The recent hype surrounding ERC-404 tokens exposed both the promise and shortcomings of merging fungible and non-fungible assets. ERC-404 brought the revolutionary concept of fractionalizing NFTs (Non-Fungible Tokens), transforming the NFT landscape by permitting multiple people to share ownership of a single, high-value NFT. However, ERC-404's experimental implementation led to concerns over efficiency, gas fees, and potential deviations from established standards.
In response to these issues, DN-404 (Divisible NFT 404) has emerged as an alternative implementation seeking to refine the divisible NFT concept. Key differences and advantages of DN-404 include:
1. Architecture
The core architectural design serves as a crucial point of distinction between ERC-404 and DN-404 standards. While both aim to achieve NFT divisibility, the way they structure smart contracts significantly impacts efficiency, compatibility, and overall execution.
ERC-404: The Single Contract Approach
ERC-404 strives for efficiency by combining the features of ERC-20 (fungible tokens) and ERC-721 (non-fungible tokens) within a single smart contract. Let's try to imagine how this contract works:
Representation: In essence, a single ERC-404 contract represents the underlying NFT as well as the fractional “shares” of ownership. These fractional tokens function similarly to how a company has divisible shares of stock.
Internal Accounting: To keep track of who owns how much of the NFT, the contract has to have sophisticated internal bookkeeping procedures. It maintains a ledger to register these fractional tokens and determine which accounts have claims on the original NFT asset.
DN-404: Separating Concerns
DN-404 adopts a modular approach, breaking down the process into two interconnected smart contracts:
ERC-20 Token Contract: This standalone contract focuses purely on issuing and managing the fungible fractional tokens that represent portions of the NFT. Think of these tokens as being just as divisible and easily tradeable as any other cryptocurrency.
Mirror ERC-721 NFT Contract: This is a specialized NFT contract that's linked to the underlying original NFT (which might reside in a separate, existing ERC-721). This mirror NFT plays a crucial role in tracking the relationship between the NFT and its fractional counterparts.
Consequences of Different Architecture
Complexity: ERC-404's single-contract design has the potential to become overly complex due to the interaction of two distinct token standards. This potentially impacts transaction costs and introduces risks through unexpected contract behavior. DN-404 alleviates some of this complexity by decoupling the fractionalization process.
Gas Fees: Because ERC-404 handles more in a single contract, operations (like minting fractions, trading, or recombining them) tend to consume more gas. DN-404's separation generally translates into more gas-efficient interactions.
Compatibility: With ERC-404's deviation from traditional standards, there may be inconsistencies in how wallets, exchanges, and other infrastructure support this specific implementation. DN-404 prioritizes adherence to well-established NFT (ERC-721) and fungible token (ERC-20) standards, maximizing future compatibility with a wider ecosystem.
2. Efficiency and Gas Costs
Transactions on the Ethereum blockchain, regardless of how simple or complex, necessitate a payment known as a "gas fee" in the network's cryptocurrency, Ether (ETH). These fees fluctuate based on network congestion, often becoming unpredictable expenses for users. The rise of complex applications like those handling divisible NFTs puts additional strain on the network, potentially making this problem even more pronounced.
Ethereum's Fee Structure: In Ethereum (and similar blockchains), each transaction, no matter how simple or complex, requires a payment in the network's native cryptocurrency (ETH) called a "gas fee." Miners prioritize transactions that offer higher gas fees.
Gas Price Fluctuations: Factors like network congestion can greatly influence the actual gas price you need to pay in ETH to successfully execute a transaction. During peak usage, gas prices can soar, creating unpredictable costs.
Why ERC-404 Can Be "Gas-Hungry"
ERC-404, in its efforts to merge fungible and non-fungible token characteristics, relies on a single contract. This requires complex internal tracking of ownership fractions, creating more computationally intensive transactions. Due to its experimental nature, some initial optimizations in ERC-404 may contain unexpected inefficiencies when compared to battle-tested standards, resulting in higher gas requirements.
Internal Bookkeeping: The single-contract architecture of ERC-404 requires its contract to perform more elaborate computations internally. It must dynamically track ownership fractions, update ledgers, and manage potential recombinations into the original NFT.
Inefficient Design: Some of the original optimizations envisioned for ERC-404 may lead to unintended costs or complexities. As a new standard, it has less real-world testing than battle-hardened standards like ERC-721.
DN-404's Gas-Saving Approach
DN-404 tackles the issue of gas consumption by separating responsibilities across two contracts: an ERC-20 to manage transferable "shares" and a "mirror" ERC-721 for the NFT asset. This modular approach allows for streamlined operations, especially during common trading scenarios involving token fractions. By simplifying and specializing processes, DN-404 has the potential to reduce gas requirements significantly.
Gas-cost comparison
Two Contracts, Specialized Tasks: DN-404 splits responsibilities. The NFT-mirroring process utilizes the proven model of an ERC-721 contract. Simultaneously, the ERC-20 handles the efficient transfer of the tokens that represent fractions. Each of these contracts is individually optimized.
Reduced Complexity: Simple interactions like 'Alice trades x shares of Y fractional NFT to Bob' primarily touch the ERC-20 contract, avoiding the complexity of interacting with the underlying "whole" NFT represented by the mirror ERC-721.
DN-404 Advantages
The refinement of divisible NFT technology, embodied in standards like DN-404, holds far-reaching implications for the broader NFT ecosystem and decentralized markets at large. Foremost among these is increased accessibility. Traditional NFTs can present steep price barriers, effectively locking out many potential investors and collectors. By dividing expensive NFTs into more affordable fractions, DN-404 can democratize participation. This empowers smaller buyers and collectors to hold meaningful stakes in high-value digital assets, art, or collectibles that were once considered the exclusive domain of wealthy participants.
DN-404's focus on efficiency and compatibility offers the prospect of improved NFT market liquidity. Fractionalized NFTs inherit the intrinsic fungibility of the tokens representing those fractions. This translates into ease of buying and selling, attracting a wider pool of market participants as compared to a single, indivisible NFT. Enhanced liquidity can create a virtuous cycle, increasing trade volume, contributing to tighter price spreads, and minimizing slippage (the difference between expected and actual execution price).
The potential implications of DN-404 don't stop at existing collectibles and art markets. Imagine an application where fractions of real-world assets, such as real estate or commodities, are represented via NFTs. DN-404's approach paves the way for fractional ownership in these spaces, opening investment opportunities in tangible assets previously unavailable to wider segments of the population. Such developments contribute to greater decentralization and diversification of investments.
A notable implication lies in the evolution of NFT portfolios and index-like products. Leveraging DN-404, projects could potentially bundle fractions of diverse NFTs into a single tokenized representation. This concept enables a type of decentralized, thematic “fund” offering curated NFT exposure while reducing entry barriers. Moreover, such tokens could potentially even gain fractional exposure to an ongoing stream of royalty payments if fractionalizing highly coveted NFTs with recurring income streams.
Accessibility: DN-404 lowers the barrier to entry by removing the requirement to purchase a whole, potentially expensive NFT. Fractions allow smaller investors a stake in highly valued assets.
Liquidity: Tokenized fractions are intrinsically fungible, easing trading, attracting more market participants, and promoting smoother price discovery compared to monolithic, indivisible NFTs.
Asset Diversity: DN-404 enables fractionalization of practically any tokenizable asset class, potentially including fractional ownership of real-world assets,commodities, and more.
Financial Innovation: Projects built on DN-404 can potentially create NFT portfolios, indices, and even funds allowing diversified exposure through curated pools of underlying NFT assets.
Dynamic NFTs: Rules around total supply, ownership patterns, and the mechanics of the underlying NFT could be made dynamic depending on market conditions,potentially unlocking a new generation of interactive and adaptive NFTs.
Table of comparison
Potential Downsides of DN-404
It's worth pointing out that even with DN-404's focus on standards compliance, integrating the concept of fractional NFTs seamlessly into various platforms may still require updates and special cases. After all, trading fractions of an NFT is inherently a slightly different process than just selling an entire NFT.
Unofficial Standard: Unlike the core ERC-20 and ERC-721 standards, which have undergone extensive review and official acceptance within the Ethereum community, DN-404 remains a developing standard. This means there's a potential for differing implementations, which could result in unexpected incompatibilities or security vulnerabilities with some platforms or tools.
Unexpected Interactions: While aligning with existing token patterns, DN-404 represents a specific way of interacting with these standards. Potential edge cases may exist in how some less standardized marketplaces or wallets interpret these interactions, especially with regard to the underlying NFT's "mirror" contract concept. Thorough testing helps mitigate these concerns.
User Friction: New users to the crypto space might face confusion when confronted with the differences between "regular" NFTs and DN-404 divisible NFTs. Clear educational material and platform implementations that make the "fractional" nature transparent are key to user onboarding. Some functionalities unique to DN-404, such as recombination rules, could create added interaction steps.
Niche vs. Universal Support: Due to its "unofficial" status, initial uptake by NFT marketplaces and other services might be less universal compared to NFTs that exclusively rely on well-established ERC-721 standards. However, as interest in divisible NFTs gains momentum, this concern is likely to diminish over time.
Conclusion
DN-404 aims to deliver on the promise of divisible NFTs while overcoming the limitations in design and efficiency present in the initial ERC-404 rollout. As both ERC-404 and DN-404 continue to evolve alongside the rapidly transforming NFT landscape, users and developers will need to weigh the benefits against potential risks. Continued refinement of DN-404 has the potential to revolutionize NFT accessibility, use cases, and market dynamism.
