NFT Fractionalization and NFT Liquidity Pools — The Next Generation of NFTs? | by Optimus Finance | LecleVietnam | Jun, 2023

Hello everyone, the NFT market is constantly evolving, with many NFTs being traded at sky-high prices and having low liquidity. However, there is a growing demand for ownership among collectors, which requires a solution to address this issue.

That’s why NFT Fractionalization & Liquidity Pools projects have emerged, aiming to increase liquidity and stabilize the NFT market. How do these protocols work? What is their potential? Let’s explore this together in this article!

I’m Neo — Admin — Community Manager of Optimus Finance and Growth Marketing of LECLE Vietnam. Let’s go!

Table of contents
1. What are NFT Fractionalization & Liquidity Pools?
1.1. NFT Fractionalization
1.2. NFT Liquidity Pools
1.3. What needs do they address in the market?
2. Current context of NFT Fractionalization & Liquidity Pools
2.1. Overview of the NFT Collectibles market
2.2. Prominent projects in the market
2.3. Data statistics of the projects
3. The paradox of NFT Fractionalization & Liquidity Pools
3.1. The paradox of “fractionalizing NFTs”
3.2. NFT dominance on Ethereum
4. The potential of NFT Fractionalization & Liquidity Pools
5. Closing thoughtsNFT Fractionalization and NFT Liquidity Pools — The Next Generation of NFTs?

1.1. NFT Fractionalization

NFT Fractionalization is the process of dividing a single NFT into smaller parts, allowing multiple fractional owners to purchase and own a portion of that NFT.

Through this process, a high-value NFT can be divided into smaller fractions to open up opportunities for investors with limited funds. Each fraction is referred to as “fractions” or “tokens” and is represented by tokens.

This fractionalization process creates higher liquidity for expensive NFTs, enabling individuals who want to invest in NFTs to participate with a smaller amount of money and share in the profits or value appreciation of that NFT.

The process works as follows:

NFT Fractionalization

The operation of NFT Fractionalization platforms typically follows these steps:

• Owners deposit their NFT into the platform’s Vault, which holds the NFT securely. Subsequently, corresponding fungible tokens representing fractions of the NFT are minted.
• The number of tokens to be minted is determined by the owner.
• These tokens can then be distributed and traded by adding liquidity on automated market maker (AMM) platforms such as Uniswap or Sushiswap.

To reclaim the original NFT, users need to deposit 100% of the initially minted tokens back into the Vault. However, in reality, collecting 100% of the tokens is nearly impossible. Therefore, these protocols incorporate a buyback mechanism to allow users to redeem the NFT without owning 100% of the token supply.

Each protocol may have different buyback mechanisms, but the general concept is as follows:

• If someone wishes to own the NFT in the Vault, they will propose a specific price to purchase the NFT.
• NFT token holders (those who own shares of the NFT) will decide whether to agree with the offered price or not, using methods such as voting or out-bidding in an auction.
• Once the final price is determined, the buyer will acquire the original NFT, and NFT token holders will receive a corresponding amount of money based on the number of NFT shares they hold. For example, if person A holds 10% of the total NFT token supply and the NFT is sold for $1 million, person A will receive $100,000.

1.2. NFT Liquidity Pools

NFT Liquidity Pools is a concept within the realm of DeFi (Decentralized Finance) that relates to NFTs. A liquidity pool for NFTs is a centralized pool of NFTs that users contribute to, aiming to create liquidity for NFT transactions.

In a pool, users can contribute their NFTs to the pool in exchange for a certain amount of cryptocurrency (e.g., ETH or other tokens). The NFTs in this pool are locked and used as collateral for transactions and borrowing. Users can access the liquidity of the NFTs they have contributed by buying back or swapping for NFTs in the pool.

By aggregating NFTs in Liquidity Pools, NFT Liquidity Pools provide a liquidity source for NFT transactions, enhancing the liquidity and tradability of NFTs. It also opens up opportunities for creating new financial products based on NFTs, such as borrowing or generating derivative financial products based on the value of NFTs.

In summary, while there are similarities to NFT Fractionalization, NFT Liquidity Pools allow users to deposit multiple NFTs into a vault instead of just one. The redemption mechanism for these platforms is also slightly more complex than NFT Fractionalization.

The process works as follows:

NFT Liquidity Pools

The operation of NFT Liquidity Pools platforms is as follows:

1. NFTs are deposited into a Vault, typically within the same collection and without distinguishing based on rarity.
2. Tokens (which can be customized) representing ownership of the NFTs in the Vault are minted. These tokens can be added to liquidity pools on automated market makers (AMMs) to earn transaction fees.
3. The redemption mechanism for NFTs within each project may vary, but generally involves using the minted tokens to redeem and receive the NFTs in the Vault.

For example, in the case of NFTX, users would need a certain amount of tokens and pay a fee (e.g., 5%) to redeem a random NFT from the Vault.

Please note that the information provided is based on the context given and may not represent the specific mechanisms of all NFT Liquidity Pools platforms.

1.3. What needs do they address in the market?

Everybody can see that both NFT Fractionalization and NFT Liquidity Pools are created with the aim of enhancing the liquidity of NFTs to meet the significant demand for ownership in the market.

This is entirely reasonable as some NFT collectibles currently have very high prices, making it challenging to buy and sell NFT ownership outright.

Average price of an Art and Collectibles NFT Sale — Source: THEBLOCK

The high average prices of NFT Collectibles drive the demand for NFT fractionalization. Some popular NFT collections in the market have average prices ranging from thousands to hundreds of thousands of dollars. In particular, CryptoPunks NFTs have an average price of $300,000 — $400,000.

Additionally, these NFTs have certain characteristics that make them appreciate in value over time, attracting the interest of many investors. Furthermore, due to their low liquidity, the prices of these NFTs are highly volatile. Fractionalizing NFTs into smaller parts can help reduce price volatility.

Based on the operational characteristics of the two aforementioned NFT mechanisms, we can observe the following:

• NFT Fractionalization: It will be used for high-end NFTs, those with high prices in the market, given their fractional nature.
• NFT Liquidity Pools: It will be used for collections where the individual NFTs have lower prices, or for NFT DAO platforms managing NFT portfolios as investment funds.

Overall, both NFT Fractionalization and NFT Liquidity Pools aim to increase liquidity and unlock more utility for NFTs.

In summary, NFT Fractionalization and NFT Liquidity Pools were developed to address the following issues:

• Increase liquidity for NFTs.
• Help stabilize the prices of NFTs with reduced volatility.
• With these impacts, they open up more applications for NFTs in DeFi, such as NFT DAOs or utilizing NFTs as collateral for lending/borrowing.

2.1. Overview of the NFT Collectibles market

Let’s quickly review some notable figures in the NFT Collectibles market. The weekly trading volume of NFTs in the late July to the end of August 2021 period was relatively high, averaging around $200 million to $400 million. The peak reached over $850 million.

Art and Collectibles NFT Trade Volume- Source: THEBLOCK

However, at the current moment, the NFT wave seems to have cooled off, resulting in a significant decrease in trading volume.

Weekly Trade Volume of NFT Collectibles

But NFT Collectibles still have a slight edge over NFT Gaming in terms of trading volume (currently accounting for about 61.28% of the trading volume).

Based on the data above, we can draw some conclusions about the current NFT market:

• The enthusiasm for NFTs has gradually cooled off, but the market capitalization of existing NFTs remains substantial.
• NFT Collectibles still dominate the majority of the trading volume in the market.

⇒ The emergence of NFT Fractionalization & Liquidity Pools platforms will leverage the large market capitalization to boost trading volume in the NFT market.

2.2. Prominent projects in the market

Prominent projects:

• NFT Fractionalization (a mechanism that allows the original NFT to be divided into smaller fungible tokens): Fractional, Niftex.
• NFT Liquidity Pools (where multiple NFTs can be deposited into a Vault to create fungible tokens representing ownership of the NFTs in the Vault): NFT20, NFTX, Unicly.

Among these 5 projects, 3 of them have their own tokens, namely NFTX, NFT20, and Unicly.

2.3. Data statistics of the projects

In terms of market capitalization, generally, these token projects have not reached a significant market capitalization at present.

NFT Fractionalization and NFT Liquidity Pools Marketcap

Specifically, the market capitalization of these tokens ranges from $10M to $50M. Additionally, it can be observed that most tokens are showing a downward or sideways trend. This indicates that this category has not yet attracted significant attention in the market.

Regarding the market capitalization of NFT Sharding (or fragmented NFTs), according to my reference from DappRadar, it currently stands at over $36M.

Fractionalized NFTs

3.1. The paradox of “fractionalizing NFTs”

NFTs (Non-Fungible Tokens) are created with the characteristic of uniqueness to distinguish them from other types of tokens. However, they are now being transformed back into fungible assets, creating a paradox.

If we compare NFTs to a valuable painting by a renowned artist, actions like “fractionalizing” or “shared ownership” would be completely unacceptable to collectors or those who truly understand the significance of the artwork.

This would undermine the original essence of NFTs and result in a significant loss of the market, as many collectors would not be willing to fractionate their high-value NFTs.

3.2. NFT dominance on Ethereum

Furthermore, there is another paradox currently observed in the NFT market, which is that the majority of NFT Collectibles and high-value NFTs are predominantly found on Ethereum — a rather expensive blockchain that is often not accessible to investors with limited capital.

Moreover, the dominance of NFTs on Ethereum, both in Collectibles and Gaming, has led to the realization that the aforementioned projects will largely have to deploy on Ethereum to generate revenue.

The high fees and slow transaction times on Ethereum will restrict the widespread adoption of NFT Fractionalization and NFT Liquidity Pools platforms.

Some potential for further growth in the future includes:

• The current NFT market has a total market cap reaching billions of dollars and is expected to increase in the long term.
• OG NFTs (original NFTs) will become increasingly valuable, coupled with long-term price appreciation and the demand for investing in them as a “Store of Value” asset.
• In addition to Collectibles, NFTs within gaming titles will also witness a demand for fractional ownership, especially for land-based NFTs.
• In the future, NFTs will develop on multiple chains that are faster and more cost-effective. Ethereum may no longer dominate, providing an opportunity for these mechanisms to flourish due to wider user accessibility.

Alongside fractionalization, NFT Liquidity Pools enable the creation of investment funds or community-owned NFT portfolios. This serves as a platform for NFT DAOs (Decentralized Autonomous Organizations) like Yield Guild Game, UJenny DAO, Flamingo DAO, etc., to further develop.

The function of enhancing liquidity for NFTs opens up opportunities for the integration of DeFi (Decentralized Finance) and NFTs in the future.

Overall, the concept of fractionalizing NFTs to increase liquidity in the current context is still relatively new and the growth potential in the future remains uncertain due to existing limitations.

Both NFT Fractionalization and NFT Liquidity Pools have made breakthroughs in making NFTs more flexible and accessible to a wider audience. With continued development and innovative applications, we can expect to see the expansion and growth of both NFT Fractionalization and NFT Liquidity Pools in the future. Will they create a new wave of NFTs in the future? Only time will tell the truth.

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