In a previous blog, we’ve gone over what an NFT is and how they work. So, what’s the difference between an NFT and a fractionalized NFT? Let’s find out.
What is a fractionalized NFT?
A fractionalized NFT, put simply, is a non-fungible token that has been broken down into pieces. These pieces can be individually owned, thereby enabling multiple people to own part of the one NFT.
What are fractionalized NFTs used for?
Right now, part of the reason there is friction between crypto becoming mainstream is the lack of accessibility. Fractionalized NFTs aim to reduce this by increasing the opportunity for more people to participate in the NFT space. As an example, let’s say a Bored Ape is worth 100 ETH. That would be considered a sizeable, and likely unachievable, investment for most people. If that Bored Ape was fractionalized into 1000 pieces however, users could become part-owners for a mere 0.1 ETH. This would allow them to experience the NFT world and all its benefits without the hefty price tag.
In a more ‘real world’ example, there is a lot of discussion about how fractionalized NFTs could contribute to the real estate market. If real estate agreements were replaced by smart contracts executed on the blockchain, then fractionalized NFTs would enable multiple people to buy a single property. In such a competitive market where housing prices are at an all-time high, this makes becoming a part of the real estate industry much more accessible. It would also mean that the owners of these real estate fractionalized NFTs would also reap a portion of the rewards. Let’s say 5 people buy into a property using smart contracts and fractionalized NFTs. They then put that property up for rent. Each NFT holder would then receive a fifth of the rental income each month.
How do fractionalized NFTs work?
Let’s use NFTs on the Ethereum blockchain to outline how fractionalized NFTs work. There are two common token standards on the Ethereum blockchain: ERC20 and ERC721. ERC721s are used to create non-fungible, unique tokens. ERC20s are used to create fungible, interchangeable tokens.
By definition, an ERC721 cannot be replicated as each token is completely unique. In order to fractionalize an NFT, a smart contract can be designed to generate a series of ERC20 tokens which are then linked to the specific ERC721 token. Once this is complete, anyone can become the owner of one (or more) of the associated ERC20 tokens that represent part ownership of the single ERC721 token. Another example is that of the token standard ERC1155. This type of token gives users the ability to to create both fungible or non-fungible tokens within the same standard. Let’s use Cryptopunk#1 as an example, and pretend that it was an ERC-1155 instead of an ERC-721: There will only ever be one non-fungible version of Cryptopunk#1, but ERC-1155s give users the ability to trade fungible copies of the same asset in tandem. The non-fungible version holds higher value, as it is one-of-a-kind, whereas the fungible copies increase accessibility on the user’s side. In this sense, fractionalized ERC1155s are a natural progression within their design.
How are fractionalized NFTs taxed?
Fractionalized NFTs are likely taxed in the same way any other NFT is taxed in your jurisdiction. At a conceptual level, the individual purchasing the fractionalized NFT is doing so by exchanging cryptocurrency for it (which in most cases would be considered a disposal event). If sold, the fractionalized NFT portion is exchanged for cryptocurrency (which in most cases would be considered a taxable event).
As an example, in Australia, buying an NFT with ETH is considered a taxable event. If an individual buys a piece of an NFT for 0.1 ETH, then the disposal of the 0.1 ETH is taxable under the capital gains tax scheme. The cost basis for the piece of the NFT is determined by how much ETH was exchanged in order to obtain ownership of it, in this case, 0.1 ETH. If the piece of the NFT is then sold later down the line for 0.2 ETH, there is a capital gain of 0.1 ETH. This gain would need to be accounted for at tax time.
If you’re unsure about the taxable implications of interacting with a fractionalized NFT, we recommend talking to a local tax professional.
How can Summ help?
The Summ (formerly Crypto Tax Calculator) platform gives you the ability to import data relating to your crypto transactions, including any fractionalized NFTs. Our algorithm will help categorize buys, sells, and cost bases relating to your fractionalized NFTs so that you won’t have to manually track these values. Any gains, losses, and relevant cost bases made in conjunction with your fractionalized NFT ownership will be taken into account when generating your final tax reports for a specific financial year.
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