Writing: NFTScan

At the beginning of last month, ERC-404 became the most important hot topic. ERC-404 is an experimental token standard open-sourced by the Pandora team in early February for creators and developers. It is a hybrid of ERC-20/ERC-721, with native liquidity and fragmentation. With the early development, more and more participants have begun to pay attention to this new protocol standard, ERC-404.

I. What is ERC-404?

ERC-404 is a protocol standard that combines ERC-20 (fungible tokens) and ERC-721 (non-fungible tokens NFT), allowing NFTs and tokens to be interchangeable, with native liquidity and fragmentation.

In simpler terms, this protocol allows NFTs to be traded like tokens, similar to splitting an image into multiple parts, allowing multiple people to collectively own a part of the image. Some blue-chip NFT projects, such as BAYC and PudgyPenguins, have prices that are so high that ordinary retail investors are deterred, especially those with rare attributes, making them illiquid and difficult to trade. The introduction of ERC-404 is a significant improvement for these originally illiquid NFT projects. These high-priced NFTs can be traded in a fragmented manner on mainstream trading platforms, making it as convenient and fast as buying token assets such as BTC and ETH.

II. What is PANDORA?

Pandora is the first project built based on the ERC-404 token standard, providing a unique way of trading. In this project, every purchase of a PANDORA token results in the minting of an NFT, which automatically appears in your wallet. Conversely, when you sell PANDORA tokens, the corresponding NFT is destroyed. The same NFT destruction and minting process occurs when tokens are transferred. However, transferring NFTs does not change their ownership.

This means that you can choose to sell your NFT to some liquidity pools without having to wait as you would on traditional NFT trading platforms. This new trading method provides holders with more flexibility and convenience, while also bringing more liquidity and vitality to the NFT market. In this way, the Pandora project has brought new possibilities to NFT trading, promoting the development and maturity of the NFT market.

The leading project Pandora based on the ERC-404 protocol standard:

https://eth.nftscan.com/0x9e9fbde7c7a83c43913bddc8779158f1368f0413

III. Innovations Brought by ERC-404

• One of the innovations of ERC-404 is its ability to act as a replaceable fungible token under certain conditions, while in other situations, it behaves as a non-replaceable non-fungible token (NFT). This flexibility allows ERC-404 to have a wider range of possibilities in the Web3 field, meeting users' needs for high liquidity trading scenarios as well as personalized and unique asset management scenarios, providing more choices.
• ERC-404 expands the application scenarios of tokens, bringing more possibilities for users. For example, it allows tokens to represent partial ownership of assets. In NFTs, the concept of partial ownership can be realized, allowing multiple users to collectively own the same NFT and share corresponding ownership rights based on the number of tokens held. In addition, ERC-404 can be applied to a wider variety of assets, providing users with more diversified management options.
• It allows NFTs to be split into smaller token units, enabling more investors to participate in the investment of high-priced NFTs without having to purchase the entire NFT, thus lowering the market entry barrier. It also increases the liquidity of NFTs, as more tokens can be traded, thereby increasing market activity.
• ERC-404 involves the seamless connection between the automatic minting and destruction of corresponding NFTs and token ownership within wallets.

IV. Limitations of ERC-404

Initially, as various ERC-404 projects were launched, the gas fees on the Ethereum network also increased significantly. However, with the emergence of issues and the loss of popularity, the attention to ERC-404 projects began to rapidly decline. The leading project PANDORA has experienced a significant decline compared to its peak, while other ERC-404 projects have experienced earlier and larger declines. What limitations does ERC-404 have?

1. Firstly, due to the increased complexity of the underlying smart contracts, the gas fees required during transaction execution are significantly higher than regular ERC-20 transfers. In the current limited performance of the Ethereum network, the high gas fees have become more prominent, directly affecting user experience.

2. Secondly, the lack of official recognition and integration challenges. The ERC-404 protocol is not officially recognized by Ethereum, which increases the uncertainty and risks it faces before being widely adopted. Integrating this new standard into the existing ecosystem of wallets, exchanges, DApps, and more will encounter many obstacles such as standardization, compatibility, and stability.

3. During the trading of fungible tokens, there is a possibility that the corresponding NFTs may be transferred to the buyer indiscriminately, without considering the rarity of the NFT. This situation may lead to the transfer of high-value NFTs owned by the original holder, resulting in the loss of their high-value NFT assets.

4. Potential technical risks. Although ERC-404 draws on the mature elements of ERC-20 and ERC-721, the way it integrates the two is entirely new, inevitably increasing the complexity of smart contracts and possibly introducing new attack surfaces and security vulnerabilities. The ERC-404 standard needs to undergo rigorous third-party security audits and penetration testing. Currently, this aspect may still be insufficient, requiring strict configuration and compatibility checks to prevent the occurrence of such vulnerabilities.

The liquidity of NFTs has always been a challenging issue, and many projects are dedicated to solving this problem. Various market platforms are trying to solve this challenge by improving user experience and increasing liquidity. In addition, some projects are attempting to enhance NFT liquidity through methods such as collateralized lending and NFT fragmentation, for example, decomposing NFTs into ERC-20 tokens and providing liquidity mining on decentralized exchanges. The emergence of the ERC-404 protocol provides a good solution to this.

In conclusion, ERC-404 has proposed a new concept of "hybrid tokens," breaking down the barriers between fungible and non-fungible tokens, and opening up new application scenarios for the Web3 ecosystem. However, as an experimental standard, ERC-404 is still in the early adoption stage, undergoing rigorous testing to ensure its robustness and reliability. Whether it will be widely adopted is worth further observation.

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