Token standards on Ethereum can be divided into ERC-20 fungible tokens (FT/Token) and non-fungible tokens (NFT) represented by ERC-721, both of which have been regarded as two types of assets for a considerable length of time. ERC-20 saw a significant improvement in on-chain liquidity following the launch of Uniswap, while NFTs have long been mired in liquidity issues. Over the past two years, a plethora of solutions for NFT liquidity have emerged, including representative ones like Bid Pools, lending protocols, perpetual contracts, and fractional protocols. The protagonist of this issue, the recent widely discussed Ethereum experimental standard ERC-404, shares some commonalities with NFT fractionalization and further blurs the boundaries between Token and NFT.
The continuous exploration of integrating Tokens with NFTs
The combination or interchange between NFTs and Tokens began with the exploration of solutions to NFT liquidity issues, especially the trend of fractionalization. Bitcoin inscriptions laid the foundation for the prototype of NFT-Token integration; Solana’s Tiny SPL then further expanded it.
The earliest can be traced back to the NFT fractionalization protocol Fractional (later renamed Tessera), which proposed to fractionalize high-value NFTs into a certain number of smaller units called Raes. Raes are essentially NFTs that represent collective ownership and governance of a specific high-value NFT and can be traded on NFT marketplaces. Fractionalizing high-value NFTs into smaller units also faced the potential for liquidity to dry up and could bring about confusion in the valuation of the complete NFT.
The fractionalization solution by Fractional did not gain widespread adoption and eventually exited the crypto stage in May 2023 due to poor profitability. However, the fractionalization trend inspired NFT OG player FreeLunchCapital, which launched a new NFT fractionalization solution in mid-October 2023 called Flooring Protocol. Flooring’s approach was to fractionalize high-value NFTs into a fixed 1 million μTokens and use the liquidity of DEXs to facilitate NFT trades. With the help of Flooring, a third-party protocol, the barriers between NFTs and Tokens were gradually broken down. However, since it relies on a third-party protocol, there is a new threshold for liquidity guidance; users must use Flooring and follow its specific rules to achieve the conversion between Tokens and NFTs.
On another network, domo developed a new Bitcoin token issuance standard, BRC-20, based on the Ordinals protocol launched by Casey. Although we are accustomed to referring to BRC-20 as inscription tokens, BRC-20 is essentially used for transactions as a JSON text file. The JSON file is an Ordinals Inscription with a unique number. Each JSON file corresponds to a specific BRC-20 and is more akin to an NFT, with data websites like CryptoSlam categorizing BRC-20 as NFT for calculation purposes. In terms of on-chain trading methods, BRC-20 transactions are also primarily conducted in the form of listings, similar to the previous NFT trading format of the Blur Bid Pool. However, BRC-20, which is more like an NFT, has gradually made its way into CEXs, and even top assets have entered leading exchanges such as OKX and Binance, quietly blurring the lines between Tokens and NFTs.
If BRC-20 represents a gentle breaking of the boundaries between Tokens and NFTs in the realm of inscription assets, Bitmap/BRC-420 is more forceful. The builder, Bitmap Tech, explains that for assets like Bitmap, the NFT is the land of the metaverse, with GameFi underpinning the value of the land; the token is the currency of the metaverse, and all GameFi support as a single unit would lead to better circulation, thus unleashing greater financial attributes of the Token-NFT combination.
On the eve of the eruption of ERC-404 and Pandora, Solana’s new token standard Tiny SPL went online with AMM trading, reviving the first Tiny SPL token Deez Nuts (DN). Two concepts need to be clarified here: one is the rent of the Solana account model, which is the cost of storing data on the Solana network and becomes more expensive as the price of SOL rises; the other is state compression introduced in April 2023, which is used to store any type of data on the Solana chain in a more economical way, with the first application being the compression of NFTs: official data shows that the on-chain storage cost of minting 100 million compressed NFTs is only $1,193. Tiny SPL introduced state compression at the token level, eliminating the need to pay rent, thus enabling bidirectional flow between compressed NFTs and tokens, which can be traded on Magic Eden as NFTs or through the project’s self-built AMM as tokens. In addition, the metadata for Tiny SPL tokens is all stored on-chain, similar to Bitcoin Ordinals inscription assets.
ERC-404 and Pandora
Acme, who claims to be a former Coinbase engineer (Twitter: @0xacme), released ERC-404 on Github on February 2nd, describing it as a hybrid implementation between ERC-20 and ERC-721, with the implementation of ERC-721 being non-standardized. Instead of NFTs being permanently minted, they are burned and minted repeatedly as needed for transactions.
Pandora is the first mixed token standard project built around ERC-404, launched by ctrl, who claims to be an angel investor from Syndicate (Twitter: @maybectrlfreak), and an anonymous developer named Searn (Twitter: @searnseele). In fact, ERC-404 and Pandora appear to be from the same team.
(It’s worth noting that this “Syndicate” is not the one invested by a16z. According to historical tweets, this “Syndicate” announced an investment in the BRC-20 trading terminal project BeFi Lasb on January 22nd of this year.)
From an NFT perspective, Pandora is a collection of NFTs called Replicants, capped at 10,000, which can be traded on supported NFT marketplaces like Blur and OpenSea; from a token perspective, Pandora is a PANDORA token with a maximum supply cap of 10,000, which can be traded on Uniswap.
When a user purchases 1 PANDORA token on Uniswap, they receive not only the token but also a newly minted Relicant NFT, which conforms to the ERC-721 standard and can be directly traded on NFT marketplaces. When a user sells 1 PANDORA on Uniswap, any owned Relicant NFT is simultaneously burned; if a user transfers their 1 PANDORA to a new address, the Relicant NFT in the original address is burned, and a new Relicant is minted in the new address receiving the token.
It is important to note that “1 unit” here refers to an integer amount, for instance, if a user purchases 1.5 PANDORA on Uniswap, only 1 Relicant NFT will be minted; if less than 1 PANDORA is purchased, no new NFTs will be minted. If a user owns 2 PANDORA and sells 1.5 of them, both Relicant NFTs will be burned.
Conversely, when a user buys 1 Relicant NFT from a seller on an NFT Marketplace, they receive not just the NFT but also 1 PANDORA token, which is an ERC-20 standard token and can be directly traded on Uniswap. When a user sells 1 Relicant NFT on an NFT Marketplace, the corresponding 1 PANDORA token is also transferred to the buyer.
From the example, it is evident that when users purchase n.d PANDORA tokens on Uniswap (where n is an integer greater than or equal to 1, and d is the decimal portion), they will receive n newly minted Relicant NFTs. This involves the process of minting and reminting NFTs, leading to two issues: one is the cost of minting, which will be included in the fees users pay when buying tokens or transferring on Uniswap; the other is the change in rarity after reminting, which could impact the current practice of obtaining rare NFTs through reveals and turn it into an unrestricted lottery-like system. As long as one is willing, one could continuously exchange and collide until obtaining a rare series.
The greatest advantage of ERC-404 lies in its native liquidity
In terms of token-NFT interchange, ERC-404/Pandora shares similarities with the fractional protocol Flooring and Tiny SPL’s Deez Nuts on Solana. It’s worth mentioning that Pandora’s core user base is the NFT+DEX community, and the token’s surging popularity might not be separable from the strong push by Flooring players.
Flooring fractionalizes NFTs into 1 million μTokens (ERC-20 Token) and supports the redemption of NFTs with 1 million μTokens. However, for users, Flooring is a third-party protocol, and any exchange or redemption must go through this specific third-party protocol; moreover, Flooring also takes on the responsibility of guiding the liquidity of μTokens for NFT projects, relying on its own platform token to incentivize liquidity.
Deez Nuts (DN) is basically identical to Pandora, but Solana’s state compression feature was introduced to economically address the rent issue, which is different from Ethereum. Furthermore, the liquidity pool for DN tokens relies more on the project’s self-built DEX AMM pool. If external DEXs or aggregators wish to add DN tokens, they need to correctly index them, similar to inscriptions.
ERC-404/Pandora is a hybrid implementation of the two mainstream asset standards, ERC-721 and ERC-20, natively fitting into NFT Marketplaces and DEXs without any third-party barriers.
This point is also evidenced by the launch of the ERC-404 project, where the project deployment address held all the tokens initially, and then added liquidity to Uniswap to put the tokens into the pool. Users purchasing tokens on Uniswap and triggering a transfer transaction would result in the minting of an NFT. Theoretically, the reverse, holding NFTs to begin with, is also possible, but the initial deployment would incur high transaction fees.
First and foremost, it must be clarified that although ERC-404 utilizes the “ERC” standard framework, it is not, in fact, a recognized standard; there is no ERC-404 standard within the Ethereum Improvement Proposals. As noted in the ERC-404 GitHub documentation, it is merely experimental. Unlike Bitcoin, Ethereum places a strong emphasis on orthodoxy, with Vitalik Buterin and the Ethereum Foundation having significant influence. Without their recognition, it might only remain niche. It’s worth mentioning that ERC-20 was proposed by Vitalik Buterin himself, while the major NFT standards, ERC-721 and ERC-1155, were not. Additionally, the process from proposing a new ERC standard to its implementation is lengthy, including but not limited to: drafting an EIP and submitting it to the Ethereum Improvement Proposals repository, broad community discussion, review by EIP editors, revisions and iterations based on community and editors’ feedback, and finally, the proposal.
Secondly, ERC-404 also has its shortcomings. From a transactional perspective, if a user holds 1 rare Relicant NFT and 1 ordinary Relicant NFT, when selling 1 PANDORA token on Uniswap, the user cannot choose which one to sell. The deeper reason is that the contract also cannot determine which token is being sold because, from the perspective of fungible tokens, the fungible tokens corresponding to both rare and ordinary NFTs are the same. Of course, users can store them using a one-token-per-address approach to circumvent this issue.
Moreover, the issue of rarity in the newly minted NFTs after a transfer could be more severe. The founder of the 111 Refuge community, CyberVector, points out that there actually isn’t a gameplay of frequently transferring to mint rare NFTs in Pandora because the rarity is essentially fixed from the start. In NFT projects, the rarity algorithm is undoubtedly kept secret, or some unpredictable source of randomness is used to increase randomness. If the rarity determination algorithm used in the contract is public and predictable, then potential attackers could exploit this information to manipulate the system. They could calculate off-chain which ID would be rare and then only mint those rare NFTs; if the rarity of a certain ID does not meet their expectations, they could choose not to mint that NFT on-chain, or roll back the transaction if the on-chain operation fails. In Pandora, where NFTs are frequently burned and reminted, if the rarity determination algorithm is still predictable, it does not resolve the issue of rarity manipulation.
Finally, ERC-404 is still at a very, very early stage, more experimental in nature. In my opinion, the combination of tokens and images is not key; the practicality after the combination is more important. However, the current hype and FOMO are already very strong. As of February 8th, 16:00, on the sixth day after launch, the price of PANDORA has exceeded $21k, with a market cap exceeding $210 million, representing an increase of hundreds of times compared to the initial price of about $200. Investors are advised to approach this rationally and not follow blindly.