ERC-404 Found: Unveiling ve404 Tokenomics
The ERC-404 standard has emerged as a novel token model that blurs the traditional boundaries between fungible and non-fungible tokens. By enabling the creation of NFTs through the aggregation of a specific quantity of fungible tokens, ERC-404 introduces a new way to represent token holdings. Separately, the concept of veTokenomics is built on the premise of locking up liquid tokens in exchange for vote escrowed tokens, with the goal of apportioning reward accrual and governance power with long term alignment. In this article we present an alternative implementation of veTokenomics using ERC-404 mechanics, which creates a system equivalent to veTokenomics but with a time-based race condition that incentivizes the token supply to be locked up as quickly as possible for the purpose of capturing governance power and protocol revenue.
Introducing ve404
This model links governance power—essentially, the entitlement to a more significant share of fees and revenue—to the tokenID of the NFTs minted via ERC-404. ve404 retains the core incentives of veTokenomics for long-term holding while enabling a new dimension of financialization. The system prioritizes holders of lower ID NFTs, rewarding early adopters and those with larger commitments with enhanced governance power, akin to the benefits provided by veTokenomics for extended lock-up periods.
How does it work?
The ERC-404 standard employs a straightforward formula to determine the conversion of fungible tokens into NFTs:
IF Tx is <1, the transaction processes as a standard ERC-20 transfer.
IF Tx is ≥ 1, the recipient receives NFT(s) for whole units and change as fungible tokens (ERC-20) for fractions.
Each time an NFT is minted upon reaching the specified thresholds, the NFT ID increments, but fractionalizing an NFT leads to the burning of the NFT, and its ID is irreversibly lost. This can be leveraged to natively incorporate information regarding seniority into the holdings of each user, which can then be used by governance contracts to apportion voting power and revenue share, with lower NFT IDs corresponding to greater governance power and revenue share. Note that under this framework the fractional tokens can still be staked to acquire governance power and revenue share.
Imagining The Fungible Counterfactual
If there was a fungible derivative token that was minted in proportion to tokens committed to vote escrow on the basis of seniority, there would be no way to formulate a mapping between the number of tokens and their redemption value. It is actually technically necessary to introduce NFTs to create a time-based race condition for incentivizing the locking up of governance tokens. The heterogeneity of the assets also prevent liquid staking wrappers that function to undermine long term alignment (e.g., Convex) from taking root.
Illiquidity Is a Feature
Liquid derivative tokens undermine lockups. Selling of the locked position impacts the secondary market, and the more liquid the locked position, the more impact there is on the secondary market of the underlying. NFTs are already relatively illiquid by their nature. More valuable NFTs have a higher capital barrier to entry; their appreciation and the attendant worsening of their liquidity profile create a natural stabilizer against the potential to siphon demand from the underlying secondary market. However, NFTs are just liquid enough to financialize, and the next section will make clear why the NFT approach to veTokenomics is superior to making them soulbound.
Made for NFTFi
NFTFi becomes the perfect setting for ERC-404 NFTs. These NFTs feature a definable floor price derived from intrinsic value, with their governance power and seniority associated with NFT IDs contributing to an "above floor" valuation. This distinct floor price clarity allows platforms like Fungify Pools and other lending protocols to service such NFT as a collateral asset with the same certainty that would come from servicing a liquid ERC20 asset. Additionally, peer-to-peer lending protocols benefit, as they can more accurately account for the "above floor" value in their loan considerations.
Conclusion
At its core ve404 is a simple but powerful idea: adding a time dimension to governance and fees, where being earlier is better. It’s using NFTs to represent an on-chain database entry and allowing it to be financialized. Whereas many other approaches to ERC-404s consume gas liberally to maintain each user’s NFT tokenID, this approach leverages the natural flow of IDs as users mint and destroy them.
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