What are fractional NFTs?

Fractional NFTs enable the division of a single, unique NFT into numerous, interchangeable units.

These units, or fractions, are represented by ERC-20 tokens, each of which signifies a stake in the original NFT. This process, known as fractionalization, is facilitated by smart contracts and essentially provides a digital "IOU" to the holder, stating their ownership of a certain percentage of the original NFT. Fractional NFTs can be sold or traded on various marketplaces, providing an exciting new avenue for investors.

However, it's important to note that NFTs themselves cannot be divided. The concept of fractionalization essentially bypasses this limitation by creating multiple fungible tokens that represent a share in the original, indivisible NFT. This process enhances the accessibility of NFT ownership, allowing people to own a portion of an NFT that they might not be able to afford in its entirety. Regardless of whether the NFT is divided into 100 or 10,000 units, anyone can claim ownership of a fraction.

In order to turn the tokens back into the original NFT, token holders would have to agree on such a move. This will depend on the rules of the fractionalization process and may be a tricky process.

While the concept of fractionalization isn't new, its application to blockchain assets brings a fresh perspective to the digital asset class. Fractionalization enables greater democratization and liquidity in the NFT market, making it easier for more people to participate in this burgeoning sector.

Benefits of fractional NFT ownership

Fractional NFT ownership some advantages that make it attractive to investors and collectors alike.

Firstly, it democratizes the process of owning NFTs. While the ownership of an original NFT is limited to a single individual or entity, fractional NFTs enable multiple people to claim ownership of a high-value NFT. This not only makes NFT ownership more accessible but also paves the way for a more inclusive digital art ecosystem.

Secondly, it can boost liquidity. Fractional NFTs create more units of a single NFT, therefore increasing the frequency of trades and making the market more liquid. This liquidity can aid in better price discovery, although the value of the tokens can be somewhat separated from the value of the NFT itself — due to the inability to easily turn the tokens back into the NFT itself.

Risks and considerations of investing in fractional NFTs

While fractional NFTs are a promising avenue for democratizing ownership and enhancing liquidity in the NFT market, potential investors must be aware of the associated risks and considerations.

One of the key concerns is the regulatory aspect, especially in the light of recent enforcement action by the SEC suggesting that NFT sales should be classified as securities. Such stringent regulations and compliance requirements could impact the trading and ownership of fractional NFTs.

Another risk is the potential for conflicts among fractional owners. For instance, if a fractional NFT owner wishes to reclaim their original NFT, they may face resistance from other fractional owners, posing challenges in terms of governance and decision-making.

Moreover, the availability of reliable secondary markets for trading fractional NFTs is crucial, as illiquid markets could negatively impact the value and tradeability of these tokens. Lastly, like any investment, fractional NFTs are not immune to market volatility.