively owned by multiple investors.
NFT fractionalization has lowered barriers to entry and improved accessibility for everyday buyers in the NFT market. This investment approach is also used in the metaverse and in alternative investment avenues like real estate and fine art.
How Do Fractional NFTs Work?
Before NFTs are fractionalized, they are locked in a smart contract.
A regular NFT uses Ethereum’s ERC-721 token standard. To fractionalize the NFT, the smart contract divides the ERC 721 NFT into smaller fractions as ERC-20 tokens.
The original NFT owner gets to decide how many ERC-20 tokens are issued, their minimum price, and other properties.
Each ERC-20 token represents partial ownership of the original NFT. Once these fractional tokens are put up for sale, anyone can purchase one or more fractions via fractional NFT platforms like Fractional.art.
It’s also important to note that the fractionalization process can be reversed, transforming F-NFTs into a regular NFT.
How does this work?
The smart contracts usually have a buyout option. This option allows any fractional NFT owner or third party to buy all the other fractions, gaining ownership of the original, whole NFT.
If someone wishes to do this, they’ll have to transfer a set number of ERC-20 tokens from a collection back to the smart contract.
Then, a buyback auction will run for a fixed period.
Suppose the original NFT owner or third party outbids the other fractional owners. Every fraction is then returned to the smart contract, and the investor who initiated the buyout gains complete NFT ownership.
Here’s a look at a few common use cases of F-NFTs.
Fractional NFT Use Cases
Here’s how NFT fractionalization is used in real estate gaming collectibles and other NFT art:
- Art: Fractional art NFTs have made it easier for anyone to invest in fractional shares of high-value digital artworks. This way, several collectors can have collective ownership of an expensive NFT that they otherwise might not be able to afford.
- Real Estate: Converting real estate property into NFTs can speed up the transfer of ownership process for property investors. Blockchain tech makes it easy for investors to verify transaction details like previous buyers, legal disputes, payment processes, and more.
This is because the transaction history is stored within the NFT. Moreover, fractional NFTs allow transfers to process without intermediaries since they rely on smart contracts. A smart contract is a self-executing program containing the terms of the agreement between buyer and seller.
- Gaming: Some multiplayer games allow players to buy fractionalized shares of rare and valuable in-game assets. For example, Axie Infinity, an NFT-based online video game, sells fractional ownership of ultra-rare Axies — popular in-game items.
Next, let’s look at four projects pushing the boundaries of the NFT space.
4 Famous Fractional NFTs
Here are four high-profile NFTs that have been fractionalized:
1. Doge Meme NFT
The Doge NFT features Kabosu, a rescued Shiba Inu, and is one of the most iconic and well-recognized fractional NFTs.
The origins of the NFT are quite comedic.
Atsuko Sato, Kabosu’s owner, took pictures of her pet with no intention of it becoming a global meme. This inspired software engineers Billy Markus and Jackson Palmer to create dogecoin,a cryptocurrency whose symbol was the dog’s face, making the meme even more famous.
In June 2021, Atsuko Sato auctioned the meme off as an NFT to a group of NFT collectors known as PleasrDAO for a record-breaking $4 million.
PleasrDAO then fractionalized the NFT into 17 billion “$DOG” tokens.
Interested collectors and buyers can now own a fraction of the Doge NFT easily.
2. Newborn 1 & 3
Created by singer and songwriter Grimes, the Newborn 1 & 3 NFT is valued at around $6,400.
However, in July 2021, Otis — a fractional NFT ownership platform — listed the fractional art NFTs for sale — at just $10 per share.
There are only 10,000 CryptoPunks NFTs in existence, and they have hefty price tags. This is a massive barrier to entry for smaller investors.
Fortunately, CryptoPunks fans can now purchase smaller pieces of the iconic NFT art project.
In April 2021, 50 CryptoPunks were tokenized into 250 million uPunks on Unicly— an NFT marketplace.
Interestingly, every F-NFT holder can bid on any of the CryptoPunks in the NFT collection. If 50% of the 250 million token owners vote to unlock the collection, then each NFT will be awarded to their highest bidder.
4. Mutant Cats
The Mutant Cats NFT project is a collection of 9,999 artworks featuring mutated cats. Every cat in the NFT collection is unique — some cats have melting fur, bubbling fur, one eye, and even organs on their face.
The fractional tokens are called $FISH — all NFT holders can stake them to earn 10 $FISH per day. (To “stake” means to lock up NFTs on a platform to get rewards or passive income without having to sell them.)
Now, let’s look at a few platforms where you can buy fractional NFTs.
Where Can You Buy Fractional NFTs?
Here are four popular fractional NFT marketplaces:
- Unic.ly: Unic.ly is a fractional NFT platform where NFT holders connect their wallets to receive ERC 20 tokens. Users can then trade the fractional tokens or bid on F-NFTs. Users can also receive ETH in return for fractionalizing assets.
- Fractional.art: Similar to Unic.ly, Fractional.art lets users redeem ETH when fractionalizing an asset. However this fractional NFT platform doesn’t offer bidding or staking options. Nonetheless, this NFT marketplace is an attractive solution for developers since it has a straightforward and permissionless protocol design, letting anyone further develop the platform’s protocol.
- Gate.io: Gate.io is a cryptocurrency exchange and a digital asset platform. Gate.io also has a newly-launched fractional NFT marketplace, Gate NFT. Gate NFT recently allowed users to own fractional shares of Azuki and MAYC NFTs, which are blue-chip NFT collections.
- Otis: Otis users can buy and sell fractional art NFTs, comics, and more. The platform’s main currency is the US dollar and the minimum investment price is $1,000. Some of the most popular NFTs available on the NFT marketplace platform include CryptoPunks, Pokémon Red, and Newborn 1 (editions #10, #50, #92) and Newborn 3 (editions #38, #52, #92).
5 Benefits of Fractional NFTs
Here are five ways investors and sellers benefit from NFT fractionalization:
1. Higher Accessibility
Most of the popular NFTs that are worth collecting have exorbitant prices. For example, CryptoPunk #5822 from the high-end CryptoPunks collection sold for $23 million in 2021.
This high barrier to entry makes it almost impossible for smaller investors to participate in the high-end NFT market.
Fractionalizing an expensive NFT lowers prices and makes it more accessible to a broader range of investors.
2. Increased Liquidity
Fractionalized NFTs can reduce the liquidity issues around high-end crypto art. Investors are more likely to purchase affordably-priced fractions of an NFT than a whole NFT.
Additionally, sellers don’t need to wait weeks or months for their NFT to sell.
3. Makes Price Discovery Easier
It can be challenging to determine the market value of an NFT since it’s a fairly illiquid market with a limited transaction history.
Fortunately, fractionalization can improve the price discovery process and help determine the accurate valuation of a particular NFT.
Since many different investors bid on each fraction, it allows for a better understanding of the whole value of the NFT.
4. Value Of Fractions Unaffected By Others
If an F-
NFT holder decides to sell their fractionalized NFT at a lower price, this price won’t affect the value of the other smaller fractions.
5. NFT Marketplaces Pay A Curator Fee
If an NFT owner decides to fractionalize their asset, they can receive an annual curator fee from the fractional NFT marketplace. While they can update this fee, marketplaces have a maximum fee limit in place.
But there are a few significant risks associated with investing in F-NFTs.
What Are The Drawbacks Of Investing In Fractional NFTs?
Here are five cons of purchasing a fraction of an NFT:
1. Undesirable Auction Buyouts
F-NFT auction buyouts usually help the original NFT owner reconstitute the entire NFT. But, undesirable buyouts can lead to the original holder losing money.
Let’s imagine you fractionalize your NFT and sell 50% of it to person X. Both of you now own 50% of the digital asset.
But another investor initiates an auction buyout and outbids both of you. Now, they’ll have complete ownership of the NFT, and you and person X will only receive 50% of the revenue each.
2. Regulatory Issues
Hester Peirce, a commissioner on the Securities and Exchange Commission (SEC), warns F-NFT creators to avoid minting tokens that could be considered a security.
Securities are fungible and interchangeable assets used for raising capital. In other words, they are the opposite of NFTs, which are unique and irreplaceable.
Since F-NFTs offer collective ownership of digital assets, the SEC can view them as fungible securities to an extent.
Such securities must be registered with the SEC, along with the sellers’ comprehensive transactional details. For those who advocate for decentralization and anonymity in the NFT space, these regulations pose quite a challenge.
3. Security Depends On Smart Contracts
The security of a fractionalized NFT depends on the smart contract it’s locked in.
Fortunately, a well-written and audited smart contract is usually secure. But smart contracts with security flaws can expose all the addresses linked with that contract.
The result? Cybercriminals can steal money from all the addresses that transacted with the faulty system.
In December 2021, a hacker stole $31 million from MonoX Finance by exploiting a bug in the software tool used to draft smart contracts.
4. Market Volatility
NFTs and F-NFTs rely heavily on the crypto market, which is highly volatile.
Let’s look at an example:
- In December 2021, the well-known CryptoPunk #4156 sold for 2,500 ETH ( $10.25 million).
- Two months later, CryptoPunk #5577 was sold for 2,500 ETH ($7.7 million).
- On July 12th, 2022, CryptoPunk #4464 was sold for 2,500 ETH ( $2.6 million).
The value gap of around $7 million between the first and last sale in less than a year, was due to cryptocurrency fluctuations. Thanks mainly to the “crypto winter” that started in late 2021 and through mid-2022. (It is yet to pick up to the early 2021 levels.)
Although F-NFTs boost democratization and make NFTs more accessible, it’s a fairly nascent market, and the legal rules around these digital assets are still evolving.
On the other hand, physical blue-chip art is an asset class with an established track record, helping you make a more informed investment decision.
The best part is you no longer have to shell out millions of dollars to invest in contemporary artwork.
Here’s how the platform works:
- Masterworks’ research team identifies which artist markets have growth potential.
- The team then locates the piece and purchases it.
- Masterworks files an offering with the Securities and Exchange Commission (SEC) to securitize the artwork.
- After you’ve invested in shares, all you need to do is wait. Masterworks may hold the painting for 3–10 years. If the piece is sold at a profit, you’ll receive pro rata returns after fees are subtracted (1.5% annual management fees plus 20% of the profit from the sale of the artwork).
- Alternatively, you can sell your shares on the secondary market.
Eight of Masterworks’ nine recent exits have handed investors +13.9% net returns.*
Ready to own shares of museum-grade art?
Complete Masterworks’ membership application to get started.
Net returns refer to the annualized internal rate of return net of all fees and costs, calculated from the offering closing date to the date the sale is consummated. IRR may not be indicative of Masterworks paintings not yet sold, and past performance is not indicative of future results.
See important Reg A disclosures: Masterworks.com/cd