TL;DR

1. ERC404 establishes corresponding interchangeability between NFTs and FTs through the protocol, realizing NFTs with interchangeable built-in attributes, defined as an experimental technical solution with a hybrid ERC20 and ERC721 nature, featuring native liquidity and fragmented semi-fungible tokens (SFTs). Different from the mainstream NFTFi’s commercial path, the 404 standard’s asset series cleverly integrates existing facilities of NFTs and FTs at the standard level to establish bilateral liquidity, featuring new characteristics of “gacha,” “native fragmentation,” and “AMM liquidity,” which will lead to more innovative gameplay, greater imagination, and development potential if widely adopted by numerous projects in the future. ERC404 is still in its early stage without long-term verification, currently having flaws such as uncontrollable burning of multiple NFTs and not being included in formal Ethereum EIP proposals. Pandora is merely the debut project of ERC404 and cannot capture actual value from ERC404’s potential future developments and widespread applications, with its future development depending more on the continuous operation of subsequent project parties.

1. Introduction

Each bull market cycle in crypto brings new asset issuance methods and corresponding technical standards, from ERC20 on Ethereum to ERC721 NFTs, and now to inscriptions on the BTC chain in this round. Among the inscriptions, the most market-recognized is BRC20, recently also referred to as semi-fungible Tokens (SFT). This article will introduce a new experimental standard ERC-404 on the Ethereum chain and its first asset, Pandora.

Assets created based on 404 enable FTs and NFTs to form corresponding interchangeability, realizing bilateral liquidity using both ERC20 and ERC721, where each FT automatically mints an NFT. If the purchase is insufficient for one, the corresponding NFT will not be minted. If users buy, sell, or transfer FTs, affecting the change of integer FTs, the NFT will be burned and re-minted, with the program automatically recording the attributes of the re-minted NFT. If users wish to retain the NFT, they can directly trade or transfer the NFT, and the NFT itself will not undergo any changes.

ERC404 is an experimental standard and theoretically should be called EIP404 now, and the number 404 does not conform to the EIP submission specifications. Whether it can be formally included in the ETH standard needs to await the foundation’s response. Pandora is an early project, although it is the first asset of ERC404, the risks are higher, and relevant risks should be rationally viewed. As of March 2, 2024, there are 719 token contracts established based on the ERC404 standard, with a total trading volume of 1.6 billion, among which the main trading volume is the first asset Pandora, accounting for 55.7% of the trading volume.

ERC404 is an experimental standard and theoretically should be named EIP404. The number 404 does not comply with the EIP submission specifications, and whether it can be formally included in the ETH standard depends on the response from the foundation. Pandora is an early-stage project. Although it is the first asset of ERC404, it carries higher risks. It is advised to rationally assess the related risks. As of March 2, 2024, there are 719 token contracts established based on the ERC404 standard, with a total trading volume of 1.6 billion. Among them, the primary trading volume comes from the first asset Pandora, accounting for 55.7% of the total volume.

2. Pandora Case Analysis

2.1. About Pandora

Pandora is the first project built on the ERC404 token standard, launched on February 2nd. For every 10k PANDORA ERC20 tokens, 10k NFT “Replicants” are generated. Pandora can be traded on platforms like Uniswap and NFT marketplaces like OpenSea.

The series consists of five rarity levels, distinguished by colors. When users trade Pandora’s FT tokens, Replicant NFTs will be minted or burned based on the quantity. For example, 1.3 Pandora generates 1 NFT, while less than 1 Pandora does not generate any NFT. Each time a Replicant NFT regenerates, its rarity is randomized. However, the rarity remains unchanged when directly transferring or trading NFTs.

Details regarding the “unboxing” process and future empowerment plans from the project side have not been disclosed yet.

2.2 Information on FT tokens and market conditions, as well as liquidity analysis:

As of March 2, 2024, basic information is as follows:

About 67% of the daily trading volume occurs in Uni v3, and the others are CEX such as Bitmart, Lbank, gate, etc.; OKX and Binance wallets already support ERC404, while Pandora has not yet launched OKX and Binance.

The current WETH liquidity of Uni v3 is 26M, the total TVL is 44M, the 7-day trading volume is about 90M, the turnover rate is high, and the market is competing on price.

2.3 Comparison of Trading Volume Data between FT and NFT

As of March 2, 2024, the total DEX trading volume is 870 million. The number of minted NFTs is 6130. The total trading volume on OpenSea is 1956 ETH, which is approximately 6.6 million based on the exchange rate of 3.4K ETH on March 2nd. The NFT trading volume accounts for only 0.7% of the FT trading volume. The core liquidity of the Pandora series is currently almost entirely determined by Uni v3 AMM pricing. Apart from the instant liquidity provided by AMM, one of the reasons is that the empowerment of Pandora’s NFT series is currently unclear.

2.4 Wallet Address

There are a total of 10 addresses holding 100 or more tokens. Among them, the first three are the official multi-signature wallet, the Uniswap v3 LP, and the contract address of Sablier V2 LockupLinea. The distribution of tokens is relatively diversified, with most holdings ranging from 19,000 to 27,000 tokens.

3. Historical Background and Team Members

The concept of Pandora and the technical solution of ERC404 are not entirely new. The history of such attempts can be divided into two parts: the “third-party fragment protocol” on the ETH chain at the protocol layer and the concept of “dual fungibility” brought by the standards at the chain standard level, such as BTC Inscriptions and Solana’s DN.

3.1 Third-Party Fragmentation Protocol

On the ETH chain, after the birth of 721 NFTs, multiple attempts at the protocol layer have emerged due to the problem of liquidity scarcity. One of them is called “fragmentation,” such as:

NFTX, which went live at the end of 2020, puts NFTs with similar prices into a vault, issues corresponding vTokens, and users can redeem NFTs from the vault by holding enough vTokens.

Fractional, a star project that raised $28 million, introduces a new role, curator, who earns revenue from fragment auctions, and fragment holders initiate voting for auctions and pricing of NFTs in the vault.

Flooring Protocol, which went live at the end of last year, allows users to store NFTs in the Vault to obtain 1 million μTokens, and then choose to abandon ownership to randomly redeem NFTs or retain ownership Keys to retrieve corresponding NFTs.

In summary, the third-party fragmentation protocol allows users holding NFTs to stake part of the series and exchange them for new ERC20 tokens issued by the protocol. The purpose is to expand the liquidity of NFTs by splitting them, introducing new roles, empowering fragmented tokens, and redeeming NFTs based on the fragmentation ratio. After the protocol goes live, most of the NFTs stored in these protocols are blue-chip NFTs.

3.2 The Birth of Dual Fungibility

The birth of the “exchange of graphics and currency,” “unification of graphics and currency,” and the concept of “dual fungibility” at the chain standard level can be traced back to the Inscriptions protocol on the BTC chain and Solana’s Deez Nuts in the Solana ecosystem.

Regarding the emergence of “exchange of graphics and currency,” “unification of graphics and currency,” and “dual fungibility,” the initial source is the new asset “Inscriptions” in this bull market cycle. Due to the UTXO characteristics on the BTC chain and the Ordinals protocol, after the BRC20 standard was created, users can inscribe any data on sat to give it unique characteristics. This implementation can be understood as an abstract protocol corresponding to graph tokens, “adding” some “uniqueness” to FT tokens and some “fungibility” to NFT tokens. In terms of expression: when inscribing inscriptions, what is inscribed is “one piece,” which is 100% an NFT. And “one piece” can be split, and the fungible tokens inside can be split out one by one. Therefore, it can also be called semi-fungible tokens.

Then, in January of this year, the new token standard Tiny SPL in the Solana ecosystem, which aims to solve network rent issues, launched the AMM trading mechanism on its own website. Subsequently, its token DN (Deez Nuts) caused market speculation. DN can be split or merged, and holders can also add NUTS to the AMM pool as LP; this design is seen by Degen as another “Inscriptions” for “exchange of graphics and currency.”

At this point, the concept of dual fungibility has been initially recognized by the market. Due to differences in technical environments and NFT infrastructure prosperity on each chain, SFT has derived new assets with different characteristics on various chains, first Inscriptions on BTC, then exchange of graphics and currency of Solana. So, what appears on ETH, which currently has the most prosperous DeFi and NFT ecosystems?

3.3 ERC404

1. In early February, another attempt to realize the “dual fungibility” on the ETH chain emerged, a new project called Uniswap Emerald, which builds NFT liquidity on top of Uniswap. However, due to contract vulnerabilities, it was attacked and replaced multiple times. The team is still under development and repair, and the Pandora project members were inspired by Emerald.
2. The 404 standard and Pandora assets are jointly built by a current team of four, with only three Twitter profiles disclosed:
3. @maybectrlfreak (ctrl):
4. Self-proclaimed startup investor. Angel investor in Syndicate. Syndicate’s first tweet was posted on January 22, early investment in BRC20 and Ordinals trading terminal BeFi Labs.
5. @searnseele (Searn):
6. No detailed information available on Twitter
7. @0xacme (Acme):
8. Published the ERC404 standard on Github and was previously an engineer at Coinbase.
9. Implementation Principle

ERC404 is defined in the documentation as an experimental technical solution that combines ERC20 and ERC721 standards, creating a semi-fungible token standard with native liquidity and fractionalization.

4.1 Lossy Encoding Scheme

Firstly, let’s understand the operational processes of ERC20 and ERC721:

When user A holds 11.11 units of token B, in a transfer operation, the smart contract deducts the corresponding amount from A’s account and adds it to the recipient’s account, managing only the balance of tokens.

When user A holds an NFT from series C with an ID of 1234, transferring the NFT involves removing it from A’s account and adding it to the recipient’s account.

Normally, these are distinctly different asset standards, and the smart contract needs to determine the type before executing the transaction.

Secondly, ERC404 employs a lossy encoding scheme that allows ERC20 token quantities and ERC721 token unique IDs to use the same data structure “AmountOrId” in contract storage.

Solidity records ERC20 token balances in the form of numbers based on the minimum unit Decimals, for example, if you have 2.3 units of Pandora, it would be represented as 230000000000000000 (18 decimals), a number much larger than the token ID of an NFT. The contract then compares this number with the ID of a 721 NFT. If the “AmountOrId” containing both parameters is less than or equal to the current “Minted” value (i.e., the number of minted 721 NFTs), the contract operates on the 721 NFT. Otherwise, it operates on the ERC20 token. This allows the contract to distinguish between ERC20 and ERC721 when making calls.

The mapping function tracks account states. If a user transfers ERC20 tokens using the “transfer” function, the 721 NFT is burned and then minted again. In the “mint” function, each time a new 721 NFT is created, the “minted” variable increases, assigning a unique, sequentially increasing ID to each new token, starting from 1.

4.2 Two flaws: the burning of multiple NFT assets is uncontrollable and gas consumption is higher compared to that of regular transfers.

When a user holds multiple tokens and their corresponding NFTs, if the user transfers FT tokens, the smart contract cannot selectively burn NFTs. Instead, it uses a Last In, First Out (LIFO) mechanism, potentially deleting NFTs the user values more. This is a current design flaw in ERC404.

Pandora addresses this flaw by introducing rarity distinctions and encouraging users to separate their FT balances manually based on rarity. Users can transfer unwanted NFTs to another account and then transfer them back or sell them on the secondary market, enabling operations on the FT balance. This partially mitigates the protocol’s inherent flaws through an economic model.

Another drawback is higher gas fees due to the ERC404 contract’s complexity in storing and monitoring multiple balances and NFT ownership. This complexity requires more on-chain computational resources and results in slightly higher gas costs.

4.3 Pseudo-random number design based on sequential IDs (Pandora’s rarity).

Due to the simultaneous mapping of tokens, the protocol automatically burns old NFTs and establishes new IDs in sequence, allowing projects to use IDs as a source of pseudo-random numbers to assign different attributes. This enables “pseudo-random pack opening” gameplay based on protocol features and assigns different attributes and visual characteristics to each token.

Pandora’s rarity mechanism generates rarity based on the hash function keccak256 applied to the first byte of the NFT’s ID, encoding the result. Since each ID maps to a unique seed value, yielding a number between 0 and 255, rarities are classified based on this range from 0 to 255.

In practical terms, rarity is determined by the sequential nature of IDs. Users who trigger the re-minting process across the network merely receive their ID’s computed seed value in sequence. Therefore, this gacha process is more akin to users drawing from a predetermined sequence and a set deck of cards, with the order of transactions determining which card is drawn.

As shown in the table above, only when the seed value falls between 241 and 255 does it generate a red Pandora box. Since lower numbers of random numbers result in fewer computations from the hash function, rarity can be seen as a result of both “luck” and repeated “effort.”

Such a rarity design can be observed in the case analysis mentioned earlier, where orders on Opensea and Blur for high-rarity red boxes are significantly more expensive than 1 unit of FT, as some players enthusiastically comment, “I got another orange box, so excited!”

However, the potential benefits of different levels of rarity generated by pseudorandom numbers await the project team’s next steps.

Initially, Pandora’s establishment of this random number meant that, through an infinite number of pseudorandom numbers, all existing NFTs could eventually become red rarity. This issue, inherent in the current technical logic of random number card-drawing, has been addressed in the project’s recent v2 update.

4.4 Recent Updates v2.0

1. The ERC-721 type Token IDs are now stored in a FIFO (First In, First Out, FIFO) queue and reused rather than being permanently incremented upon minting and burning. This results in a set of predictable NFT token IDs, much like a typical NFT collection.

2. This means that the previously mentioned infinite possibility of rarity will be changed. A finite number of Token IDs will produce a finite number of red rare NFTs. Once the first complete sequence of IDs reaches the maximum number in the NFT series, high rarity will only be retained spontaneously by user behavior, with no possibility of increase unless accidentally deleted. As a result, the act of gacha will become unnecessary as incentives decrease.

3. Transfers of complete ERC-20 type tokens will now transfer ERC-721 type tokens held by the sender to the recipient. In other words, if 3 complete tokens are transferred as ERC-20, the 3 ERC-721 tokens in the wallet will be transferred directly to the recipient, rather than those ERC-721 tokens being burned and new tokens IDs minted for the recipient.

4. Predictable events issued during transfers, approvals, and other operations clearly indicate whether they are attributable to ERC-20/ERC-721.

5. The removal of a fixed supply cap in contracts allows for selective addition of fixed token supply caps as needed.

6. Simplified and centralized transfer logic, with significant logic optimizations and gas savings.

7. Support for EIP-2612 and EIP-165, among others.

5. The Differences from ERC721-NFT

The author believes that assets based on the 404 standard cleverly blend the distinct protocols of ERC20 and ERC721, making the nature of the assets difficult to define. They can be referred to as “Inscriptions on the ETH chain,” “NFTs with native fractionalized mutable attributes,” or “meme coins with NFTs.” The unique value brought by the technical mechanism lies in its refreshable attributes.

Fragmentation and native liquidity at the standard level

The FT of 404 can provide native liquidity on DEXs like Uniswap, while also automatically generating NFTs. Depending on the highly developed DeFi infrastructure, 404 FTs can even directly support on-chain protocols such as lending protocols and perpetual contracts for complex DeFi operations in the future.

Intrinsic gacha logic and interchangeability within the NFT series

With known limited Token IDs, each ID can naturally be allocated to different attributes and visual presentations. 404 NFTs have programmable functionality and pseudo-randomness. Therefore, users can use minimal gas fees in the on-chain environment to engage in frictionless sequential “pseudo-gocha” loops, obtaining a preset NFT from an orderly established NFT series based on pseudo-random numbers. This offers more interesting variations and a native experience compared to 721 NFTs.

However, in essence, since the rarity is actually fixed from the beginning, it is called pseudo-randomness. Therefore, once high rarity is refreshed, the refreshing process gradually loses its meaning. In practice, Pandora does not actually involve frequent transfers to generate rare NFTs.

Clear diversion of the value and pricing rights of different asset attributes

Each unit of FT corresponds to each unit quantity of NFT, making the underlying value of each NFT to be one unit. Users have no cognitive threshold, allowing for more comprehensive pricing and liquidity through AMM.

Additionally, because 404 NFTs can change random numbers through transfers, Pandora’s holders may even enjoy the “unveiling” moment similar to 721 NFTs multiple times in the early stages. Therefore, highly premium traded rare NFTs in the NFT market clearly reflect the market value of the probability attribute of “luck and multiple refreshes.”

In summary, FT serves as the “floor price” for the entire 404 NFT series, while 404 NFTs of different rarities represent the “floor price” plus the “random number value.” This differs significantly from users’ perception of the value of PFP-class 721NFTs in general, such as which clothes and shoes look better, or cultural attributes, and so on.

6. The Development of NFTFi

The author believes that if 404NFT is defined as a category within the broader NFT spectrum, then ERC404 can be seen as a unique NFTFi solution for this type of NFT.

Recently, when Pandora went online, many key opinion leaders (KOLs) expressed the view that once this paradigm innovation in asset issuance gains widespread recognition and adoption by numerous new projects, it may lead to the exit of some NFTFi projects from the stage of history. Here, the author attempts to analyze and break down this situation:

Firstly, based on demand, NFTFi can be divided into Trading, Lending, and Derivatives.

NFT Trading currently has four methods: order book, aggregator, fragmentation protocol, and AMM, with examples being Opensea, Blur, NFTX, and Sudoswap, respectively.

NFT Lending involves peer-to-peer lending, pool lending, and buy now, pay later models, with fewer projects emerging in this category, such as Blend and BendDao.

Regarding NFT Derivatives, no projects with decent TVL have been found yet. Derivative protocols with higher liquidity requirements may be relatively early in their development.

Upon further examination of the many NFTFi projects mentioned above, two main characteristics can be preliminarily summarized:

Firstly, the liquidity and pricing of the vast majority of NFT series rely on the order book model, with AMM mechanisms and fragmentation solutions such as Sudoswap accounting for only 0.12% of the market trading volume. This indicates that instant liquidity solutions have almost no market share.

Second, in terms of NFT Lending, Blend uses a peer-to-peer solution to occupy a dominant position. The NFT Lending protocol has several characteristics: the protocol relies on token incentives to attract external funds into the capital pool as lending liquidity; it introduces complex gaming mechanisms or third parties to provide price settlement and other actions; except for Blend, other protocols rely on Blur. It itself has security risks and trust and understanding thresholds for the user side. The NFTs and external liquidity circulating under layers of screening are decreasing layer by layer.

When we compare the issuance logic and business path of the 404 project with mainstream NFTFi, we can find many differences:

After comparing them, the author can tentatively conclude that as a new asset category, 404 differs significantly from the mainstream NFTFi business paths of 721NFTs. The 404 asset series cleverly utilizes existing facilities of both NFTs and FTs to establish bilateral liquidity, introducing new features such as “gacha,” “native fragmentation,” and “AMM liquidity.” Once matured, it is likely to lead to more innovative gameplay, offer more interesting imaginative possibilities, and possess greater development potential.

7. Project Risks

ERC404 and its inaugural project Pandora are still in the early stages, with both the standard and the asset carrying corresponding risks:

The ERC404 standard itself faces issues of uncontrollable burning of NFT assets and higher gas fees due to complex logic.

The ERC404 standard is complex and has not been thoroughly validated over the long term, posing a risk of unknown security vulnerabilities that could lead to hacker attacks or unforeseen problems.

ERC404 is an experimental standard, and theoretically, it should be referred to as EIP404. The number 404 does not comply with the EIP submission guidelines, so attention is needed on how the Ethereum Foundation responds to this standard.

Pandora is only the inaugural project of ERC404, and it may not capture actual value from the potential future development and widespread adoption of ERC404. It may only capture some speculative value.

Pandora has not yet revealed its NFT series (“opened the box”), and as an NFT series, it still requires ongoing operation by the project team. There is also the possibility of being overtaken or replaced by other projects based on the 404 standard.

8. Other 404 Standards

Recently, after the popularity of ERC404, there have been voices in the market advocating for similar standards. The future development of these protocols may need to be observed from the perspective of protocol issuance and the wealth effect, as seen in assets like Ordi and other meme assets. Alternatively, observing from the perspective of blue-chip NFTs such as Bored Ape Yacht Club may require attention to community atmosphere and operational strategies. Here, I’ll provide a brief overview of similar standards.

8.1 DN404

Unlike ERC404, which attempts to merge ERC-20 and ERC-721 standards into a single contract, DN404 utilizes two independent but interconnected contracts - a basic ERC-20 contract and a mirrored ERC-721 contract for unique NFTs.

The series with the highest trading volume based on this standard is Asterix, consisting of 10,000 PFPs (Profile Picture NFTs). Currently, operational details are uncertain, but the project team has mentioned conducting snapshots. Until the subsequent “reveal,” the current fully diluted valuation (FDV) is 26 million.

8.2 ERC-1111

The new token standard developed by the PFPAsia team, also known as the REDT protocol, adopts controllable state changes, allowing users to initiate the conversion process between FT and NFT. Additionally, the ERC-1111 protocol enables the proportional reduction of NFT to FT.

Using the ERC-1111 standard, the PFPAsia team has developed 10,000 PFP NFTs featuring a fusion of Korean and American styles. The ratio of NFT to FT is 1:10000. Distribution began in January, with FT publicly available for sale in February. Recently, NFT freemint sales have commenced in whitelist form. As of March 2nd, the fully diluted valuation (FDV) is 1.7 million, with exchange of graphics and currency not yet activated and reveal pending.

In August of last year, HashKeyNFT, NFTAsia, and PFPAsia collaborated to create a commemorative SBT, celebrating HashKey Exchange’s status as Hong Kong’s first licensed trading platform catering to retail users.

8.3 ERC-X

Multiple standards can be utilized within a single standard (ERC-20, ERC-404, ERC-721, ERC-721 A, ERC-721 Psi, ERC-1155, and ERC-1155 Delta), allowing both ERC-1155 and ERC-721 tokens to be supported by the protocol, leading to greater gas efficiency.

The project developed based on this standard is MINER, aiming to create a cross-chain hybrid token volatility mining protocol based on LayerZero standards. The protocol encapsulates on-chain NFT assets and the MINER token, with the goal of distributing profits among token holders.

Upon its initial launch, the project encountered contract vulnerabilities. However, these were addressed and fixed on February 19th, with operations resumed thereafter. As of March 2nd, the fully diluted valuation (FDV) stands at 3 million.

8.4 ERC-404+

Developed by the Forge team, the project has introduced the _burnedTokenIds array, which tracks all IDs of NFTs that have been burned. Once the total supply limit is reached through the Mint function, the contract design will recycle new NFT IDs from the _burnedTokenIds array, aligning closely with the design approach of Pandora v2.

Currently, the flagship project representing ERC-404+ is FORGE, featuring a series of 6666 PFP NFTs. As of March 2nd, the fully diluted valuation (FDV) is approximately 520K. Additionally, Forge’s official website recently launched a Launchpad, with one project already initiated and launched.

9. Conclusion & Outlook

As a new asset class, 404-type assets ingeniously leverage the existing infrastructure of NFTs and FTs to establish bilateral liquidity, introducing new features such as “gacha,” “native fractionalization,” and “AMM liquidity” at the standard level. Furthermore, they hold the potential to leverage the mature DeFi infrastructure on the Ethereum chain for more complex financial operations, presenting an intriguing new direction for NFT development.

Looking ahead, similar standards to 404 may spawn new “blue-chip” NFT collections and offer a plethora of interesting use cases and scenarios. One envisioned scenario is the emergence of full-chain GameFi, with potential use cases including functional or tool NFTs. Programmable mutable attributes and native fractionalization could empower these types of NFTs with complex value propositions and facilitate financialized gameplay using DeFi facilities. These speculations serve as a starting point for discussion and exploration.

Statement:

1. This article originally titled “深入解析ERC404：NFT的潘多拉魔盒还是流动性革命？” is reproduced from [panews]. All copyrights belong to the original author [@0x_ethan_Crypto]. If you have any objection to the reprint, please contact Gate Learn team, the team will handle it as soon as possible.

2. Disclaimer: The views and opinions expressed in this article represent only the author’s personal views 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.