‘Every token is already a micro-pool’: ERC-404 as a Frankenstein’s monster in NFT 2.0

Back in 2020, NFT 2.0 projects could be counted on one hand. Today, thanks to Uniswap v3, the NFTfi segment and lending protocols such as Blend and NFTX, the topic gets more airtime—usually without much detail. Web3 entrepreneur Vladimir Menaskop set out to fill the gap.

Today I want to examine aspects of ERC-404 that concern not the “standard” itself (not least because it is not a standard at all) but its links to broader trends. First, some primers to get up to speed:

1. Key concepts and a description of ERC‑404.
2. Risks associated with it.
3. A possible evolution.

We can now turn to the main trends that ERC‑404 illustrates.

Trend no. 01. The decentralisation of liquidity

What unites large bitcoin pools, Lido, the censorship of Ethereum blocks by validators, and the more than 10,000 tokens and coins listed on CoinMarketCap? In fact, three trends at once:

1. The evolution of cryptoassets, which lets builders create ever more complex instruments.
2. The evolution of DeFi as a distinct industry, ultimately making the principle of self-embedded dapps a reality.
3. The evolution of liquidity, which boils down to this: it matters not only how many assets are issued (Total Supply) and how many are in circulation (Circulated Supply), but also how much corresponds to their initial liquidity.

Let me unpack the last point.

First, liquidity tends to equilibrate along two dimensions:

1. For any available unit of time (t), to deliver the highest capital efficiency.
2. To minimise any transaction costs.

Decentralisation, in one sense, undermines both principles—but separately. The more holders of liquidity (providers, to use the standard term), the higher the transaction costs: on average, 100 people generate more transactions than one.

So with efficiency: having 100 bitcoin lets you compound far faster than with one satoshi, if only because of the latter’s atomicity—even in the era of Ordinals.

Paradoxically, if you consider decentralisation together with both parameters, it improves each—and both at once.

So to make sense of ERC‑404, consider how decentralised liquidity evolved before it. A brief excursus, from Bitcoin’s birth:

1. At first there was one network—lacking a central actor to manage issuance and distribution, but having a single chain for transmitting value.
2. Because bitcoin had weaknesses, forks appeared. Each affected liquidity in its own way: some prioritised anonymity of ownership (X11), others speed of exchange (Litecoin), and so on. In any case there were now several decentralised networks, but they interacted mostly through centralised protocols and venues (exchanges) and were themselves centralised around a single chain—the blockchain.
3. Then, in the BitShares and Ethereum families (and elsewhere, though those are now exotic), liquidity began to blur between the network’s native token (coin) and second‑order tokens, even as the chain remained a single skewer onto which liquidity was impaled piece by piece.
4. Around 2016 DeFi emerged: the infamous decentralised fund The DAO, the successful ICO of Bancor, and so on. In‑network exchange became faster and more decentralised, though true cross‑network value transfer was still distant.
5. Next came a long transition from multichain to cross‑chain. Today there is even L0 (LayerZero and the like)—in pure form and via Polkadot parachains, Cosmos hubs and Avalanche subchains—though the EVM family remains paramount. All this decentralises liquidity not only at the network level but, more importantly, between networks.
6. In parallel, the move beyond a single, uniform chain has come via DAG‑based designs and sharding, while liquidity itself has been aggressively optimised. Witness the shift from staking to liquid staking to restaking, and the revival of social points.
7. Along the way, centres of gravity such as Lido or Uniswap inevitably emerge, so projects try by all means to persuade users to park liquidity with them—though the answer is obvious: a combination of first‑ and second‑layer solutions.

What do L2s do for L1s? They solve the same problems that first‑wave altcoins tried to solve for Bitcoin, only now in tandem with a base network (above all Ethereum), which, per the trilemma, acts as a security layer.

Thus liquidity is being decentralised along two basic vectors:

1. External—from Bitcoin’s single‑chain story to the altcoins’ multichain era, on to today’s cross‑chain, and further to the “offline‑online” interface via combinations of centralised and decentralised solutions.
2. Internal—the liquidity provider is not only a miner, node operator or other super‑node, but any holder of an ERC‑20 token, an NFT, etc—even just an active user of a GameFi app. No wonder Notcoin and Hotcoin are so popular.

On this second vector ERC‑404 takes a step forward, leaving external decentralisation to EVM interoperability. And that is not all.

Trend no. 02. A market for collateralised derivatives

Ever wondered why the past 150 years have seen so many crises? Even if you pick just the 20th century’s swings, you get 1903, 1907, 1914, 1929, 1939, 1961, 1972, 1981, 1998—cycles lasting from one to three years to a decade in different regions.

There are many problems, but one fundamental one is squarely on point today: derivatives.

In recent decades the derivatives market has outgrown the “money” market roughly ten to one. What was meant to help us manage the future by hedging the past ends up killing the present, turning it into perpetual bill‑paying.

What to do?

The answer is obvious: build a market for collateralised derivatives. DeFi did precisely that. Perhaps you simply did not notice. A few examples:

1. Uniswap v3. When you create a pool, your concentrated liquidity is bound to an NFT. That greatly simplifies the transfer not only of the pool’s assets but of its income. In effect, the NFT is a first‑order derivative. If, say, a futures contract on next year’s harvest is backed by the harvest only roughly 50/50 (hail or frost may wipe it out), an LP‑NFT is always backed at the pool’s floor price. Moreover, even if something happens to the actor who opened the pool, the pool can keep working. Terra (LUNA), the FTX token and others are “fine” examples—if not the only ones. Hence the NFT binding became the de‑facto standard: look at MonoSwap, which recently launched on Blast testnet. The linkage mirrors Uniswap v3. Go further to Maverick, which manages liquidity even more efficiently—still via NFTs.
2. Bridge tokens. They are less fashionable than two or three years ago, but they epitomise the interplay of external and internal decentralisation of liquidity. Creating, say, xUSTt in one network against frozen USDt in another gives birth to a collateralised derivative of the first order. Hence Wormhole and similar solutions, including those built atop them, spawned whole subfamilies of stablecoins.
3. Decentralised stablecoins. The evolution of DAI or even Frax—and then a line‑up of algorithmic stablecoins—shows that they are themselves derivatives, either of collateral (which sets a price band and a unit of account) or of other quantitative parameters.
4. stETH and the market around it—derivatives of the first, second and higher orders. If ETH is the base asset, then stETH is the asset plus a yield stream. From there you can borrow against it, wrap it, bridge it, and so on, spawning ever more intricate models.

Many more examples exist, but they all point to one thing: DeFi is a native toolkit for building collateralised derivatives. The form they take is another question. I am partial to the NFT 2.0 approach.

Trend no. 03. NFT 2.0 and DeFi 2.0 as NFTfi

Whatever your view of the NFT 2.0 market, it plainly exists. Core projects number in the hundreds, and a great many top protocols use NFT 2.0 under the hood: Uniswap, ENS (wrapped decentralised names in v2), Aave insurance, markets for unissued tokens wrapped into NFTs, and much else besides.

That is because NFT‑isation is simply a way to express the external and internal decentralisation of liquidity:

1. On one side, the more protocols that “attach” NFTs to liquidity and its parameters, the greater and better the external decentralisation.
2. On the other, each such NFT is already a micro‑pool.

In this sense ERC‑404 packs the best—and the most dangerous—elements of all three trends.

Does it have a future?

To answer my own question: I hope not.

First, Pandora, which spawned the 404 market, did so a little too swiftly and zealously: with huge, pumped‑up liquidity and anonymous creators who clearly wanted to upend convention by choosing “404”, long associated in IT with something that does not exist.

Second, there are far tidier—and, crucially, safer—protocols than 404 in any guise. Third, this is hype, froth; the substance lies elsewhere.

Yet it would be wrong to deny that 404 had an effect: for a moment, however brief, everyone considered that liquidity could be (a) fractionalised; (b) NFT‑ised; and (c) exist in two guises—fungible and non‑fungible—at the same time.

In any case ERC‑404 is NFT 2.0.

That said, ERC‑404 is far from the whole of NFT 2.0 and certainly not its best exemplar. One more plus of this “standard” is seldom mentioned: it gives a boost to low‑liquidity assets (NFTs).

This problem is long‑standing, which is why there are so many NFT‑related (and not only NFT‑related) EIPs: everyone tries to build either pools (NFTX), or direct bindings (Charged Particles, Envelop) between NFTs and collateral (Collateral/Vault), or composable strategies, or even to prop up the floor price artificially.

But the crux is not the much‑discussed boost for NFTs; it is making that boost natural, native—intrinsic to the asset a priori.

Is that even desirable? Not necessarily. Reputation can serve as collateral, but it is not transferable. A rating can be: one can eat apples or paint them, but “printing” fiat money is not a great idea.

This brings us to the key point of the piece: the digital—more precisely XR—world has, via NFTs, arrived at uniqueness, which it lacked when any digital object could be copied endlessly. Now we must decide which unique properties attach to a given object, and even to a subject: we have never before colonised virtual and adjacent worlds.

In that sense ERC‑404 is a Frankenstein’s monster that may be human inside but not outside, even if it looks like a human.

Once again: an existential, and thus financial, crisis looms—when something that “quacks like a duck, walks like a duck, flies like a duck” is not a duck. In this, ERC‑404 is one of the supernovas amid galaxies and other clusters.

It is fascinating to watch, but do so at a safe distance—or be fully prepared to plunge into the black hole of hyper‑efficient liquidity, where AI bots drive speed and the crowd’s perpetual‑motion machine—greed—slashes costs.

Postscript

If you want to dig deeper, here are a few links:

1. The liquidity of black holes, or a DeFiN interaction model via AdS/CFT correspondence.
2. DeFi risks as a driver of decentralised finance’s evolution.
3. The positives of DeFi.
4. Why decentralisation matters for evolution.
5. wNFTs and the market for collateralised derivatives—the future of Web 3.0?