Non-fungible tokens, or NFTs, have taken the art world by storm. But with floor prices in the tens or hundreds of thousands of dollars, many of the most popular collections are unaffordable for would-be collectors. At the same time, NFT collectors are putting all of their eggs in one basket by holding a limited number of high-value NFTs.
NFT fractionalization solves these problems by dividing a single high-value NFT into more affordable and tradeable pieces. In some ways, the concept is similar to dividing public company ownership into shares of stock. Collectors can access some liquidity without selling their entire piece and the NFT is more accessible to the general public.
Let's look at how fractional NFTs work, where to buy them, and some of the benefits and risks to keep in mind.
Fractionalization enables anyone to collect high-value NFTs while improving liquidity and price discovery.
What Are Fractional NFTs?
Fractionalization is dividing a whole NFT into pieces, conveying ownership to multiple people. While the concept is relatively new in crypto, it has become a popular way to buy everything from shares of stock (or even fractions of a single share) and high-priced, non-digital alternative investments, such as fine wine and fine art.
Most NFTs are ERC-721 tokens on the Ethereum blockchain, but these tokens are not inherently divisible. As a result, fractional NFTs require a smart contract that generates multiple ERC-20 tokens linked to the ERC-721. That way, anyone that holds one of the ERC-20 tokens owns a percentage of the linked NFT – verifiable on the blockchain.
The most common strategy involves NFT owners minting a “vault” that takes custody of the NFT and issues the owner 100% of the fractional ownership tokens. With these tokens in hand, the owner may conduct a Dutch auction, add liquidity to DeFi protocols, or give them to friends while keeping in mind that they represent real, algorithmic ownership in the NFT.
Existing fractional owners typically vote on the reserve price for the NFT – or the price that a third-party would need to acquire the entire NFT. If someone wants to acquire the NFT, they must bid at least the reserve amount to begin an auction process. And if successful, all fractional owners may cash in their fractional ownership on a pro rata basis.
When curating an NFT collection (multiple NFTs), owners can also charge “curator fees” on an annual basis. These fees are similar to the management fees that ETFs or mutual funds may charge and act as incentives for the owners to share their NFTs with the public.
Example
Suppose that you want to own a $100,000 Bored Ape. A fractional NFT platform might hold a Bored Ape and mint 1,000,000 ERC-20 tokens worth $0.10 a piece. After connecting your wallet, you might purchase 100 of the Bored Ape's ERC-20 tokens for $10.00, giving you a 0.01% ownership stake in the NFT – and the ability to diversify across many collections.
If the price of Bored Apes rises, you can easily sell your ERC-20 token in the secondary market. These transactions influence the price of the underlying NFT since you can multiply the transaction amount by the ownership stake to determine the value. But of course, the transaction amount plays a role in the valuation's relevance.
Fractional NFT Platforms
Fractional NFTs are still a relatively new concept, but you can access them using several new platforms. In general, these platforms mint custom ERC-20 tokens that represent a share of each NFT or NFT collection. Unic.ly and other platforms may also have their own governance tokens that influence how the overall platform evolves over time.
Fractional.art is the most popular platform for buying, selling, and minting fractional NFTs. You can buy a fractional piece – from one of the collection vaults – of a single NFT or an entire collection. Currently, the platform features nearly 200 vaults holding CryptoPunks, BoredApes, and other famous NFTs, with about 40,000 unique wallets holding fractional assets.
Unic.ly enables NFT holders to connect their wallets and create a fungible uToken – or a custom ERC-20 token representing ownership in a single NFT or a collection of NFTs. In addition to buying fractional ownership, the platform provides its own $UNIC governance token that anyone can buy to vote on organizational decisions or farm for income.
Benefits of Fractional NFTs
Affordability
Many popular NFT collections are unaffordable to the average person. For instance, the Bored Apes floor price was about 90 ETH or $107,270 in June 2022 – and that's after ETH prices collapsed to $1,190. Rather than relegating these NFTs to celebrities and wealthy collectors, fractional NFTs open the door for anyone to participate.
Liquidity
Higher prices generally translate to lower liquidity since there are fewer buyers. For instance, a Bored Ape may only sell once every six months, making it difficult to know the current market price. On the other hand, the ERC-20 tokens behind a fractional NFT may be bought and sold constantly, making it easy to compute the current market price.
Visibility
Artists may only be able to create a limited number of pieces each year, but they need to sell them for enough money to make a living. Rather than trying to attract wealthy buyers, fractional NFTs enable these artists to sell to a broader target market. And the involvement of more people creates network effects that may support future sales.
Risks to Keep in Mind
Valuation
Fractional NFT platforms don't have a built-in way to keep fractional prices in line with the underlying NFT's valuation. As a result, you should carefully consider a fractional NFT's implied valuation before investing in it. Of course, coming up with these valuations can be a challenge in illiquid markets – especially when dealing with a basket of assets.
Liquidity
The liquidity of a fractional NFT depends on the underlying platform. For example, if a fractional platform goes out of business, the associated ERC-20 tokens could become less liquid as investors move to other platforms. As a result, you should carefully consider the traction and finances behind the fractional NFT platform you use.
Volatility
Fractional NFTs could open the door to more investment capital, including highly speculative "meme" traders. As a result, the high-end NFT market could see more volatility and potential bubbles over time. You should be aware of these risks when selecting NFTs to invest in and consider building a diversified portfolio of crypto assets.
The Bottom Line
Fractional NFTs enable anyone to participate in the world of high-end collectible NFTs. Using platforms like Fractional.art or Unic.ly, you can purchase parts of popular NFTs for under $1.00, building a diversified portfolio with exposure to the high-flying crypto art world.
If you trade NFTs or other crypto assets, ZenLedger can help you organize your taxes and identify ways to save. The platform aggregates transactions across wallets and exchanges, computes your capital gains or losses, and auto-fills popular IRS forms. You can even find ways to harvest tax losses throughout the year.
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