Paradigm's new research: How to solve the fragmentation reorganization and liquidity issues of NFTs?

Authors: Paradigm Research Partners Dave White, Dan Robinson, Fractional Protocol Founder andy8052
Compiled by: Overnight Congee, Babit
Summary: In this article, the authors describe an NFT fragmentation scheme called "RICKS," which addresses the reassembly problem, ensuring that RICKS can always be converted back to its underlying NFT while avoiding liquidity and coordination issues associated with all-or-nothing buyout auctions.
1. Introduction
This article introduces a new NFT fragmentation primitive: RICKS (short for Recurrently Issued Collectively Kept Shards).
When you split an NFT into RICKS, the protocol mints new shards at a constant rate (e.g., 1% per day or 5% per month) and sells them. The proceeds are distributed as staking rewards to existing RICKS holders.
This design addresses the reassembly problem, ensuring that RICKS can always be converted back to its underlying NFT while avoiding liquidity and coordination issues associated with all-or-nothing buyout auctions.
2. Today's NFT Fragmentation
2.1 Reassembly Problem
Fragmenting NFTs is challenging because it faces an all-or-nothing problem.
If you want to sell 25% of 8 cookies, you can sell 2 cookies, and if you want to sell 25% of a business, you can sell the rights to 25% of its future cash flows. In either case, the remaining 75% is still useful to you.
On the other hand, owning 75% of an in-game asset may not allow you to use a portion of that asset in a given game. If you sell 25% of such an asset to a buyer, and they refuse to sell it back, or even lose their private key, you are in trouble. Because NFTs cannot be reassembled, even if you nominally own 99.99% of the ownership, that ownership may become worthless.
Therefore, fragmentation protocols must provide some method to reassemble NFT shards back into the original NFT, which we refer to as the reassembly problem.
2.2 Buyout Problem
The most popular solution to date has been pioneered by fractional.art, which is the buyout auction mechanism.
Situation: Alice uses a fragmentation protocol with a buyout auction mechanism to sell 25% of her NFT to Bob.
Buyout auction: A third party, Clara, can trigger a buyout auction for the fragmented NFT at any time: the highest bidder (possibly Clara) will receive the entire NFT, and the sale proceeds will be distributed to Alice and Bob in a 75/25 ratio.
2.3 Purpose of Buyout Auctions
The existence of buyout auctions is to ensure that the fragments of Alice and Bob maintain their fair market value by addressing the reassembly problem.
To understand why, suppose Alice uses a protocol that does not provide buyout auctions to split her NFT (representing in-game assets) into 100 shards; in this case, only the person who owns all 100 shards can reconstruct the NFT.
If someone accidentally destroys or loses one of these 100 shards, then no one can reconstruct the NFT, and the remaining shards will lose all value. Due to this risk, even at the time of fragmentation, the value of each of the 100 shards is far below 1/100 of the original NFT's value.
However, with buyout auctions, losing one shard no longer destroys the value of the other shards. For example, if Alice loses one of her shards immediately after minting, she can initiate a buyout auction and submit a winning bid to reclaim the NFT, with 99% of the proceeds going to her.
In this sense, buyout auctions are more of a necessary evil than a feature. They are certainly not in the interest of potential interested buyers like Clara, who are not stakeholders in the fragmented NFT from the outset, and thus do not warrant special consideration by the protocol.
2.4 Accidental Buyout
Unfortunately, buyouts may encounter issues due to funding constraints: if the NFT is valuable enough, once the auction begins, no one may be able to raise enough money to pay a fair price.
For example, consider the following situation:
Alice has an NFT worth 1,000 ETH, and she uses a fragmentation protocol with a buyout auction mechanism to split it and sell 50% of the shards to Bob. Subsequently, market conditions suddenly change, and the fair value of this NFT jumps to 100,000 ETH, which is the value it could achieve under optimal selling conditions (e.g., at a Christie's auction).
Capital constraints: Finding a buyer willing to purchase the NFT at full valuation within a short time frame may be unrealistic. Perhaps this NFT could only fetch a maximum of 10,000 ETH in an on-chain auction within a week.
Fragment holder disagreement: Since 10,000 ETH is far below the fair value of this NFT, Alice would strongly oppose selling at that price. On the other hand, Bob does not have a strong feeling about the fair value and is willing to sell the NFT at a lower price, as it is still ten times his original purchase price, allowing him to buy other NFTs he prefers.
Collector opportunity: A savvy collector, Clara, discovers this opportunity and initiates a buyout auction at 10,000 ETH. No one, including Alice, can outbid Clara's offer in a short time, so she wins ownership of the NFT and later sells it at Christie's for 100,000 ETH.
2.5 Reserve Price
To avoid this situation, fractional.art includes a reserve price in its buyout auction mechanism, which specifies the minimum price at which a buyout auction can be initiated. In the example above, if the reserve price is set at 100,000 ETH, Clara cannot initiate an auction at 10,000 ETH.
However, problems arise when users attempt to set a reserve price. In the above example, Alice does not want to sell the NFT for far below its fair value of 100,000 ETH, but Bob does not mind. Reaching an agreement here can be very difficult and contentious, especially when the parties involved may change as the shards change hands.
In practice, setting a reserve price requires active participation from shard owners. Therefore, due to the attention demands of participants, they are not frequently updated. No one has yet found a reserve price mechanism that effectively addresses the issue of accidental buyouts.
3. Real Case Study: Zombie Punk Buyout

The Party of the Living Dead is a group of NFT enthusiasts who banded together to bid on a rare Zombie CryptoPunk, which they purchased for 1,200 ETH. They then fragmented it on fractional.art and distributed the shards to contributors based on their contributions.

In the initial fragmentation process, 5 whale addresses collectively owned 56% of the shards of this NFT, while the remaining shards were distributed among 451 other participants.

3.1 Buyout

The shards of this Zombie Punk were subsequently traded on Uniswap, and an anonymous collector realized that the price of these shards was undervalued compared to other Zombie Punks. This collector purchased enough shards to increase their personal reserve price voting power, then lowered the buyout reserve price and initiated a buyout auction.

This buyout auction started at 1,100 ETH (below the Party of the Living Dead's acquisition price) and ultimately closed at 1,900 ETH.

Note: If you contributed to this PartyBid, please ensure you collect your dead token here so you can claim your final buyout price portion.

3.2 Unhappy Shard Holders

Many non-whale shard holders were dissatisfied with this buyout auction, believing the acquisition price was too low.

Unfortunately, they found themselves essentially powerless. Individually, none of them could obtain enough liquidity to outbid and directly purchase the NFT. Even if they wanted to band together to purchase the NFT as a single bidder, the coordination costs and limited available time made this path unfeasible.

4. RICKS

4.1 Overview

RICKS addresses the reassembly problem while avoiding the liquidity and coordination issues of complete buyouts.

The protocol is not an all-or-nothing buyout auction mechanism but instead issues new RICKS for a given NFT at a constant rate (e.g., 1% per day or 5% per month), which are sold in auctions for ETH, with proceeds provided as staking rewards to existing RICKS holders.

As we will explain below, buyers who wish to increase their ownership and have limited liquidity can always trigger an auction for less than a full day's worth of newly issued RICKS.

This means that ownership of the NFT gradually flows to those willing to pay the most for it, while existing owners benefit from this process.

RICKS allows motivated buyers to gradually acquire the vast majority of ownership of the NFT over time. We solve the reassembly problem by adding a mechanism to complete ownership with an extreme majority owner and reassemble the NFT.

For example:

When Alice's NFT is worth 1,000 ETH, she sells 50% of its shards to Bob using the RICKS mechanism. Now, market conditions have changed, and the fair value of the NFT at optimal execution is 100,000 ETH. However, no one can provide that much liquidity in a short time.

Fragment holder disagreement: A third party, Clara, wants to buy the entire NFT for 10,000 ETH. Bob is satisfied with this offer, but Alice does not agree; she does not want to sell the NFT for less than its fair value. At this point, Alice and Bob each have 50 RICKS (a total of 100), and the issuance rate is 1%.

Collector opportunity: Clara participates in the daily auction and bids 10,000 ETH for 1% of this NFT, making the total value of one RICKS 100 ETH.

Protecting fair price: Alice realizes this bid is too low and bids 90,000 ETH, or 900 ETH to purchase one RICKS. Since she owns half of the existing RICKS and will receive half of the auction proceeds, she only needs to provide 450 ETH to fund her bid.

4.2 Potential Outcomes

After this, the following two outcomes may occur:

1. If Clara's bid does not exceed Alice's, Alice will win the auction. She will pay Bob 450 ETH and receive an additional RICKS, so she now owns 51/101 RICKS, or 50.5% of the supply. Alice and Bob trade with each other at prices they both find favorable.

2. If Clara's bid is higher than Alice's, say at the fair price of 1,000 ETH, then Alice and Bob will each receive 500 ETH, and Clara will receive one RICKS, so she now owns 1/101 of the shards, or slightly less than 1%. Similarly, Alice, Bob, and Clara all trade at prices they are satisfied with.

In either case, if this activity continues over time, it will attract attention and buyer liquidity, increasing the likelihood that all parties involved can trade at fair prices.

4.3 Completing the Buyout

Suppose Clara's goal is to own this NFT and repeatedly bids RICKS at a valuation of 100,000 ETH, a price that others cannot match. Eventually, she owns 99% of the RICKS (perhaps after winning the auction 458 days later), and now she wants to claim this NFT, for which an additional mechanism will be required in the protocol.

One method is to acknowledge that RICKS has some inherent flaws and use a lottery mechanism. For example, if a holder controls 99% of the NFT shards, they might trigger a coin toss program: if the coin lands heads up, they receive the entire NFT (thus gaining the extra 1%), and if it lands tails up, the positions of all other owners will double (thus this holder will lose 1%). From an expected value perspective, this program is entirely fair.

To avoid strange situations near the 99% boundary, we can allow major shard holders to trigger the coin toss program at 98%, 90%, or even 75%, but note that the further away from the 99% threshold, the lower their probability of winning the remaining shards.

4.4 Auction Details

If fragmented NFTs become expensive enough, bidding even 1% may be prohibitively expensive for most people. Additionally, on certain days, there may be no interest in the auction, making it a waste to hold one.

Therefore, the RICKS protocol can implement an on-demand auction system instead of holding daily auctions: if t days have passed since the last auction, and the issuance rate is r/day, then the protocol will auction:

shards. We take the minimum of the elapsed time and 1 day to avoid issuing too many RICKS at once.

For example, if the issuance rate is 1% per day, so r=1.01, and half a day has passed since the last auction when triggering a new auction, then the protocol will issue and sell:

new RICKS supply.

5. Additional Features

5.1 Arbitrage

Just like current fragmented NFTs, we want RICKS to be tradable on AMM DEXs like Uniswap. This provides a convenient arbitrage mechanism to ensure that RICKS auctions do not close at too low a price: if the closing price of the auction is significantly lower than the RICKS price on Uniswap, arbitrageurs can profit by buying RICKS in the auction and immediately selling them on Uniswap.

5.2 Auction Reserve Price

We can consider pushing this logic further and specifying that RICKS auction bids must be at least 5% or 10% higher than the Uniswap TWAP price.

Because a sufficiently aggressive buyer can still accumulate ownership of the NFT over a long enough time frame, the reassembly problem will still be resolved. Moreover, since the auctions will trade at prices above Uniswap, they may exert minimal selling pressure.

On the other hand, this modification would reduce the consistency of staking rewards for RICKS holders. It also makes reassembly more difficult and complicates the ability to assess its impact on the market a priori.

5.3 Fragmentation Release

RICKS provides a natural mechanism to initiate new partial shards of the NFT, allowing NFT owners to simply use RICKS for fragmentation without having to provide shards on Uniswap and choose a price, starting as 100% owners and letting automatic auctions handle the rest.

5.4 Claiming Auction Proceeds

RICKS holders need to stake their RICKS to receive auction proceeds.

However, this poses challenges for composability. In particular, it is always impossible to determine how much RICKS each concentrated liquidity position on Uniswap V3 holds, meaning that auction proceeds cannot be directly provided to Uniswap V3 liquidity providers.

Instead, the RICKS protocol will track the total RICKS held by all Uniswap V3 LPs and use all of these auction proceeds for liquidity mining rewards in Uniswap V3 pools, as described in this article. In this way, it incentivizes market participants to provide liquidity to the funding pool as efficiently as possible.

There are other potential solutions to this problem, including (1) creating a wrapped RICKS token that includes RICKS and ETH auction proceeds; (2) redirecting auction proceeds to RICKS buybacks, but both have significant drawbacks.

6. Next Steps

We hope RICKS can make NFT fragmentation more interesting and useful.

They also open up a whole new design space; for example, we could allow RICKS stakers to automatically use their rewards to bid in future auctions. RICKS could also be pooled together to form on-chain "committees" composed of RICKS with similar attributes, such as Zombie Punks or Wizard Hat and Scarf Ocelots.