The Decentralized Fractionalization
Introducing Nftfy
Securitization is probably the biggest concern for regulators in the aspect of cryptocurrency. In the centralized context, it is an extremely bureaucratic and expensive process, which leads to a massive restriction of users.
This process requires considerable compliance and auditory regulated by a government or an agency to guarantee the backing of value for all the concerned participants — and, consequently, ensuring the value of the shares created. All these intermediaries and regulators result in a more expensive process, making it limited, little-explored, time-consuming, and, thereby, being useful only for big players.
Given the context of the Exponential Framework and DeFi, this article contains a brief introduction to a project responsible for reverting a highly complex situation in the centralized world — and still not well sorted-out in the decentralized world — being transformed into one of the simplest applications of DeFi, and democratizing the access to securitization.
Nftfy — NFT Fractionalizer
Nftfy is a Decentralized Application (DApp) that fractionalizes Non-Fungible Tokens (NFTs), generating Fractions ERC20 compliant fully backed by the NFTs. Nftfy is an Ethereum-based and open source platform that runs autonomously without vulnerabilities to censorship. It is an easy and fast way to fractionalize a Non-Fungible Asset, allowing anyone to trade Fractions of it.
Just as previously described, securitization in the physical world is a highly regulated process with numerous intermediaries responsible for ensuring that the shares represent the value of the asset. Therefore, the decentralized fractionalization process must also guarantee the backing of thefractions and the user’s rights.
In Nftfy, the backing mechanism is entirely decentralized and software-guaranteed, without the necessity of any intermediary such as regulators, auditors, or compliance. Employing the methodology Lex Cryptographia, Nftfy brings legal contractual elements and adapts them into code through Smart Contracts, making them inviolable and robust, and guaranteeing all the user’s rights in a highly simplified way. The contracts are self-executing, and they create a logical interpretation of the inputs possibilities by the user and control the respective outputs, without censorship or exclusive agents.
Specifically, in the securitization process, which divides the right of property of an asset among numerous other parties, is necessary to establish rules that will manage the shareholders’ individual interests and that embrace all the possibilities. These rules are described in a contract commonly known as Shareholders’ Agreement, and it has clauses that approach many possible scenarios. But how to bring this concept to DeFi? How to guarantee a smooth, immediate, and perfect process that guarantees all the participants’ rights? Moreover, how to make these concepts to be applied directly through smart contracts?
By solving these issues, Nftfy Protocol proposes a Minimum Viable Fractionalization (MVF), that will be explored as follows.
Shareholders’ Agreement
A Shareholder’s Agreement is composed of the following clauses:
As a major component in the Shareholders’ Agreement, a set of exit rules are defined. Referred to as <Exit Mechanism>, they conduct the way parts in disagreement — by protecting their individual interests — should organize to reverse the fractionalization process and collective ownership to the uniqueness of the asset. It is directly within these rules that the Nftfy Protocol works, and this is going to be discussed in more detail later in this text.
Clauses of <Governance> are also previously defined in a Shareholders’ Agreement and they determine that the whole decision-making process is going to be made through voting. They define how the voting power is measured, whether it will have arbitrary decisions, for which competences the Shareholders have decision-making power, and who has the control power that allows direct actions in the asset. There is a vast number of these clauses implemented in DAOs and in platforms that provide decentralized governance, just like DAO Stack, Snapshot, and Aragon.
<Vesting> rules are also covered in the Shareholders’ Agreement. They are commonly seen in startups by offering participation in the company’s shares for a determined time to employees with great importance, whose activities have a direct impact on the growth of the company. These vesting rules are present in the DeFi scenario as well, and they have two main functions:
- to decentralize governance through token distribution and eventual dilution of participation over time; and
- to attract users and liquidity by rewarding participants in the protocol.
Indeed, Nftfy will use these concepts in its Tokenomics, but it isn’t our main proposal in this article. A popular Vesting protocol is available in the repository of Open Zeppelin, and it is used by numerous other DeFi projects.
It is also in the Shareholders’ Agreement that <Dividends> distribution rules are defined. As well as it is important for a company to obtain profits and have enough capital to develop itself over time, dividend distribution is an essential mechanism to attract investors, making fractions attractive when compared in a basket of diverse assets. In DeFi, this distribution is directly related to users’ specific activities and respective profits. The distribution of dividends isn’t related to the core development of the Nftfy protocol either.
Therefore, as the competences of a Shareholders’ Agreement are defined, and given the main activity related to the fractionalization process that the Nftfy Protocol proposes to solve, we will expand the analysis of the Exit Mechanism to arrive at the expected Minimum Viable Fractionalization.
In order to protect Shareholders and their interests, this mechanism consists of four main clauses:
1. Exit Price:
It is a basis for measuring the total value of the asset. This concept is going to be explained in more detail in the next section of this article.
2. Drag-along:
It is a clause that protects the shareholder, usually the majority, who has an interest in taking the total ownership of the securitized asset. This clause, therefore, ensures that no one can prevent or delay the process from happening. Suppose a buyer wants to buy 100% of the shares. In that case, the minority shareholder will not be able to interrupt or hinder the trade and will be obliged to sell their shares under the same conditions as the majority shareholders.
3. Tag-along:
Usually, minority shareholders relate their corporate interest to that of a principal-agent, and if this major shareholder is willing to sell the holdings, the minority shareholders have the right to sell their respective interests under the same conditions as that one. This concept of Tag-along does not apply in situations of public offering, nor when shareholders aren’t known, due to the nature of the ERC20 standard, and the anonymity expected for the Nftfy fractionalization protocol. Something also commonly seen in the DeFi protocols is the temporary blocking of tokens from the project’s development team, which in a way guarantees the team’s commitment to execute the proposed roadmap, giving security to investors, and preventing an uncontrolled issuance of tokens. In that way, it enables the predictability of token offerings and facilitates risk analysis for investors.
4. Right of First Refusal:
Shareholders who request this right receive the purchase prerogative after the first proposal is offered by another participant. The application of this clause creates delays and uncertainties, so it will not be approached in the MVS.
Once again, the Nftfy protocol will use some of these procedures, but will not apply all of them to its core software, because some of them are not an indispensable clause for an MVS. In the figure below, you can see how the Shareholders’ Agreement is structured.
Therefore, once the concepts are explained, we separate those that are essential to consolidate the MVS process are separated as follows:
To ensure that the MVS operates in an autonomous, fluid and immediate way without depending on the manifestation of those involved, it is necessary to simply apply an Exit Mechanism with a Drag-along that prevents any flow blocking, and a basic algorithm that determines an asset value — Exit Price.
This Exit Price can be as simple as a constant that we will call Exit Price Fixed, and it was the basis applied for the MVS.
Expanding the analysis of Exit Price
The Exit Price can also be composed of algorithms with internal or external variables provided by oracles — and it will be the subject of future implementations. Some examples of rules that could be implemented are:
* Exit Price Algorithmic with internal variables
Algorithms can be developed to increase a fixed interest rate over time, or based on the number of wallets that hold the token, or simple mathematical calculations.
* Exit Price Algorithmic with Oracles
Algorithms can be developed to define the price of the asset over time, based on variables such as interest rates, stock exchange performance, and price variation of currencies or cryptocurrencies. This implementation is fundamental to anyone that needs external information preferably provided by decentralized Oracles such as Chainlink and Band Protocol.
A very important detail is that, whether the algorithm used to define the Exit Price is fixed or based on internal or external variables, the fractions’ price is not linked to this set value, because it varies in a way totally based on supply and demand rules of the free market. Therefore, the efficiency of the fractionalization process is not affected by acting in its simplest form with the Exit Price Fixed. Moreover, it isn’t necessary to improve the protocol for these more complex algorithms, and they will evolve naturally along with the entire DeFi ecosystem development.
But how to apply these legal contract rules in code? How does MVS apply? What are the user flows and how to use the platform?
In the next article, we will highlight the operation of the Nftfy Fractionalization Protocol, explaining in detail how to access the platform and how to easily securitize your first NFT. If you have any questions or want to share your opinion with us, feel free to join our Discord group. Your comments will be always appreciated!
Know more on nftfy.org.
