Investing in individual non-fungible tokens or NFTs is a problematic task. The NFTs that seem likely to do well as investments are selling for astonishing sums pricing out both newcomers and established collectors. For those seeking exposure to high-flying NFTs, fractionalization may well be the answer.
The Basics of NFT Fractions
NFT fractions, also known as shards, are created by issuing an ERC-20 token that represents the underlying asset, whether that asset is a single NFT or a basket of NFTs. A growing number of services now make it possible to invest in NFT fractions and even to fractionalize one’s own NFTs.
ERC-20 tokens allow for the creation of what are essentially derivatives of the underlying asset. Rather than trading publicly on an exclusive exchange such as the NASDAQ, ERC-20 tokens can be traded on a wide range of decentralized exchanges or DEXs.
Unfortunately, the similarities to the stock market do not end there. Multiple legal experts have noted the likelihood that NFT fractions in some cases are, in fact, securities and now SEC commissioner Hester Pierce has confirmed that likelihood. This unresolved situation raises unanswered questions about what will happen when and if regulation occurs.
Credit: NFT20 Creator Very Nifty Logo
NFT Fractions and NFT Index Funds
The two most well-known NFT fractionalization services, NIFTEX and NFTX, also represent the two main categories. NIFTEX is a service for investing in NFT fractions while NFTX is an NFT index fund. However, NFTX does not provide exposure to an actual group of NFTs that reflect an industry sector, as one sees in stock-based index funds.
Both companies offer the opportunity to trade fractions of NFTs as ERC-20 tokens that can represent single NFTs or multiple NFTs held in funds or vaults.
NFT fractionalization services may also offer unique features on their own platforms such as vaults and liquidity pools.
Liquidity pools are familiar to those with DeFi experience, but here, they exist to create a larger pool of a particular group of NFTs, such as CryptoKitties. These offer the option for NFT owners to add an NFT from a particular group of NFTs and to become a liquidity provider. It is best to check the NFT fractions service for current details regarding their liquidity pools as they function rather differently than ERC-20 liquidity pools on DEXs.
Credit: NFTX Logo
NIFTEX offers the option to create both single NFT fractions and baskets of fractions. It recently launched NIFTEX V2 with a number of interesting developments including lower gas prices on all transactions and the ability to include fees from secondary markets trading, which go back to the NFT artist, similar to royalties.
The project is moving towards a community governance model using a “DAO-like entity.” A unique development is the ability to vote for a fraction creator to offer “on-chain rights” to shard owners which allow for voting on proposals related to the fractionalized NFT or basket of NFTs.
Credit: NIFTEX Logo
NFTX offers two fund options; single NFT D1 funds or D2 funds which combine D1 funds. NFTX is also a full-fledged DAO emphasizing community governance. NFTX recently introduced multiple new funds featuring very popular NFTs, including Axies, CryptoKitties and Avastars, available via “NFTX vaults on SushiSwap.” In addition, community-created NFTX vaults regularly appear including an Alpaca City vault which is strongly supported by the Alpaca team with initial seeding and a liquidity competition.
NFT20 is a decentralized protocol for creating and fractionalizing pools of NFTs rather than individual NFTs. It allows participants to deposit NFTs into available pools and immediately receive ERC-20 tokens. Participants can also create new pools. Governance is managed by the dev team with input from the community. Some decisions are made by holders of the $MUSE token. NFT20 has a much stronger emphasis on NFTs with lower valuation and on swapping NFTs than do NIFTEX and NFTX. Activity takes place on the NFT Dex with ERC20 tokens immediately tradable on Uniswap.
Fraction is a new entrant to the space focused on fractionalizing individual NFTs. Initial sales of ERC-20 tokens will occur on the Fraction platform after which the tokens will be available via the DAOfi DEX. DAOfi launched on the xDai network which is an EVM sidechain thus reducing transaction fees. Tokens are placed on a bonding curve. In addition, some art will offer physical merch options as well as events in token-permissioned Telegram rooms. Airdrops of additional assets may occur.
Credit: Fraction Creator DAOfi Logo
But Wait, There’s More!
Related services doing interesting things with ERC-20 tokens include PieDAO’s PLAY Metaverse NFT Index, which is closer to an actual index fund than any of the above, and Charged Particles, which enables an NFT to act as a basket holding ERC-20 tokens and/or other NFTs.
Are NFT Fractions Securities?
Chris Donovan on Twitter
Legal experts have previously pointed out that NFT fractions could be considered securities. As he noted on Twitter, Chris Donovan, Head of Legal for Outlier Ventures, considers that to be the case:
“NFTs CAN be securities in certain circumstances
* fractionalised NFTs embodying rights to royalties; or
* NFTs sold with promise of future liquidity & continued services from issuer”
Preston Byrne, Partner at Anderson Kill, explains further:
“For example, if Alice fractionalized the NFT and sold fractions of a book or profits from one, that might fall foul of the securities laws…An NFT that performs the function of a regulated product will be regulated like a regulated product.”
More recently SEC Commissioner Hester Pierce confirmed that “the definition of security can be pretty broad” and that those selling NFT fractions “better be careful that you’re not creating something that’s an investment product…a security.” Though the SEC may soon take up such issues, she also states that she doesn’t “know how it will all play out.”
Pierce is hoping to see a safe-harbor policy enacted that would allow for a three year period exempting businesses from immediate regulation and therefore protecting both businesses and investors in uncharted waters. At this point the future regulation of NFT fractions remains in question with some hopeful signs. As usual, Do Your Own Research (DYOR) remains the order of the day.