#268: Making the Non-Fungible Fungible with ERC404

What if ERC721 and ERC20 had a 👶?

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Pandora and ERC404

Over the past few days, there’s been a lot of commotion over these boxes.

Just another typical pixelated 10k NFT collection right? Not quite.

In the picture above, these are NFTs. Specifically, these are ERC721s — a Ethereum token standard that many NFTs that we know and love (and hate) are based on. Each ERC721 token is unique.

On the other hand there are ERC20s, fungible tokens such as USDC, UNI, or memecoins like SHIB. These tokens are interchangeable and aren’t unique.

Just as SUVs, sedans, and trucks are types of cars, there are different token standards. These token standards have different features and capabilities but are all categorically tokens at the end of the day. So what happens when you combine these unique features from different token standards?

Enter ERC404

On February 2nd, Pandora announced that they were the first token created with the ERC404 token standard. What is ERC404?

• The token standard combines attributes of ERC20 and ERC721 with native liquidity and fractionalization

• ERC404 makes this possible by introducing pathing between the two standards, isolating the ERC20 and ERC721 logic. At any given time a token can be one or the other, not both at the same time.

• The ERC721 implementation (the NFT or non-fungible part) is unique where tokens are burned and minted repeatedly

• ERC404 is still in an experimental phase and in the process of being audited, so anyone creating ERC404s should be thoughtful when building with it

The Github repo is here for further reference.

Alright TPan, WTF is this? Give it to me in picture terms

ERC404s are sorta like Dr. Banner/The Hulk — You either get the rational genius scientist, or the green giant with super-strength and each is appropriate for the right situation. Let’s ignore the in-between nuances of ‘Smart Hulk’ and other scenarios for the sake of this comparison 😉

What does this look like in practice?

Pandora

With ERC404, Pandora is both a nonfungible NFT collection and a fractionalized token. Due to the excitement around this new standard and speculation of what holding one could mean in terms of future airdrops, the value of the token + NFTs have shot up with the ERC20 form at ~$7,700 for one full token and the ERC721 form at 3.4 ETH (~$8,100) at the time of this writing.

The difference in pricing between the two forms of the same token is likely due to the ERC721 version (NFT) requiring one full token while you can purchase fractions of the ERC20 version (token).

How do these two variations of the same token interact with each other without disrupting the total supply? For clarity, ‘Token’ = ERC20, ‘NFT’ = ERC721

• When you purchase a full token, the NFT gets minted to your wallet

• When you sell the token, the NFT gets burnt

• When the NFTs are minted, the traits are randomized and box colors have varying rarity. Details around box rarity are unrevealed for now.

• When tokens are sent from one wallet address to another, the protocol will burn and mint a new NFT, effectively re-rolling the NFT traits

• The NFTs can also be bought and sold, and the traits are not re-rolled

This new interaction model creates more optionality for participants:

Buyers

• Do I want to purchase the token or NFT?

• If I want to purchase the token, how much do I want to purchase (fraction, whole amounts, both)?

• If I want to purchase the NFT, how many do I want to purchase (whole amount)?

Sellers

• Do I want to sell the NFT on a marketplace or the token on an exchange?

• Do I want to transfer the NFT to ‘re-roll’ for a chance at a rare trait and then list it for sale on a marketplace instead of an exchange?

• If I have the NFT: Do I want to sell a fraction of the NFT on an exchange while retaining the difference in token form?

As a result, there are a couple of additional interesting dynamics that occur:

• Supply will never reach max: Although the maximum supply of the collection is 10k, it will probably never reach that amount because there are holders of fractional amounts of the token

• NFT IDs surpass 10k: In standard NFT collections, the token IDs are limited by the total supply of the collection. If a collection has 10k supply, there won’t be a NFT with ID #99999 due to the collection cap. However, with Pandora, we’re seeing NFT token IDs like #32612 due to the mint and burn mechanism that is implemented. These NFTs can come and go depending on the actions of the holder.

Shoutout to tom and dragos for their ERC404 explainers.

What does the future of ERC404 look like?

As mentioned, this type of token is in its infancy. There are already some implications though.

Financialization of NFTs

The march towards NFT financialization has been going on for a while now. Marketplaces like Blur allow lending and borrowing, there are lend/borrow-specific platforms like Gondi and Arcade, you can place leveraged bets on NFT collections on Wasabi, and you can purchase fractions of a NFT on Floor Protocol 😵‍💫

The key phrase in ERC404’s documentation is native liquidity and fractionalization. The ability to purchase and own a fraction of a NFT can become a built-in feature. This doesn’t necessarily diminish the role of a Floor Protocol, but rather it expands the ‘how’.

I thought NFTs were about pictures, not numbers 😡

This type of fractionalization and financialization is a turn-off for some folks. The NFT ecosystem of 2021 was about attaching your identity to an onchain JPEG and building a community with like-minded individuals. That still remains true, but there is now a growing layer of NFTfi that is here to stay.

That said, I think there will be ways to build a community that consists of NFT holders and fractional token holders under the same roof. Striking the right balance will require nuance and finesse.

Projects exploring ERC404

There are already several projects playing around with ERC404, such as Rugged Art, DeFrogs, and Palette, the first art collection on the token standard.

There is also a fair amount of developer interest with 23 forks of the code so I guess we’ll have to wait and see what’s in store 👀

Gaming x ERC404

What can be done for builders thinking about the implications of ERC404 beyond creating a hybrid NFT collection + token to make a quick buck?

Thinking about the purpose of a token vs. a NFT within the context of ownership:

Tokens are the atomic unit of participation and ownership while NFTs are a holistic unit of participation and ownership.

With web3 gaming, the concept of crafting and scrapping combined with ERC404 could be intriguing:

When players craft items, they need to collect enough of a resource or item (aka token) in order to create the desired item. For example, Minecraft players create ladders by combining sticks.

Source

When players scrap items, players can recycle their items for resources. For example, Fallout 4 players can scrap their items for raw material, which will then be used to craft other items.

Source

The crafting part is already happening in web3 gaming, but what about scrapping? What if there are multiple types of core resources beyond gold (eg: wood, metal, oil?). Could ERC404 (or a future refined version of it) be a foundation for these types of mechanics that don’t quite exist yet?

Separately, airdrops can take on a whole new meaning with players being airdropped a fraction of a special item. In order to mint that item (acquire 1 full token), they either need to purchase more of that item from other players, or earn the remaining fractions by completing quests.

Web3 gaming has embraced tokenization for their games, and fractionalization of items within the games may have room for innovation 🤔

There will be a lot more exploration with these types of interaction models, so keep your eyes peeled if ERC404 takes off.

See you Thursday!