Fractionalization & liquidity: What you should know when trading NFTs

Fractionalization solves the problem of affordability and accessibility. Think about it, very few wallets hold blue chip NFTs like CryptoPunk, Moonbird, VeeFriends, etc. This means that while they offer unique utilities, most of these top NFTs are beyond the reach of many traders and collectors because of their high prices. This makes them exclusive, unique quality but with its disadvantage also. Exclusivity may also mean the market for trading these blue-chip NFTs is less efficient and illiquid as only a very few people can buy a premium NFT in one fell swoop (see the case of the Tiffany and Co NFTiff collection priced at 30 ETH mint price). By fractionalizing NFTs into smaller shares, the possibility of multiple traders buying and selling their preferred premium NFT collection post-mint is significantly increased, which helps promote inclusiveness.

In conventional businesses and traditional settings, co-ownership of assets is possible because there are legal provisions enabling it. Several persons could own a piece of real estate and generate income from it. But a singular NFT, which is always different from others even in the same collection, can only be owned by one collector at a time. Even walkarounds like pooling funds by a group of people to mint or buy an NFT are still limited as the NFT gets to reside in just one wallet at a time. What if several people can individually hold one NFT? This is the concept behind fractionalization. By dividing an NFT into multiple equal parts, multiple buyers can provably own a singular NFT.

Few people can access and acquire premium NFTs, whose prices are between double to quadruple digits in ETH. For example, the floor price of a BAYC is around 87 ETH, and BAYC #4464 sold for 2500 ETH in mid-July 2022. But fractionalization reduces this entry barrier by splitting the NFT into multiple equal parts, making it possible for retail traders to buy and own them. The fractionalized NFTs are ERC-20 tokens, and they can be used to tap into growing DeFi utilities to explore more opportunities through staking, yield farming, or even lending.

Understandably, fractionalization brings numerous benefits to NFT holders and the overall NFT industry, the problem with liquidity, especially for traders who wish to trade actively and flip NFTs like they would conventional crypto assets, cannot be wished away. The NFT market is highly illiquid compared to the fungible token market, where a token X token can be easily and quickly exchanged for, letting us say token Y because there’s sufficient market liquidity. In the NFT market, participants who want to acquire and trade NFTs must seek buyers IRL or on marketplaces and wait before a trade can be executed. This arrangement is inefficient and not scalable. It is easier to take a position and difficult to exit, and this gets even more difficult in a case where the NFT is not premium.

There are several NFT fractionalization platforms that help to drive inclusion and promote shared ownership of nonfungible assets, as well as measures to build up liquidity for NFTs. One of these is Quantix, a community-driven NFT marketplace that enables you to fractionalize and trade premium NFTs using its built-in virtual AMM (vAMM) for fairer price discovery. The Quantix marketplace was designed to increase the velocity for trading premium NFTs and usher in a new era for non-fungible assets.

Quantix focuses on the three high-level problems in the NFT market: inclusion, liquidity, and fair valuation. As a decentralized NFT marketplace, Quantix facilitates the splitting of premium NFTs into multiple equal parts through a process known as Quantization. This then enables an NFT seller to access liquidity quickly. While the illiquidity from NFTs is transferred to the fraction holders, the fractions are seeded into the Quantix vAMM as liquidity in the Free Market Phase. NFT fractions trading in the Free Market Phase is open to traders (buyers) irrespective of their portfolio size to buy and sell the fractions instantly for profit or loss. Hence, the initial fraction holders can benefit from the trades if the price appreciates based on market principles (demand and supply).

A collector can also buy all fractions in a Buyout. When this occurs, the fractional buyers or early backers during the Quantization Phase will be credited at the market rate of the NFT with additional QNTX as rewards.

Fractionalization is aimed at solving the problem of inclusion, but, it also bears its risks. Through fractionalization, a singular seller can transfer their NFT to multiple market participants (buyers) who inherit illiquidity in the whole NFT. Until a buyout is initiated, the fraction buyers are at risk of being ‘bagholders’. Aside from the inherited illiquidity, there is also concern about the legal rights of fraction holders. Do fractional NFT holders own any legal claim to the fractions or not?

It is becoming more evident that some of the defining challenges must be equally addressed to attract the multi-trillion dollar market out there into the NFT industry. Fractionalization and measures of boosting liquidity like vAMMs are currently being explored, which is a welcome development. Yet, more should be done — like defining legal rights and exploring to find new ways to unlock utilities for fractional NFT holders. As the industry evolves and more infrastructures are built around NFT fractionalization, the industry, especially retail users, stands a chance to benefit greatly, which will be an added boost for mainstream adoption of NFTs.