Fractionalization has become increasingly popular in the investment world, but does it really provide a solution to liquidity for high-value assets? 

In this piece, we delve into the concept of fractionalization, and its practical applications, and explore whether it truly enhances liquidity or if there are any underlying challenges that investors need to be aware of. Lastly, we explain the difference between fractionalization and securitization. 

What’s Fractionalization 

Fractionalization is a process of dividing high-value assets into smaller pieces, making them more affordable for a larger pool of investors. 

During the fractionalization process, the ownership of an asset is divided into tokens, with each representing a fraction of the underlying asset. These tokens or fractionalized shares can be bought and sold on various platforms, enabling investors to trade their fractional ownership stakes like traditional securities.

This approach has become increasingly popular in recent years, especially in alternative investments such as real estate, artwork, and music royalties. The primary objective of fractionalization is to democratize access to previously exclusive assets and provide investors with the opportunity to diversify their portfolios. 

Examples 

JKBK

JKBK is a company that allows people to buy partial ownership of a song. The securities are sold on a song basis, and the holders can receive the royalties and other revenues generated from the underlying song.

Realt

Realt is a real asset fractionalized platform in the US. Investors can purchase fractionalized real estate with rent paid out in a stablecoin on the Gnosis Chain in a given interval. Additionally, holders of the real estate tokens can use them on DeFi. 

Masterworks

Masterworks enables users to purchase a part of an art with their USD. Here is their explanation of how their platform works:

Fractionalization != Better Liquidity

Although fractionalization is often praised for enhancing liquidity, it’s not guaranteed. Here are some reasons:

• Uncertainties: The complexities in fractionalized assets' ownership and legal frameworks can turn off potential investors, diminishing market participation and liquidity.
• Illiquid in Nature: Some assets, like unique real estate or art pieces, are inherently niche, posing challenges in attracting two sides of the market. Moreover, the low trading volumes for these assets can’t justify employing market makers to facilitate trades, further deteriorating liquidity.

For example, StockX, once known for fractionalizing rare sneakers’ ownership, has pivoted away from that direction. The once $3.8 billion company is now a resale site for rare items like trading cards, sneakers, and handbags. The reason for the detour might be somewhere between the listed reasons above.

Difference Between Securitization and Fractionalization

In finance, there is a similar term called “securitization, “ but with a subtle difference. 

Securitization is a process of pooling various types of debt or other financial assets and transferring them to a consolidated company, where its stocks/equities can be sold to investors. The underlying assets are often illiquid but become liquid as part of a security. This consolidated company is known as a “special purpose vehicle” or “SPV.” 

Credit rating agencies often rate these securities, making it easier for potential investors to assess risks.

In other words, “securitization” is about pooling and transferring similar (and multiple) finance assets to an SPV and then selling the company’s shares to potential investors. Meanwhile, “fractionalization” divides an asset's ownership into tokens and then sells the tokens to potential investors.