In the first part, we were introduced to the big picture of the existing puzzle pieces in the NFTFi market. In this article, let’s dig deeper into a very potential market niche called Fractionalized NFTs.
What are Fractionalized NFTs?
With the current gloomy market situation, spending large capital to buy NFTs as a hoarding asset is quite risky. Moreover, because of the originality (indivisibility) of tokens of ERC-721 standard, it is difficult for users to invest in NFTs with the DCA strategy. Therefore, a solution to this problem has been found: fractionalized NFTs or fragmented NFTs. This is initially a solution to make it easier for ordinary users to access blue-chip NFTs, which have a very high floor price. Basically, projects provide this solution by converting NFTs into fungible tokens with ERC-20 standard (similar to yield-bearing tokens of DeFi projects like AAVE’s aTokens or SushiSwap’s xTokens).
Fractionalized NFTs projects
Unic.ly and Fractional.art (Tessera)
Users can create a vault for one or more NFTs in the same collection and split it into multiple fungible ERC-20 tokens. When another investor wants to redeem an NFT in the Unic.ly vault, they will have to pay a price higher than the trigger price that the vault owner has set. At this point, the auction process will take place, and the overall winner will buy one or more intact NFTs according to ERC-721 or ERC-1155 standards and return the ETH to the vault. The initial investors will be entitled to receive this ETH according to the percentage of their ERC-20 tokens in the vault as shown in Figure 1.
Fractional.art has a similar mechanism to Unic.ly, but the trigger price will not be pre-determined by the vault creator. Instead, the co-owners will have to vote to determine the reserve price – the lowest price that the buyer who wants to buy back the original NFT copy has to pay. If more than 50% of the total supply of fragmented NFTs (i.e. ERC-20 tokens) is used for voting, the reserve price will change. This price will be calculated according to the weighted average of all votes.
For example, if 75% vote for a reserve price of 150 ETH and 25% vote for a reserve price of 200 ETH, then the final reserve price result will be 162.5 ETH.
NFT20 and NFTX
These projects also create pools and allow users to deposit NFTs in them like Unic.ly, but the difference is that the buyer has to buy enough ERC-20 tokens in the pool to redeem any NFTs in that pool.
Also, ERC-20 tokens that are fragmented from the original NFTs can stake these tokens for an additional reward of transaction fees (like the LPs of AMMs in DeFi) or mortgage and borrow stablecoins to execute yield farming.
Szns is also a project on NFTs fragmentation, yet with a different approach where the NFTs in each collection acts like the governance token for that collection: Token holders will jointly participate in the process of managing & using the NFTs in the collection through voting.
Operating on the Solana blockchain, Bridgesplit has many products around NFTs, typically fractionalization, yield farming with fragmented NFTs, index funds, etc. Like the above projects, Fragmented NFTs can also be traded on Solana AMMs such as Raydium. Token holders will also have voting rights on the selling price and timing of the sale for NFTs.
The reason that fragmented NFTs are correlated with native NFTs is because of arbitrageurs. For example, when the floor price of CryptoPunks rises, the arbitrageurs will buy ERC-20 tokens in the NFTX pool to obtain an original CryptoPunks, then list that CryptoPunk on OpenSea (which has a floor price higher than the total purchase price of ERC-20 tokens) to make a profit.
Accuracy here can be understood as the correlation of fractionalized tokens with the NFTs they represent in the pool. The higher the correlation coefficient, the more accurately the fractionalized tokens reflect the returns of the original NFTs.
Figure 2 shows that all fragmented tokens have a positive correlation coefficient (greater than 0) with the floor price of NFT collections. NFTX’s PUNK token shows the most correlation (0.81), followed by Unic.ly’s UPUNK (0.7), Fractional.art’s HOODIE (0.68) and NFT20’s GPUNKS20 (0.54).
The reason for this difference in correlation is due to the difference in liquidity in the swap pool of fragmented tokens. In particular, PUNK and HOODIE are mainly traded on DEXs while UPUNK is traded on MEXC and Unic.ly’s DEX (Figure 3). Moreover, Fractional.art’s HOODIE token is fragmented from a single NFT, Punk #7171, rather than fragmented from a pool of many NFTs like NFTX, so the liquidity is also somewhat lower.
SZNS’s MeebitsDAO pool consists of 92 NFTs of which the correlation coefficient to the floor price of BST Meebits is 0.36, and the liquidity in the pool of ERC-20 tokens is around $82,540 (at press time).
It should also be added, that it is thanks to the high liquidity of the PUNK token that it has been used as a token in the reserve fund of FloorDAO – a protocol that works similar to OlympusDAO (Figure 4):
- First, users will deposit PUNK into FloorDAO to receive FLOOR tokens back at a discounted price
- FloorDAO will use the PUNK received to continue deploying to NFTX to receive rewards for providing liquidity
Fragmented NFTs tokens are created mainly to serve investment needs without having to own the NFT. A major downside to holding these fragmented tokens is that users do not have full authority when it comes to buying/selling the fragmented NFTs they hold. Also, NFTs in a normal vault cannot be rented out to create a new cash flow for owners unless the members of the DAO of SZNS organization vote to rent, making the optimization of profit from assets in the pool much reduced.
Fragmented NFTs projects, although not very active, are still a useful tool for investors who want to allocate capital into the NFTs market but are still concerned about the illiquidity of this asset class. Therefore, when investing in the fragmented NFTs segment, investors need to choose reputable projects with high liquidity and active trading volume to minimize risks for their portfolios.