What Is ERC-404 Token Standard?
ERC-404 is a newly invented token standard by the developers known as ctrl and Acme from Pandora Labs. In simple terms, it is a combination of ERC20s and ERC721s.
But what problem does ERC404 solve?
The main goal is to make NFTs liquid to be traded and used as collateral or liquidity for DeFi protocols. Moreover, they present a concept of fractionalized ownership, when several users may have a part of one NFT, making previously inaccessible tokens to be attained by a larger number of users.
Thus, they take the ability to be fractioned as well as ERC-20 tokens and be unique as well as ERC721 tokens. Therefore, with ERC-404 tokens, investors and DeFi enthusiasts meet fewer difficulties when purchasing, selling, or trading ERC721s. But let’s look at how it looks from the technical side.
Technical Overview
It’s quite simple and can be easily explained with a diagram:
During every transfer, the ERC-404 contract checks if the number of tokens the user has is whole or with decimals.
In simple terms, if a user has a whole number (1, 2, 3, etc.), they get an entire NFT, but if there are decimals, they get a fraction of that ERC-721 in fungible tokens.
For example, if a user wants to get <code-word>69.420<code-word> ERC-404 tokens, they’ll get <code-word>69<code-word> ERC721 and <code-word>42<code-word> ERC20 tokens.
This is what we see when looking at the <code-word>_transfer()<code-word> function in ERC-404 smart contract.
It is important to note here that the ERC-404 contract doesn’t inherit from ERC-20 or ERC-721, it is a newly built smart contract implementing functions and mechanics of its ancestors.
We have to remember that ERC-404 tokens are still experimental, unaudited and don’t have any Ethereum Improvement Proposal (EIP). Therefore, at the moment of writing, they cannot be accurately recognised by all of the protocols, which involves several security flaws described later in this article. Also, they don’t have token IDs as well as ERC20 tokens, unlike ERC721 tokens.
Use cases
The first ERC-404 tokens were released this year, but there are already <code-word>20+<code-word> of them with a <code-word>300m+<code-word> market cap in total as of March 2024. Let’s take a look at how we can use them.
Real World Assets (RWAs)
First and foremost, it facilitates trading and purchasing RWAs, for example, houses, luxury products, etc. With ERC-404 tokens users may own fractions of expensive & illiquid tokens, which makes them easier to trade and use to earn more yield.
Defi
The main reason is that NFTs will become more liquid and can be used as collateral for lending & borrowing or liquidity for protocols. It opens up a large number of new opportunities to invest in dApps.
Gaming
Since in-game assets will be fractionalized, developers will have more freedom in setting up gameplay mechanics and economies. As for users, it’ll be easier for them to purchase and trade in-game assets.
Real Examples
The three most famous ERC404 collections now are Pandora, DeFrogs and Monkees. Let’s take a closer look at Pandora — it was the very first ERC404 token which has <code-word>10,000<code-word> NFTs linking to other <code-word>10,000<code-word> ERC20s. For minting 1 PANDORA users receive <code-word>1<code-word> NFT.
But there’s a set threshold of how many tokens each user has. If they have more, they get a newly minted NFT, and if they don’t, the NFT is burnt. Therefore, such constant minting and burning of tokens refreshes the value and rarity of each non-fungible token.
Earlier in the article we showed a snippet from the ERC-404 contract which is specifically used for PANDORA, and you can see that there’s a specific accounting to check if the user’s NFT should be minter or burnt.
Security Considerations
As we’ve already said it’s still an experimental standard and not fully compatible with protocols, therefore, we can highlight two main flaws here:
1. Most of the developers are not aware of how ERC-404 and there’s no EIP standard. Therefore, the near future ERC-404 may have major differences in their mechanics.
2. Protocols cannot work 100% accurately with such tokens, thus allowing a wide range of attacks connected to arbitrary external calls or simply incorrect interactions will lead to users losing funds.
Conclusion
ERC404 tokens may become a breakthrough in Web3 by combining the two major ERC standards by taking the best traits of each one opening new horizons for developers and users to make DeFi better and more user-friendly
But, we have to remember that of now it’s an experimental standard that, first, doesn’t have any EIP and, second, is not fully compatible with protocols. Therefore, users may get unexpected losses and errors while interacting with such tokens and malicious actors have more opportunities for attacks.
