404
by Thomas Zink and Hiroki Kotabe
tl;dr
- ERC-404 is a novel, albeit experimental, token standard in the Ethereum ecosystem, that seeks to bridge the gap between ERC-20, the standard for fungible tokens, and ERC-721, the standard for NFTs representing digital collectibles.
- Given that ERC-404 lacks security auditing and peer review like actual ERC standards, it’s vulnerable to potential exploits that may lead to asset loss
- Pandora is the leading and original ERC-404 project and its token $PANDORA has surged 30x in value in days
- Community sentiment around ERC-404 is mixed, with polarized views not unlike what we saw with the rise of ordinals in early 2023
- Exercise caution when investing in any ERC-404 project, given their nascent and unproven nature
ERC-404
You’ve probably seen the mysterious “ERC-404” mentioned lately. Despite the surrounding confusion, here’s a distilled overview of what’s currently known along with some of our thoughts on it:
ERC-404 is Ethererum’s latest experimental token “standard,” blending properties of ERC-721 and ERC-20 into a novel concept of “semi-fungibility.” The goal is to allow NFTs — which are typically illiquid assets — to be traded with the robust liquidity of fungible token pools.
To accomplish this, ERC-404 basically checks whether the amount being approved is within the range of the minted NFT, then executes an ERC-721 approval if it is, and otherwise executes an ERC-20 approval.
Pandora, the project that pioneered this standard, has seen its token value skyrocket more than tenfold since its inception.
Pandora offers a window into one of many innovative functionalities of ERC-404. It launched as 10,000 ERC-404 tokens, each associated with a “Replicant” NFT, with the NFT’s color indicating its rarity. When a user buys 1 $PANDORA, they will receive one random Pandora NFT bound to it. Selling the token or part of it will burn the linked NFT, and a new one is minted for future transactions.
This mechanism enables a robust liquidity pool for $PANDORA and incentivizes continuous trading activity. Traders are driven by the prospect of acquiring higher rarity NFTs through buying and selling. Essentially, the rarity of the NFTs can be “rerolled” through trading $PANDORA, adding a unique element of engagement and speculation in ERC-404 trading.
Already, Replicants are trading on major DEXs like Uniswap and the top NFT marketplaces including Blur and OpenSea.
Despite the controversy around ERC-404, traders and investors are steadfast in their pursuit for gains. In just one week, the price of a single PANDORA surged from ~$1,000 to over $30,000.
One project called Monarch stood out to us as the first gamified iteration of ERC-404, which will allow players to natively evolve their NFTs via competition on chain. In this game, 1 MNRC token will “hatch” 1 Base Dragon NFT. Everyone will start with a Base Dragon — there’s no predetermined rarity but rather rarity is created through on-chain game activities.
Rug-pulls Will be Rife
For the near term, we can expect a bunch of ERC-404 projects to keep springing up, but caution that many of these will be junk projects and rugpulls will be rife. Simply devs and bad actors trying to make a quick buck.
While innovation is exciting, there are lots of concerns that this “standard” brings. It hasn’t gone through the formal EIP process yet, meaning it lacks the security auditing and peer review that established standards like ERC-20 and ERC-721 have.
In a revealing X thread, @0xQuit recently unveiled a technical analysis suggesting that the ERC-404 codebase may contain a “catastrophic” flaw that can lead to the loss of assets over time due to the overload of existing function signatures with new mechanics.
Where do we go from here?
While ERC-404 enables a blurring between the lines of non-fungibility and fungibility, it’s evident that much groundwork remains. Currently, the main benefit of this novel scheme — and one not to be underestimated — is infusing NFTs with the deep liquidity of fungible tokens.
However, the landscape may unfold in unpredictable ways, owing to permissionless open innovation in web3. There are already ERC-404 GameFi projects. There’s already ERC-404 projects on Base. As these initiatives progress, they will provide a richer context for evaluating the actual potential and limitations of ERC-404.
The rapid influx of money into ERC-404 sets a risky precedent about the proliferation of “fake” ERCs hungry for the same sort of capital influx. With hundreds of millions of dollars flowing into these projects within days, there’s a risk of countless other standards without clear oversight — What quality standards did they follow? Who built them? What’s the motivation behind them? On the upside, it could potentially usher in a wave of innovation in the open ethos of web3; on the downside, it opens the doors to a heavy dose of scams and rug pulls.
Well, enough on ERC-404 for now, let’s check out the next shiny new thing: ERC-69 :)
Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice, or investment recommendations. This post reflects the current opinions of the authors and is not made on behalf of Inception Capital or its affiliates and does not necessarily reflect the opinions of Inception Capital, its affiliates, or individuals associated with Inception Capital. The opinions reflected herein are subject to change without being updated.
