Introduction

2023 and 2024 have been a period of experimentation with new token types: ordinals, inscriptions, Token2022, and now - ERC404 and its derivatives. ERC404 has emerged quite recently. In early February 2024, an aspiring developer created a new token named EMERALD, which preceded ERC404 but collapsed due to an error. However, some developers saw potential in this concept and in early February, they refined the standard into ERC404.

This standard adds a particular interest in the context that it questions the viability of platforms that facilitate fractional ownership of NFTs and may significantly alter the NFT-space landscape, including NFT-AMMs and lending platforms for NFTs.

To begin with, let’s examine the different types of tokens to establish solid boundaries:

• ERC20, BEP20, SPL - these are regular fungible tokens used for exchange and employed in various networks with different creation mechanisms as code. SPL tokens, specifically Solana tokens, stand out as they utilize a different accounting mechanism linked to accounts instead of directly stored on wallets.
• BRC20 - essentially similar to ERC20 but for Bitcoin. The difference lies in BRC-20 tokens not relying on smart contracts like their counterparts in Ethereum and other networks; instead, they employ ordinals and inscriptions for their operations. These tokens are unique as they are embedded directly into Bitcoin satoshis using JSON code. Another interesting aspect is that BRC-20 tokens operate in parallel with the Bitcoin blockchain, meaning transactions can be accepted on the Bitcoin network but rejected according to the BRC-20 protocol if they do not meet the specified conditions.
• Inscriptions - this token type resembles NFTs; they represent metadata fragments that can be added to a block on the blockchain. They can store data of any type, such as text, images, or even code, directly on the blockchain, making them permanent and immutable. NFTs, in this case, differ in that they contain metadata pointing to the actual data of the digital asset stored elsewhere, such as IPFS or centralized servers like Amazon AWS.
• Ordinals - essentially similar to Inscriptions, a method of recording data into individual satoshis, also referred to as NFTs on Bitcoin. Using a logical ordering system called ordinal theory, each individual satoshi can be assigned a unique number. This allows developers to embed arbitrary data such as images, videos, or text into each satoshi, creating a wide range of potential applications for this technology. Inscriptions in BTC and BRC20 operate based on the Ordinals technology.

1. ERC404

ERC404 is a new unofficial experimental token standard that developers launched on Ethereum in early February 2024. This standard combines the interchangeability of ERC20 with the uniqueness of ERC721 NFTs and essentially constitutes a mixed implementation of these two token types. It’s considered unofficial because ideally, each ERCxxx should correspond to a specific EIPxxx (Ethereum Improvement Proposal). Usually, this is done through agreements among the Ethereum developer community. However, this time the standard was created by third-party developers who did not coordinate it as an EIP.

If a standard ERC721 token is a Non-Fungible Token that is transferred from address to address and its entire ownership history can be traced, similar to Inscriptions, then in ERC404, the ERC721 portion is implemented differently. Tokens are burned and re-minted according to basic/fractional transfers. So, essentially, one ERC-404 token equals an ERC20 token plus an NFT. This sounds somewhat similar to ERC1155, which essentially allows users to own multiple NFTs with the difference from ERC721 being that in ERC1155, all tokens are essentially different, whereas in ERC1155, the user’s wallet may contain a balance of NFT tokens similar to fungible tokens, as done with ERC20.

However, ERC1155 deals only with NFT tokens, while ERC404 allows for simultaneous operation of both NFTs and ERC20. ERC-404 itself is simply a smart contract that generates an ERC-20 contract and an additional ERC-721 contract.

At a basic level, 1 NFT token in ERC721 cannot be divided into smaller parts, and 1 ERC-20 token usually equals 10 units to the power of 18, which is its divisibility. But if a user’s account balance is less than one ERC-404 token, they own the corresponding amount of ERC-20 tokens instead of the whole NFT. If the account balance equals or exceeds one ERC-404 token, then they own that amount of ERC-20 tokens and the corresponding amount of NFTs.

How it works simply:

• A collection is created containing, for example, 10k NFT replicas and 10k ERC20 tokens that can be fractionalized.
• If a user owns a quantity of fungible tokens exceeding a predetermined amount, the contract automatically issues a user non-fungible token. For instance, if a user had 0.7 ERC404 tokens (also called a token fraction), and users acquire (or buy) an additional 0.4 tokens, users end up with 1.1 tokens. In this case, the contract automatically generates 1 ERC404 NFT in the wallet and leaves 0.1 ERC20.
• If users spend enough fungible tokens to drop below a predetermined amount, the contract automatically burns one of your non-fungible tokens. If you sell 0.2 tokens from these 1.1 tokens, your NFT is burned, and you’re left with 0.9 ERC20.
• What if the user’s balance is 2.2 ERC404 and you sell 0.4 tokens? In this case, the last NFT transferred to the user’s wallet by any means is burned, and the user ends up with 1 NFT and 0.4 ERC20. If the user doesn’t want to lose an NFT with certain characteristics, the most logical step is to temporarily transfer it to another wallet.

Figure 1: ERC404 flow

These NFTs can be traded on NFT marketplaces like OpenSea, while ERC-20 tokens can be traded on decentralized exchanges such as Uniswap. This provides liquidity from both the NFT marketplaces and decentralized exchanges.

Risks of ERC404-based projects:

• One of the main risks is excessively high gas fees. Users often paid gas fees several times higher than the value of the tokens themselves.
• Another nuance is the high number of rug pulls amidst the frenzy. SlowMist founder Yu Xian also expressed concern about potential risks in ERC-404 token trading processes, where associated NFTs may be at risk of being transferred or destroyed without scrutiny.
• Another potential risk may be associated with using ERC404 standard tokens in credit protocols, as this creates the opportunity for manipulation due to the imbalance between NFTs and their fractions.

Additionally, ERC404 creates quite unusual mechanics that are simultaneously conditioned by its drawbacks:

• When transferring between addresses or during disassembly (burning) into ERC20/assembly into a whole NFT (mint), NFT properties may change. This happens because metadata is lost when burning, and different metadata is created when restoring.
• In theory, the price of NFT should be linked to the price of ERC20 tokens, but in reality, it’s slightly different. In fact, we have two different liquidity pools and different price formation mechanisms - for the NFT pool on NFT marketplaces and for the ERC20 pool on DEXs. Theoretically, this creates arbitrage opportunities that should align prices. Why this happens: if someone wants to quickly sell a token on OpenSea, they will more likely set the price below the Floor Price. If they want to sell on Uniswap, the transaction will occur at the current price.

One of the most popular projects in this field is Pandora, as evidenced by the dominance of its trading volume relative to all ERC404. Second in trading volume is DeFrogs, and third is Alphabet.

Figure 2: Distribution of ERC404-based projects by trading volume. Source: @candlestick_io, Dune.com

Pandora is actively developing ERC404, working on the second-generation contract version (ERC404 v2). It is expected that the gas cost for token minting in ERC-404 V2 will decrease by approximately 28%, while the token transfer cost may decrease by around 50%. However, the token destruction cost is expected to increase by 80%, and this change is related to the reuse of token identifiers and aligns with expectations.

Let’s consider the price dynamics of Pandora: on OpenSea, the Floor Price is 9.36 ETH, which at the Binance exchange rate (3530$ per ETH) translates to $33,040. On Uniswap, we observe a price of $22,503:

Figure 3: Pandora price comparison on OpenSea and DEX. Source: opensea.io, cryptorank.io

We see the same with DeFrogs, another popular ERC404 collection, with Opensea priced at 0.395 ETH or $1,394 and Uniswap at $1,021:

Figure 4: Defrogs price comparison on OpenSea and DEX. Source: opensea.io, cryptorank.io

In the case of Alphabet the situation is similar, but a strong gap in trading volume is visible: on Opensea it is 0.781 ETH with a price of 0.34ETH ($1,220), and according to dashboard data from Dune the total trading volume is $103.5m with a current price of $192 on CoinW and Uniswap:

Figure 5: Alphabet price comparison on OpenSea and DEX. Source: opensea.io, cryptorank.io

2. ERC404 Evolution and Competing Solutions

2.1 DN404 (Divisible NFT)

DN404 is a direct competitor to ERC404, supported in multiple networks and aimed at providing more flexible and efficient transactions in the NFT space, allowing users to own and trade fractions of NFTs. The idea behind ERC404 was to create a single contract that could act as both fungible and non-fungible tokens. However, this cannot be achieved without introducing exploits and violating standards. Instead, DN404 uses a more complex and understandable approach: it has two contracts - a “base” ERC20 and a “mirror” ERC721. In this case, the ERC20 token contract tracks user balances and manages the minting/burning of mirror NFTs. DEX Trader Joe was the first platform to adopt the DN404 standard, releasing a token called SHOE. Additionally, DN404 is supported on chains such as BNB, Polygon, Arbitrum, Ethereum, Fantom, Optimism, and Base.

Figure 6: DN404 stats. Source: @cryptokoryo_research, dune.com

It’s also interesting to note that the same developers who contributed to the creation of ERC721a were involved in its development, indicating that this protocol has slightly higher chances of receiving official approval and recognition within the Ethereum ecosystem, but this is not certain yet. A representative of this category is The Asterix project, based on the DN404 protocol, a collaborative effort between the founder of ERC721a, optimizoor, and 0xCygaar, significantly optimizing the ERC-404 protocol.

2.2 ERC404m

This standard was developed by Muon and allows ERC404 to be supported on different chains, with tokens being able to move between the chains they are deployed on. Currently, these chains include Optimism, Arbitrum, and Mainnet Muon. ERC-404m tokens can be listed on any DEX exchange and NFT marketplace. ERC-404m inherits the necessary functions for connectivity through the mint/burn protocol. By using this protocol, ERC404m tokens can exist on multiple chains and be exchanged between them without needing to convert them into the ERC20 or ERC721 standard. Furthermore, the Muon team is working on a solution to the accidental replication problem (erasing attributes when burning NFTs and creating entirely new attributes when minting ERC404 NFTs). This solution involves creating an autonomous replica database at the Muon canary network level.

2.3 ERC404 Plus

This is modified standard proposed by Bitcoin Cats reduces gas usage when working with ERC404. Another interesting fact is that BitcoinCats404 could only be minted by linking NFT Bitcoin Cats to Ordinals by linking ETH and BTC wallets directly on the BitcoinCats website. This move made it possible to launch trades not only on Magic Eden and OKX but also on Uniswap, Opensea, Blur and even CEX.

2.4 CW404

This standard, developed by Injective, is a ported ERC404 that combines CW20 and CW721 standards. In fact, this is the ERC404 port from Ethereum to Injective. The first representative of this collection is Sushi Fighter NFT.

2.5 ERC-X

The ERC-X is an optimized experimental standard that allows multiple standards to be used in one (ERC20, ERC404, ERC721, ERC721A, ERC721Psi, ERC1155, and ERC1155Delta). ERC-X is considered more cost-effective than ERC404 and scales practically to any project size with a regulated number of tokens totaling NFT value. The first representative of this standard is Miner.

Figure 7: Miner workflow. Source: twitter.com, @minerercx

This standard, implemented by Miner, unlike ERC404 specifications, allows for the use of either ERC721 or ERC1155, and also divides the fee for wrapping/unwrapping NFT tokens (minting/burning) into several commissions: 10% to partners who created the pod, 10% to the Miner Treasury, and 80% distributed among the stakers. Additionally, the ERC-X standard enables significant gas savings and brings back essential features from the ERC20 standard, such as anti-snipe mechanisms, to ensure smoother project launches. Moreover, with minimal adjustments, ERC-X allows for the presentation of NFTs as either ERC721 or ERC1155, catering to different project requirements.

Figure 8: Comparing the effectiveness of different standards. Source: docs.miner.build

In addition, Miner offers a technology called EasyLaunch, which simplifies the token launch process to just two steps: deployment and liquidity addition. This simplicity contrasts with other versions of ERC404 and DN404, where you need to deploy, whitelist your wallet manually, initialize liquidity pool without adding tokens (a step not supported by Uniswap interface), whitelist liquidity provider, and then add liquidity.

2.6 NAP (Native Assurance Protocol)

All previous standards are based on combining ERC20 and ERC721 by creating new smart contracts, which means no interaction with existing collections. NAP, initiated by the b0rder1ess team on Polygon two years ago, allows incorporating DeFi elements into existing ERC721 and ERC1155 NFT collections, preserving their originality, enabling exchange for ERC20 tokens, and improving royalty yields, which the standards discussed above cannot offer. NAP taps into potential synergy between the two creating opportunities for arbitrage earnings between NFT and DeFi markets.

Essentially, NAP functions as a lending protocol, not token minting/burning. Instead, NFT users can receive and hold their NFTs in traditional ways, whether by creating or purchasing on the NAP platform or any other market without the need to own the associated DeFi token. DeFi users can participate in promoting the collection by exchanging stablecoins for a guaranteed DeFi token without owning the NFT.

Figure 9: NAP workflow. Source: docs.borderless.art

Conclusion

ERC404 and its derivatives are indeed an interesting and somewhat revolutionary technology. However, the main issue at the moment is that there are some aspects of it that actually make its usage quite limited: lack of price anchoring, lack of metadata preservation, and so on. This significantly differs from well-developed EIPs, where the developer community considers different vectors, plays out and analyzes various scenarios, and so forth, to form the most well-thought-out proposal with minimal risks and maximally logical processes within.

Even comparing ERC404 to the experimental Token2022 on Solana - it was also developed for a long time by a large team of developers and is still undergoing testing and risk identification. And NAP, which was initially developed on Polygon, for some reason has not gained widespread adoption in the two years since its development began and remains in the shadows.

Most likely, it will take a lot more time for such mechanics to be implemented in non-EVM blockchains, despite their apparent simplicity. The thing is, in other blockchains, there are their own rules and standards for creating tokens and smart contracts. And at a fundamental level, the idea of NAP, ERC404, and ERC-X differs in that it allows implementing the functionality of combining fungible and non-fungible tokens at a native level, without upper-level additional smart contracts.

Therefore, it is probably worth waiting for further development of this standard or the creation of a new standard with EIPs, which may be more complex and well-thought-out from various angles. The idea of ​​being able to divide NFTs into ERC20 tokens can bring many new use cases, including in DeFi for options mechanics, index tokens, futures, and complex tokenomics such as those at Tapioca DAO. Additionally, such mechanics could prove very useful for web3 games, as it could significantly simplify the design of the in-game economy architecture.

Disclaimer：

1. This article is reprinted from Dewhales Research )], Forward the Original Title‘ERC404, DN404, ERC404m, ERC-X, NAP and Other Similar Standards Explained’, If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.

2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.

3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.