- ERC-4626 tokens are fundamentally tied to Decentralized Finance (DeFi).
- The EIP -4626 proposed in December proposed the creation of the ERC-4626, a token whose objective would be to optimize the different types of design of performance tokens.
- This update is known as “the tokenized vault standard” as it provides a general way to create assets that reward users for various platforms.
The ecosystem on the Ethereum blockchain does nothing but grow and expand. If you’re familiar with non-fungible tokens, or NFTs, you’ve probably heard of the ERC-721 token, or if you know what Ethereum is, you’ll be familiar with ERC-20 tokens. However, there is another that everyone should know and they are the ERC-4626, which are fundamentally linked to Decentralized Finance (DeFi).
Since 2020, Decentralized Finance (DeFi) has become known around the world and, consequently, the Total Value Locked (TVL) has increased at an impressive speed. In fact, currently the TVL of DeFi on the Ethereum blockchain is $71.03 billion USD, according to DeFiLlamabut, to grow, DeFi has many processes to standardize to reduce costs and risks.
Yield farming and yield aggregators
The objective of any product or service that is included under the DeFi terminology is to redefine traditional financial services, such as payments, investments, loans, insurance and others, seek to end the role of the intermediary. And, consequently, financial services such as loans and decentralized trading usually live in the ecosystem.
However, there is one concept in DeFi that is particularly relevant to this article. Its about ‘Yearn Finance’, or ‘yield farming’. This consists of the returns that a user obtains for depositing funds on a platform, that is, lend them. It closely resembles the interest payments offered by traditional banks.
But, there is a problem, yield farming by itself is not attractive for users with little capital or knowledge on the subject, and as always, a solution emerged: “Yield Aggregators”. These consist of a set of Smart Contracts that pool user funds to optimize returns. Currently, they are known as “Vaults”.
As is often the case, another problem arose: lack of standardization. Protocols and performance aggregators had to adhere to different interfaces.
Basically, DeFi developers, to integrate tokens that will generate returns, commonly created unique coding solutions. That is, they had to spend their own or the project’s money to audit that custom code since it is prone to errors.
As you might imagine, this increased complexity and cost, since each protocol had to implement its own adapters, making them prone to errors and waste. This is where the ERC-4626 becomes relevant.
What is the ERC-4626 token?
On December 22, an Ethereum improvement proposal (EIP) was made to change the context without standardization in the vaults, being the EIP-4626. This update suggested the creation of the ERC-4626, a token whose objective would be to optimize the different types of design of performance tokens.
This update is known as “the tokenized vault standard”, since it provides a general way for platforms like Aave or Yearn.Finance to create assets that reward users.
So what it does is standardize the vaulting process, while ensuring that the cryptocurrencies are protected.
However, the benefits of the ERC-4626 are not limited to end users. By standardizing the process, developers will be able to create interfaces for the tokens that are part of the vault process without spending too much time or money and not having to write new code. And it is a shared interface.
In fact, although the original scope of the proposal was as mentioned, it could now cover a new set of use cases. Especially, some in the crypto community are of the opinion that ERC-4626 has the potential to transform DeFi.
Since its approval on March 18, a large number of DeFi protocols, such as Yearn Finance and Balancer, have implemented ERC-4626 in their vaults.
Features of the ERC-4626
As many of you know, a large part of the tokens available in the crypto market comply with the ERC-20 standard, this means that the tokens can move on the Ethereum blockchain without any problem. Consequently, the ERC-4626 adds even more flexibility to the blockchain, since any application created on top of an ERC-4626 vault will work for any such token.
In this way, ERC-4626 extends the ability of ERC-20 tokens to move through the ecosystem that exists on the Ethereum blockchain. In fact, the staking tokens of these DeFi protocols must also comply with the ERC-20 standards.
Therefore, developers have the ability to implement ERC-4626 however they wish as long as the protocols interface with the implementation in compliance with the standardized interface.
An important aspect to note is that ERC-4626 classifies vaults as transferable and non-transferable:
- Transferable Vaults: In them, a representative ERC-20 token is issued to the user. That is, the token represents the user’s share of the vault pool.
- Non-transferable vaults: In this case, tokens are not used.
¿Why is it so important?
The cryptocurrency ecosystem continues to develop and still has many challenges ahead, therefore the same logic applies to all products that are enshrined under DeFi, considering that it is an even more recent industry.
Yearn Finance, one of the stakeholders in the ERC-4626 and also one of the most important in DeFi, referred to it as the “gold standard”, and that is, by standardizing the establishment of vaults, new possibilities are opened for interoperability between different protocols.
It is essential to understand that the issue of interoperability in the cryptocurrency ecosystem is particularly important. By reducing friction between blockchains, users will be able to move freely throughout the ecosystem, but, in addition, interoperability and standardization allow the doors to be opened to innovations.
However, although several DeFi protocols have implemented it, it remains to be seen how ERC-4626 will spread through DeFi.
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