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Breaking Down the Next Big Thing in NFTs: ERC-404 Spotlight

by Serge BaloyanFebruary 20th, 2024

Too Long; Didn't Read

Fractionalization allows anyone to invest a small amount and own a piece of the pie. ERC-404 is a proposed standard that aims to revolutionize fractional NFT ownership. It is baked directly into the token standard rather than handled off-chain. Each fractional token is cryptographically linked to its corresponding piece of NFT.

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NFTs have taken the crypto world by storm over the past year. From Bored Apes to CryptoPunks, valuable digital collectibles are selling for millions. But what about the rest of us who can't afford a whole NFT but still want in on the action?

That's where fractionalization comes in. Platforms like Pandora have pioneered the concept of dividing up ownership of an NFT into multiple tokens. This allows anyone to invest a small amount and own a piece of the pie.

However, existing fractionalization methods have their limitations. You have to trust a middleman to securely store your NFT. Liquidity can be an issue if you want to sell your fraction. And recombining pieces back into a whole NFT is a pain. A solution to this is ERC-404 - a proposed standard that aims to revolutionize fractional NFT ownership.

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And now, here’s a deep dive into what ERC-404 is all about:

A World of Native Fractionalization

Most tokens issued on Ethereum and traded on exchanges follow the ERC20 standard. NFTs, on the other hand, adhere to the ERC721 standard. However, the popularity of NFT projects like CryptoPunks and Bored Ape Yacht Club has left many crypto enthusiasts frustrated that they only have a limited amount of funds in their wallets but want to profit from the hype surrounding expensive NFTs.

With ERC-404, fractionalization is baked directly into the token standard rather than handled off-chain. When an NFT is initially minted on ERC-404, it simultaneously mints a set of ERC-20 tokens that represent ownership shares.

What's the Point of ERC-404?

Each fractional token is cryptographically linked to its corresponding piece of the NFT. Buy 0.5 tokens? You own half the asset. Collect enough to make a whole token? The full NFT is migrated to your wallet. No more relying on third parties.

Let us consider a practical example.

Say, I issue 5000 PIXEL tokens in the ERC-404 format. PIXEL tokens include 5000 ERC-20 tokens and 5000 NFTs. Each ERC-20 token in this system is linked to a specific NFT, allowing for fractional ownership.

• When buying 1 whole ERC-20 token, the corresponding NFT automatically appears in the buyer's wallet, confirming full ownership of the asset. • If only a fraction of the ERC-20 token is purchased (for example, 0.5 PIXEL), the associated NFT is destroyed. As a result, the buyer only has a share of the token without linking to the NFT. • When the owner of the fractions collects enough to form a full ERC-20 token (for example, bought 0.2 PIXEL, then 0.5 PIXEL, and another 0.3 PIXEL), a new NFT is created in their wallet, restoring full ownership of the unique asset.

Built-In Liquidity From Day One

Because ERC-404 tokens behave just like normal ERC-20s, liquidity pools can be set up from the beginning. Want to sell your fractions? Just swap on an AMM dex like usual. No manually finding a buyer or dealing with order books. Additionally, unlike ordinary fractionalized NFTs, ERC-404 can be automatically fractionated into one NFT or an entire collection.

Massive Potential But Major Caveats

The promise of smooth, trustless fractionalization is undeniably appealing. However, ERC-404 is still very early and carries risks like bugs, scams, and lack of adoption.

Let’s not disregard the fact that the Ethereum developer community has not officially approved the standard, so rug pulls, vulnerabilities, and other issues are quite possible. Moreover, combining two tokens will not return the same NFT, so its value may be variable—this will depend on the specific project. Last but not least, eternal mints, remints, and burns are driving up the price of gas. Today, it reached its maximum in 8 months - $60 for an ordinary transaction in the Ethereum network.

We strongly believe that with refinement, ERC-404 could be huge. We already started to work with ERC-404 projects. However, in its current state, it’s better to keep a close eye on ERC-404 as it develops — only time will tell if it lives up to the lofty vision.