Fractional NFTs in 2024: Liquidity & Access to Small Investors

NFTs were the shining star of the crypto markets in 2021. Many well-known NFTs are selling in six and seven figures territories. However, they are an illiquid investment with a high price barrier that keeps many small investors away from the blue-chip NFTs. Fractional NFTs have the potential to change this significantly. This article will explore fractional NFTs, their benefits, and the platforms that provide fractionalization services. 

What are fractional NFTs?

Fractional NFTs are one or a portfolio of NFTs divided into pieces. Each piece is purchasable and provides ownership of the NFT based on the fraction amount. For example, The Dodge NFT (Figure 1) was sold for $4.1 million in November 2021, and since then it has been divided into 16 billion fractions. Its implied value has risen to $13.9 million at the time of writing. Currently, each fraction is purchasable for less than $0.01.

Figure1. The Doge NFT

Source: Fractionalart

How do fractional NFTs work?

NFT Fractionalization

Currently, there is no industry standard, and platforms are different from each other in detail but generally, fractionalization works in the following manner: 

1. NFT owners stake their NFTs in a smart contract.
2. Smart contracts fractionalize the NFT to a predetermined number of fractions that are either specified by the platform or the owner. 
3. The owner will set a reserve price/exit price. This price is the minimum amount of money required that, if paid, the NFTs will be redeemed 
4. The owner initially owns all of the fractions and can sell all or a portion of the fractions.

NFT redemption

If someone wants to buy the whole NFT, they will have to pay the exit price. Some platforms initiate an auction if a buyer is willing to pay the exit price. The auction winner will receive the NFT. Some other platforms do not use auctions, and anyone who pays the exit price immediately will become the new owner of the NFT. In both cases, the fractional owners will get compensated on a pro-rata basis based on the exit price.

5 Benefits of fractional NFTs

1- Reduces entry cost

NFTs can cost millions of dollars. For example, The Merge NFT was sold for $91.8 million but if we break it down to 10 million fractions, the price for a fraction will be much lower. This will enable more participation from smaller investors.

2- Increase liquidity

More people can afford a $1000 investment in a fraction of NFT than $10 million for the whole NFT. This can create a more liquid market for NFTs. If offered by NFT marketplaces, Fractionalization can be a complementary service that can increase liquidity and engagement with the platform.

3- Price discovery

Selling fractions of an NFT can help with price discovery as it can be used to estimate the price that collectors and investors are willing to pay for the NFT.

4- Risk diversification 

Fractional NFTs can be used to diversify a collector portfolio of NFTs with less amount of capital. NFT fractionalization is not limited to a single NFT or collection, various NFTs and collections can be combined and fractionalized. A fraction of a diversified set of NFTs can be bought to diversify the portfolio concentration to different collections and NFT types. 

5- Investment product creation 

Fractional NFTs can be used to create investment products that provide indirect exposure to the NFT market, which can increase NFT’s market capitalization. This can allow traditional and crypto-based investment institutions to create a new product. For example, the JPG NFT index is an investable coin that has used fractionalized NFTs to create an investable product that provides exposure to blue-chip NFTs.

For more on indirect investment in NFTs, read Indirect Investment in NFTs: VCs, ETFs & Indices. 

Regulatory risks

Fractional NFTs have resemblances to securities, this was pointed out by the SEC commissioner Hester Peirce. In May 2021, she warned that fractional NFTs can be considered investment products and said, “You better be careful that you’re not creating something that’s an investment product — that is a security”. If SEC recognizes fractionalized NFTs as securities, then it will force the NFT fractionalization platforms to follow SEC rules and guidelines, which would require disclosure of information on the buyers and sellers that go directly against the decentralized nature of NFT and crypto communities. 

Platforms

• Fractional
• NFTFY

Further reading 

• NFT Loans: Unlocking Utility for Collectible NFTs? 
• 5 Factors to Consider about NFT Drops