What is ERC-404 and how does it bridge fungible and non-fungible tokens?

Have you heard about ERC-404? It's the latest token standard that could help fuel a comeback for digital collectibles. ERC-404 combines the best attributes from ERC-20 and ERC-720, the fungible and non-fungible token standard on the Ethereum blockchain.

TL;DR

• ERC-404 combines features from both ERC-20 and ERC-721 to introduce an Ethereum token standard. These semi-fungible tokens offer conditional fungibility and increased functionality, making them suitable for various purposes.

• ERC-404 introduces innovative concepts like partial ownership of NFTs and dynamic assets, aiming to increase the liquidity and accessibility of the NFT market through a token mint-and-burn mechanism that allows fractional ownership.

• Despite its promise, ERC-404 is hindered by obstacles such as unverified code, absence of official recognition as an Ethereum standard, and difficulties with integration. This has lead to worries about potential security risks and acceptance by the market.

• Even though it's still experimental, the ERC-404 standard has already garnered significant attention and shown its potential for promoting value and creativity in digital assets through projects such as PANDORA, DeFrogs, and Monkees.

• "ctrl" and "Acme" are collaborating on a proposal for Ethereum Improvement Proposal (EIP) for ERC-404. This involves active development and community deliberation to overcome its drawbacks and establish a reliable and safe structure for semi-fungible tokens.

What is ERC-404?

ERC-404 is an emerging, experimental token standard on the Ethereum blockchain that aims to innovate digital assets. The concept combines the characteristics of ERC-20 (fungible tokens) and ERC-721 (non-fungible tokens).

Combining these two approaches results in the creation of a unique type of token called semi-fungible tokens, which combine the advantages of both methods. Through this fusion, ERC-404 aims to broaden the use and functionality of tokens on the Ethereum platform, providing fresh possibilities for creators, developers, and users.

How ERC-404, ERC-20, and ERC-721 differ

Here's a quick breakdown of how ERC-20, ERC-271, and the token standard that draws from them both — ERC-404 — differ.

ERC-20 (fungible tokens)

• Uniform: Every token has the same value and properties as another.

• Divisible: Can be divided into smaller units.

• Use cases: Ideal for creating cryptocurrencies or utility tokens.

ERC-721 (non-fungible tokens):

• Unique: Each token has distinct characteristics and values.

• Indivisible: Expressed as complete units or possessions.

• Use cases: Ideally suited for showcasing unique items such as art, collectibles, or property.

ERC-404 (semi-fungible tokens):

• Hybrid nature: Combines features of both ERC-20 and ERC-721 tokens.

• Conditional fungibility: Tokens can be either fungible or non-fungible assets, depending on their purpose or when they're used.

• Enhanced utility: Introduces fresh token opportunities, including partial ownership of NFTs or dynamic assets that evolve with time.

If you're having difficulty picturing ERC-404 tokens, here are some examples to help paint a clearer picture.

Think of ERC-404 tokens as tickets to a concert. Before the event, these tickets are interchangeable — one is essentially the same as another. But once you're at the concert, your ticket transforms into a one-of-a-kind keepsake of the experience, similar to an NFT.

Here's another helpful example. When collectible coins are first minted, they're fungible and can be traded based on their face value. However, over time, certain coins become rare or develop historical significance, making them unique and valuable in ways that differ from their original, fungible state.

How does ERC-404 work?

Picture yourself at an art sale where a valuable piece is beyond the budget of one individual. As a solution, the artwork is split into manageable pieces, allowing several individuals to own a piece of the art.

The concept is similar to the functioning of ERC-404 in NFTs. Through the division of NFTs, ERC-404 promotes equal access to valuable digital assets, making them accessible to a wider audience. This strategy enhances the liquidity of the NFT market and reduces the barriers to entry potential investors face.

The mechanics of ERC-404 involve a token mint-and-burn process that allows for the fractional transfer of an NFT's ownership. Here, an ERC-404 token is purchased and a linked NFT is minted in the buyer's wallet.

Meanwhile, disposing of a portion of this token will destroy the associated NFT. A new NFT is generated automatically when a wallet amasses sufficient fractions to form a complete token. This mechanism presents an innovative method of exchanging and interacting with NFTs, enhancing the market's liveliness and inclusivity.

Though ERC-404's approach is groundbreaking, it also adds complexity and possible security issues, as with any new technology. The current standard is still being developed and needs to be thoroughly audited, leading to concerns about potential weaknesses, particularly in the burning and minting mechanisms of linked NFTs.

Despite these challenges, major exchanges have supported ERC-404, indicating a significant interest in its potential to give NFTs a new lease on life. Is ERC-404 the missing piece NFTs need to progress further in the Web3 space?

Who are the creators of ERC-404?

"ctrl" and "Acme" are the brains behind ERC-404. Within the blockchain community, pseudonymity isn't uncommon, and these two devs have fully embraced anonymity. Their involvement in the progress of ERC-404 is a testament to their knowledge and commitment towards improving the blockchain space.

Motivation and vision

The origin of ERC-404 can be identified as the joint goal of "ctrl" and "Acme" to tackle the increasing demand for uniform communication methods in the Ethereum community.

Motivated to streamline interactions between decentralized applications (DApps) and enhance interoperability, they developed a system to make sharing data between various platforms easier.

The ambition behind ERC-404 for "ctrl" and "Acme" goes beyond simply advancing technology. It strives to create a more inclusive and effective decentralized ecosystem. Their goal is to give developers and users the ability to discover innovative ideas and unleash the maximum capabilities of blockchain technology.

What projects are using ERC-404?

Over the last few weeks, new projects have emerged using ERC-404, with PANDORA kicking things off.

• Pandora (PANDORA): Led the implementation of ERC-404. On February 2, 2024, PANDORA experienced a significant rise in value, going from under $5,000 to over $23,000, representing a 400% growth. Its market cap reached almost $200 million, and its liquidity surpassed $36 million.

• DeFrogs (DEFROGS): This rival to Pandora, comprised of 10,000 frog PFPs using ERC-404, experienced a price hike of over 2,000% in just three days, reaching $2,800 per token and a market cap of $27.6 million.

• Monkees (MONKEES): MONKEES is another PFP project. Since its debut, the value has increased by over 2,000%, reaching $17,000 per token, with a market cap of $1.8 million and liquidity at $256,000.

• Punks404 (PUNK) and EtherRock404 (ROCK): Two other initiatives using ERC-404, PUNK has a smaller market cap of $760,000, whereas ROCK has achieved greater success with a market cap of $4.4 million.

What are the risks and limitations of ERC-404?

Although ERC-404 presents exciting opportunities for owning and trading digital assets, it also has limitations.

Unaudited code

One of the primary concerns with ERC-404 is that it's currently unaudited. This means the code has yet to undergo a rigorous review by security experts to identify potential vulnerabilities or flaws. Engaging with projects based on unaudited code inherently risks exposing assets to unforeseen security breaches or bugs.

Lack of official recognition

ERC-404 isn't an officially recognized token standard in Ethereum. This puts assets at risk as the standard hasn't gone through the rigorous vetting process of the Ethereum Improvement Proposal. This process provides community discussion and scrutiny for security, utility, and compatibility.

Experimental nature

The experimental label of ERC-404 itself is a risk. This status implies that the standard is still in a developmental phase and may undergo significant changes. Projects adopting ERC-404 might face challenges adapting to these changes, leading to instability or compatibility issues.

Potential for exploitation

A specific concern raised is the potential vulnerability of NFTs that use the ERC-404 standard to theft if placed into lending protocols not properly adapted for its unique requirements. This highlights a broader risk of integrating experimental standards into the wider ecosystem without fully understanding their implications or making sure of compatibility with existing protocols.

Integration challenges

Integrating both fungible and non-fungible token features in ERC-404 may bring difficulties to existing platforms and protocols built around well-established standards. These obstacles could restrict the usage and effectiveness of projects using ERC-404.

Market acceptance

Acceptance and adoption are crucial factors for any new token standard's success. However, the experimental nature of ERC-404 and potential security risks may impede its acceptance by users and developers, thus limiting its growth and potential impact.

What's next for ERC-404?

"ctrl" and "Acme" are collaborating to propose an EIP that will help to firmly establish this standard. Despite having not undergone an official audit and receiving total recognition, the ERC-404 initiative is committed to guaranteeing the strength of the proposal and addressing the challenges of incorporating these token standards.

The objective is to provide a smooth and safe structure for producing semi-fungible tokens, which may incorporate functionalities such as inherent fractionalization and liquidity.

Like most new token standards, the community's reception of ERC-404 has been mixed, with significant interest from developers and platforms alongside cautious scrutiny regarding its security and implementation challenges. There's been much discussion about the security consequences of incorporating this new standard, specifically about the possibility of weaknesses in NFT transactions within lending protocols that aren't properly set up for ERC-404.

Despite its early challenges, the ERC-404 standard is a unique effort to introduce new ideas into the Ethereum blockchain. By allowing partial ownership of NFTs and merging the advantages of other token standards, ERC-404 could create opportunities for managing and using digital assets in novel ways.

A new token type called 'DN-404' has been created by Ethereum developers to address the negative impact of ERC-404 tokens. ERC-404 tokens, while gaining popularity, brought higher transaction fees and caused network congestion on the Ethereum platform.

DN-404 solves these problems by implementing a more streamlined two-contract approach, eliminating the high gas fees commonly seen with ERC-404. Also using the well-established ERC-20 and ERC-721 protocols, DN-404 guarantees seamless integration and operation for both interchangeable and unique tokens, providing a practical and effective substitute for ERC-404 tokens.

As the team behind ERC-404 continues to refine the standard and navigate the EIP submission process, the broader Ethereum community's input and adaptation will be crucial.

The implementation of ERC-404 has the potential to open up opportunities for tokens on the Ethereum blockchain, allowing for greater adaptability and creativity. This could significantly impact various industries, including digital art, collectibles, and even real estate.

The final word

ERC-404 combines the strengths of ERC-20 and ERC-721 standards on Ethereum to introduce semi-fungible tokens to the market. The standard has the potential to greatly impact the ownership and market liquidity of digital collectibles. Despite its innovative approach, ERC-404 faces challenges like unverified code and integration hurdles, raising questions about security and market acceptance.

With successful projects including PANDORA and DeFrogs already launched, and progress towards being officially recognized through an Ethereum Improvement Proposal also underway, ERC-404 can significantly impact the blockchain ecosystem. Will ERC-404's semi-fungible tokens unlock new possibilities for digital assets, or are the hurdles too great to overcome?