ERC-404 Tokens: What Are They, and How Do They Work

By Lipsa Das

NFTs are a revolutionary asset class that allows users to truly gain ownership over their digital assets. Every NFT is “non-fungible, ” meaning it cannot be exchanged on a 1:1 basis for another NFT. However, non-fungibility also introduces challenges in liquidity, particularly for high-value items. Selling an NFT i.e. listing it on a marketplace and finding a willing buyer is a cumbersome and slow process. 

Enter ERC-404: an unofficial protocol that brings in liquidity for NFTs natively. Launched in Feb 2024 by pseudonymous creators “ctrl” and “Acme.”, ERC-404 has fundamentally changed how many market participants view NFTs.

In this article, Ledger Academy will unpack what an ERC-404 token is, how it works, and its impact on the NFT market.

What Is an ERC-404 Token

ERC-404 is an experimental protocol that brings fungibility to non-fungible tokens by combining aspects of ERC-721 and ERC-20 tokens. Essentially, the ERC-404 token standard allows NFTs to be fractionalized within the boundaries of the Ethereum protocol.  With ERC-404 tokens, fractional ownership is embedded directly into the NFT’s smart contract. This allows you to trade fungible fractional portions of the NFT.

However, it’s important to note that ERC-404 is not an official Ethereum token standard, but a sub-class of asset. The creators have not submitted an Ethereum Improvement Proposal (EIP)—a crucial step for modifying the core Ethereum protocol. Instead, ERC-404 operates exclusively through smart contracts. That said, the long-term roadmap is to integrate with the Ethereum protocol.

So if the ERC-404 token standard is not official, then where did it come from?  Let’s take a look.

The Origin of ERC-404 Tokens

The idea of ERC-404 initially originated from a failed project called Emerald. Emerald was built on the back of another Ethereum protocol called ERC-5335 in early February 2024. While the project didn’t work out due to a critical flaw, it set the stage for the development of ERC-404. 

Subsequently, ERC-404 tokens were developed by Pandora. They launched the first ever ERC-404 token, $PANDORA in 2023. The token caught on pretty quickly, hitting a $100M market cap just a few days after its inception. Currently, other projects are using this standard to make fractionalizing NFTs much easier.

How Do ERC-404 Tokens Work?

ERC-404 tokens enable fractional transfer of NFTs using a link and burn mechanism. Every ERC-404 token has a linked NFT, automatically minted to your wallet when you buy a full token. If you sell fractions of your token, the protocol burns your NFT. Conversely, if you buy enough fractions to form a complete token (say 0.2 and 0.8), the protocol automatically mints you a new NFT.

Let’s understand this with an example:

Imagine you have an NFT of a famous piece of artwork. The original token is unique, thus non-interchangeable. However, using the ERC-404 standard, this NFT can be split into multiple fungible portions.

The portions are fungible. They can be interchanged with one another. In addition, anyone who collects all of the portions would be able to reconstruct the original NFT. It also allows you to buy or sell bigger or smaller portions of the token as a single NFT due to the built-in burn mechanism. In short, the smart contract can destroy the smaller fractions and reissue them as a single token representing the same value as the fractionalized pieces. 

But what does that mean exactly? To understand their importance, let’s look at why ERC-404 tokens are so interesting in the first place.

Why Are ERC-404 tokens So Interesting?

For starters, ERC-404 tokens offer a range of new use cases to NFTs, such as DeFi, without needing third-party platforms. Let’s see how they achieve this.

Removing the Need for Third-Parties

Before ERC-404, fractionalized NFTs were only possible through third-party protocols. Typically, these protocols would take your NFTs, lock them up in the protocol wallet, and issue tokens in return. However, this mechanism introduces two key challenges. Firstly, you need to trust a third party to safeguard your NFT tokens. Secondly, the value of tokens you get from the protocol often lags behind the value of the assets — which means you may take an unrealized loss.

On the other hand, the ERC-404 standard natively binds the value of tokens and NFTs. NFTs built using this standard mirror their actual floor price in real-time. Since the mechanism is handled by a decentralized smart contract, it eliminates potential price discrepancies and the need for third parties. 

Bringing DeFi Mechanisms Into the NFT Scene

ERC-404 tokens also solve a critical problem in the NFT space: liquidity. Using ERC-404, you can sell portions of NFTs via liquidity pools. To explain, liquidity pools lock funds in a smart contract and can facilitate trades between different assets without needing a third party. When you sell an ERC-404 token in its liquidity pool, it’s the same as selling the corresponding NFT directly. Apart from you can send a third of the full NFT or even an 18th of an NFT in a decentralized manner. Using a smart contract, the system can recognize the true price of that asset, or fraction of an asset, in real-time.

With these features, ERC-404 tokens facilitate a more dynamic and efficient NFT market.

Top ERC-404 Tokens

The ERC-404 standard is still evolving, thus new tokens drop each day. However, the three leading ERC-404 tokens are Pandora, DeFrogs, and EtherRock. Let’s look at these projects and see what makes them different.

Pandora

One of the first tokens on the ERC-404 protocol, Pandora brands itself as a type of “semi-fungible” token. Pandora’s NFT collection has 10,000 ERC-404 tokens (called “Replicant NFTs”) linked to 10,000 PANDORA tokens, fungible ERC-20 tokens. Apart from traditional ERC-404 characteristics of fungibility, Pandora NFTs have a unique feature called “regeneration”. Every time you move a PANDORA token, the associated NFT “regenerates” to produce a completely different NFT.

DeFrogs

DeFrogs is a collection of 10,000 Pepe Frog NFTs made using the ERC-404 token standard. As a classic reference to crypto’s meme culture, DeFrog aims to be a cute PFP collection with a strong community base.

Pundi X PURSE 

PURSE is a project powered by Pundi X. It aims to act as a loyalty token for merchants worldwide. The idea is that PURSE will act as an incentive for users to complete certain tasks or perform certain actions such as writing tweets. Using the ERC-404 token standard, PURSE users can swap their loyalty tokens for one another without having to worry about losing out. Since the fractionalized portions can be split or rejoined together, it’s possible to exchange one token for another with a calculatable exchange rate.

Which Platforms Support ERC-404 Tokens?

As ERC-404 tokens are still experimental, and not yet an official asset type in the Ethereum ecosystem, there are a limited number of platforms that accept them. That said you can currently interact with them on the following platforms:

• Uniswap (a top decentralized exchange)
• Blur (a popular NFT marketplace for NFT traders)
• Opensea (The first NFT marketplace)
• Wasabi Finance (a DeFi Protocol)
• Peapods Finance (another DeFi Protocol)

Of course, as the ecosystem grows, you can expect more protocols and platforms to support these assets in the future.

The Risks of ERC-404 Tokens

As with any experimental technology, the ERC-404 standard is inherently risky. Since ERC-404 tokens aren’t an official Ethereum standard yet, they haven’t undergone extensive community testing for security flaws. Put simply, the ERC-404 standard overlaps two very distinct token standards that were not initially designed to integrate. Therefore, there is a chance of smart contract exploits and bugs, which can lead to loss of user funds. To illustrate, the first rug pull on ERC-404 was executed minutes after the protocol was live.

Plus, established marketplaces may not support them yet, so users should proceed with caution while using them across DeFi and other applications.

The Future of ERC-404 Tokens

The future prospects of the ERC-404 token standard are too early to predict. The next step for ERC-404 tokens is to file an Ethereum Improvement proposal to get the standard formalized. 

However, the EIP approval and implementation process is notoriously slow, with a timeline that can stretch into years. It might be a while before ERC-404 becomes part of the Ethereum protocol. Developers are also introducing newer protocols like DN-404 in an attempt to improve on the existing ERC-404 mandate.

That said, experimental Ethereum tokens have seen a lot of interest in the past. Today, it’s hard to imagine an Ethereum chain without ERC-721 and ERC-20 tokens, which were both unexplored at one point.

But, while ERC-404 tokens are still finding their footing, it’s important to take a cautious approach. If you’re going to interact with them, consider segregating your funds across multiple accounts and using a burner wallet. Doing so will protect your main holdings from the plethora of risks involved with interacting with experimental assets. 

Luckily, using a Ledger device you can generate and manage multiple wallets within the same interface, allowing you to experience innovations like ERC-404 without endangering your main holdings. That’s the beauty of Ledger’s security model. Your Ledger device, alongside its trusty companion app Ledger Live, gives you all of the tools you need to keep your assets safe. So what are you waiting for? Experience the next frontier of NFTs with a Ledger device.