Resolving Challenges in the NFT Market! What is ERC-404?
ERC-404 was first introduced in February 2024 and is an experimental token standard developed by the Pandora team (please note that as of February 16, 2024, ERC-404 has not been included in the standard Ethereum EIP). It combines the liquidity of ERC-20 tokens with the uniqueness and collectible value of ERC-721 non-fungible tokens (NFTs).
ERC-404 allows NFTs to be divided into smaller parts, which has the potential to address some of the major challenges in the NFT market, such as lack of liquidity and price volatility.
Pandora Project: The First Application of ERC-404
Pandora is the first project to be launched using the ERC-404 standard.
When users purchase PANDORA tokens, the system automatically mints a randomly generated Pandora NFT. Conversely, when PANDORA tokens are sold, the corresponding NFTs are destroyed. This mechanism means that holders of Pandora NFTs can enjoy the liquidity of $17 million in the PANDORA token liquidity pool without worrying about the liquidity of the NFTs.
Pandora NFTs exist in five different rarities, with one rarity being randomly chosen each time they are minted.
However, when users transfer PANDORA tokens from one wallet to another, the NFTs are destroyed and re-randomized. Therefore, the only way to avoid re-randomization while transferring NFTs is to directly buy and sell the NFTs.
The Potential and Risks of the Token Standard
The core technological innovation of ERC-404 lies in allowing fungible tokens (FTs) and non-fungible tokens (NFTs) to coexist within the same framework and achieve seamless conversion between the two.
This new token standard of “combining fungible and non-fungible tokens” can be compared to a loyalty card, where physical goods (NFTs) can be redeemed using points (FTs). This innovation not only expands the possibilities and imagination of digital assets but also combines the liquidity of ERC-20 tokens with the uniqueness and collectible value of ERC-721 tokens.
Thanks to the innovative potential of this token standard, two leading trading platforms, Binance and OKX Web3 Wallet, have already launched markets that support ERC-404 token trading.
In addition to $Pandora, other tokens based on the ERC-404 concept, such as $DEFROGS, $RUG, $ANON, and $CRYSTAL, have also been listed for trading.
However, the ERC-404 standard currently has the following potential risks:
1. Indiscriminate transfer of NFT rarities:
When trading FTs, the corresponding NFTs may be transferred to the buyer without considering their rarity. This could lead to the original holder losing a higher value NFT.
2. FT precision issues leading to accidental burning of NFTs:
Due to FT precision issues, even a slight decrease in the quantity of FTs (e.g., from 3 to 2.9999) could result in the burning of an NFT.
3. Increased gas consumption:
The complex contracts of ERC-404 lead to increased gas consumption. Especially when dealing with FT and NFT transfers and burning mechanisms, more calculations and storage operations are required, which increases transaction costs.
4. Limitations of the whitelist mechanism:
Although the whitelist mechanism allows certain pairs/routers to process FT transactions without frequently dealing with NFTs, it may limit the flexibility and openness of the system. Once revokeOwnership is executed, if the whitelist mechanism is not updated subsequently, the availability and security of the system may be compromised. If revokeOwnership is executed, the subsequent whitelist mechanism will not be updated, which may result in the loss or opacity of contract control and increase the risk of contract management.
Market Reaction to ERC-404
Due to the potential issues with ERC-404, Ethereum developers (code-named “cygaar” and “quit”) quickly introduced DN-404 to address some core issues, especially in terms of efficiency and transaction fees:
1. Improved efficiency and reduced transaction fees:
DN-404 is expected to reduce the impact on transaction fees by 20% through optimizing the structure and operations of smart contracts. This is achieved by splitting the attempt to combine fungible and non-fungible token functionalities into a single contract in ERC-404 into two separate contracts – a “base” contract based on ERC-20 and a “mirror” contract based on ERC-721.
2. Simplified smart contract complexity:
By separating ERC-20 and ERC-721 functionalities into two independent contracts, DN-404 reduces the complexity of smart contracts. This not only makes the contracts easier to understand and audit but also potentially reduces the risk of vulnerabilities introduced by complexity.
3. Compatibility with existing standards:
DN-404’s design allows the “mirror” ERC-721 contract to be treated like any standard ERC-721 token, ensuring compatibility with existing protocols that support ERC-721. This design supports wider ecosystem integration without the need to modify existing infrastructure to accommodate the new token standard.
4. Seamless integration process:
When the underlying ERC-20 tokens are transferred, the corresponding mirror NFTs are automatically minted or destroyed, providing a smooth and seamless user experience while maintaining a close connection between FTs and NFTs.
5. Handling extreme scenarios:
DN-404 aims to address potential issues that ERC-404 may encounter under certain edge conditions, such as the problem of reassembled NFTs possibly being different from their original state. This is achieved through clearer contract logic and operations.
Additionally, SmartLayer proposes further integration of SmartLayer’s TokenScript when trading ERC-404 NFTs, allowing users to independently choose which NFT to burn when prioritizing transactions in wallets. This allows for the retention of high rarity NFTs while refreshing the rarity of NFTs.
Conclusion
ERC-404, similar to the recently hyped Tiny SPL token standard-based NUTS on Solana, breaks the framework of “tokens” and “NFTs”. Although it is still in the experimental stage, they indeed give NFTs native financial attributes and seamlessly integrate them into DeFi protocols, making it easy to achieve financial applications such as lending, collateralization, and leverage.
Projects like Pandora have already demonstrated the practicality and market popularity of this hybrid standard. Whether ERC-404 will ultimately become the mainstream token standard in the Ethereum market or not, it provides an innovative approach that brings more flexibility and possibilities to cryptographic assets.
The viewpoints expressed in this article do not represent the position of “WEB3+”.
Proofreading Editor: Gao Jingyuan