Explaining ERC-3525: What it is and How it Works
By Mike Meng, Co-author of ERC-3525 token standard, Co-founder of Solv Protocol
As of Sep 6th, 2022, the semi-fungible token standard ERC-3525 has moved to final and become an official token standard before the long-planned ETH merges.
However, 35 token standards have been approved by the community. Amid the rise in popularity of token standards, here comes a question: what makes ERC-3525 stand out?
ERC-3525 defines a new asset class, semi-fungible token (SFT). ERC-20 and ERC-721 standard commenced in 2015 and 2018 saw the market notching hundreds and tens of billions by now. However, ERC-3525 is of virtually the same magnitude as ERC-20 and ERC-721. Is ERC-3525 on track to open up a new market contending with the other two standards?
In juxtaposition to other specified token standards, ERC-3525 is a more “universal standard”, designed by core members of Solv Protocol and propped up by core developers of the Ethereum community. The process extends up to 20 months from initial proposal to definitive acceptance of the community, buffed up with several drafts. “Slow fire makes sweet malt” is rare in the space but has been a source of pride for the team members.
In advance of answering that, it’s necessary to understand the interpretation of SFT and differentiation among FT, NFT and SFT.
What is SFT — started with FT and NFT
Fungible token (FT), as its name implies which is identical, numerable and interchangeable, is the earliest token standard, often perceived as the crypto equivalent of currency, common share, or credits of the traditional world in the average joes. In 2015, the idea of using smart contract-based tokens was raised by Vitalik Buterin on the heels of Ethereum mainnet launched. In November of the same year, Fabian Vogelsteller officially proposed a standard for the adoption of ERC-20. Upon that, ERC-20 has sparked endless innovations and bootstrapped crypto world’s multi-billion-dollar market growth.
Non-fungible token, often referred to as NFT, stands on the other end of the spectrum from ERC-20s. As opposed to the mutually interchangeable ERC-20s, an NFT has its own ID and custom metadata, making itself unique (i.e., not interchangeable). Specifically, an ID consists of an address of maternal smart contract and a serial number, and metadata contains information which describes the diverse attributes of the NFT. Because they are unique, NFTs are suitable as digital vehicles to represent digital goods like arts, domain names, sound clips, in-game items, and more.
The definitive standard for the NFT is ERC-721, proposed in early 2018 by William Entriken, et al. Over the three years since its initial introduction, the NFT remained a lesser known digital entity compared to its fungible ERC-20 counterparts. It wasn’t until CryptoPunks, Nyan Cats or Beeple‘s Everydays: The First 5,000 Days later on that NFT saw a serious breakthrough in transaction volume and market value. In early 2022, over US$36-billion-dollar worth of NFTs were minted (created) and put on the shelves. Today, there’s an unshakeable consensus that the NFT will be one of the pillars for Web3 and metaverse.
What is SFT?
Semi-fungible tokens, or SFTs, are the third type of general-purpose, blockchain-based, digital asset class right after FTs and NFTs. These tokens are semi-fungible because they are at a sweet spot combining the liquidity features of fungible tokens and descriptive attributes of non-fungible tokens. To understand SFTs, we must first consider what kind of ownership or rights could be represented by this exotic, hybrid-ability token.
Generally speaking, any digital good that has quantitative attributes and may under some circumstances require quantitative fractionalization or combination could be represented by an SFT. Bonds, coupons, vouchers, invoices, promissory notes, land titles, sophisticated financial contracts like futures, options, ABS are examples of such a digital good. Under the SFT standard, two identical, $500 on-chain bonds should be able to combine frictionlessly into a $1,000 bond.
The SFTs are powered by what’s known as the ERC-3525 Semi-fungible Token Standard (finalized Sep. 2022), an EIP standard created to combine the quantitative (computable) attributes of fungible tokens and descriptive features of non-fungible tokens. ERC-3525 is a general-purpose token standard and therefore is scalable into various uses and functionalities. Solv Protocol, the creator of the standard, uses the ERC-3525 as a sort of digital asset container in which a user could package unlimited amounts and types of tokens inside it for various purposes. Users of the ERC-3525 token could also transfer digital goods directly in and out the token freely so that complex on-chain activities such as repaying a bond issuance to multiple lenders can be done quickly and at a low cost.
How does ERC-3525 work?
A Web3 user may leverage the ERC-3525 token in a few way:
1. Create advanced digital financial assets such as CDs, checks, bonds, options, futures, swap, insurance policies, equities, or ABS, etc. Using the ERC-3525 token to represent these assets provides the liquidity advantage as an ERC-3525 token could be split into infinitely many pieces, as well as the visualization advantage as the key terms of a contract and attached file links would be easily accessible.
The greatest gift of the ERC-3525 token used as a financial asset is perhaps the look-through transparency enabled by the blockchain, which provides when the user wants to find out how an underlying investment asset is performing.
2. Build digital goods or items of Web3 or the metaverse such as fractionalized virtual lands, upgradable/mergeable in-game items, virtual membership cards, gift cards, raffle tickets, etc.
3. Onboard real-world assets (RWAs). ERC-3525 tokens could embed legally binding contract documents (in PDF files, for example) and enable access through blockchain oracles to real-world information on the related assets.
Examples for ERC-3525s as tokenized RWAs include tokenizing solar panels and right to their ungenerated profits and real estate tokenization. Both cases could use surface area or the square footage of a house as the token’s quantitative parameter allowing users to perform split or merge operations in all ways possible. Lastly, ERC-3525s as tokenized RWAs are regulator-friendly since they provide multiple benefits to regulatory compliance such as reduced frictions between multiple parties, secure decentralized records, and authenticated provenance of assets or materials.
4. Tokenized wallet. ERC-3525’s ability to nest any crypto assets inside means an SFT is practically a blockchain wallet for any digital assets going from Bitcoin, Ethereum, BAYC NFTs, SFTs, or all of them at once. Besides everything an ordinary blockchain address does, an ERC-3525 “wallet” also offers fractionalization and transferability features that no other wallets do.
5. Tokenize and visualize smart contracts. Every ERC-3525 token has a full-blown smart contract embedded inside that can store, send, or receive a given crypto asset if invoked. Tokenization means every smart contract is visualized, transferable and fractionable, making every ERC-3525 token not just a tokenized, but superior smart contract. Developed by creators who recognized the cruciality of smart contracts to the blockchain ecosystem, ERC-3525 is designed for all possible uses and is truly application-agnostic.
One area that would benefit significantly from tokenizing smart contract would be the supply chain industry. Tokenizing a batch of goods using an SFT, for example, makes the distribution process more trackable and manageable than otherwise. Another use is tokenizing traditional contracts such as trade agreements, lease agreements, or loan agreements with collateral where related parties are able to leverage ERC-3525 for fast, automated, and fool-proof contract executions.
ERC-3525 is one of the most advanced and versatile general-purpose token standards for digital goods and assets by far, but that doesn’t mean it has to be costly to use. Here’s why.
Despite bringing many exciting capabilities, the developers of the new SFT standard worked hard to make sure it will be just as gas-efficient as ERC-721 — if not more. To make it accessible, the creators designed ERC-3525 to be composable and backward-compatible with ERC-721, meaning that every wallet, protocol, or marketplace already supporting the NFT will have zero issue integrating ERC-3525 tokens.
To encourage innovation through collaboration, ERC-3525 is completely open-source. To date, protocols such as FujiDAO and Buffer Finance have begun building on-chain options markets based entirely on ERC-3525, and Solv Protocol is the first and largest market that utilizes ERC-3525 tokens as fractionalized on-chain bonds that help institutions get financing and access credit markets.
ERC-3525 is conceived with the aim of addressing key barriers to participation in Web3, digital assets and blockchain economy, hinting at trillions-scale demand outlook. The world is on the track to wake up to the incredible potential of the new standard.