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ERC-4626 TOKENIZED VAULT STANDARD: THE RESURGENCE OF DEFI

Decentralized Finance (DeFi) still faces difficulties with tokenized vaults. This has led to the creation of the latest standard called ERC-4626. While there are a couple of prominent token standards at the moment, ERC-4626 is a newly proposed Ethereum token standard. 

In the context of Decentralized Finance (DeFi), this new standard is highly anticipated to solve the mishmash of design types for tokens that print money. Let’s explore what ERC-4626 and its associated terms are all about.

What exactly is the ERC-4626?

ERC-4626 is a technical standard that optimizes and unifies yield-bearing vault metrics. In its current form, it provides a standard API for creating tokenized yield-bearing vaults that represent shares of an underlying ERC-20 token. Also outlined in ERC-4626 is an optional extension to allow depositing, withdrawing tokens and reading balances for tokenized vaults using ERC-20.

What is a Vault?

Cryptocurrency vaults are multi-signature solutions or smart contracts that can store and manage assets. Vaults always have tokens they generate as returns. The tokens generated during this process will be exchangeable for the original tokens held in vaults. 

As an example, when you stake Sushi on Sushiswap, which is an automated market maker (AMM), you will receive xSushi. The USDC stablecoin will also give you cUSDC if you borrow/lend it on Compound, a DeFi protocol. 

cUSDC and xSushi are yield-bearing tokens that can be redeemed for USDC or SUSHI (in this example). Whenever locked tokens in vaults or pools increase in value, yield-bearing tokens will also increase in value. 

Many DeFi protocols choose to deposit their funds in a vault because vaults are perceived to be more secure than wallets. Vaults are used by DeFi protocols like Sushiswap, Aave, Balancer, and Compound.

ERC-4626 Specifications

For EIP-4626 tokenized vaults to represent shares, they must implement EIP-20. It may revert on ‘transfer’ or ‘transferFrom’ calls if a Vault is non-transferable. Vault ‘shares’ represent claims to ownership on a fraction of the Vault’s holdings, and are used in EIP-20 operations such as ‘balanceOf’, ‘transfer’, and ‘totalSupply’.

Tokenized vaults that implement EIP-4626 must implement EIP-20’s optional metadata extensions. The underlying token’s name and symbol should be reflected in the ‘name’ and ‘symbol’ functions.

It may be possible for tokenized vaults in EIP-4626 to implement EIP-2612 to enhance the UX for approving shares across various integrations.

Definitions
  • Asset: Token managed by the vault. Units are defined by the corresponding EIP-20 contract.
  • Share: The Vault’s token. This ratio denotes how many underlying assets are exchanged on mint, deposit, withdrawal, and redemption (determined by the Vault).
  • Fee: The amount the Vault charges the user for assets or shares. The Vault can charge fees for deposits, yield, AUM, withdrawals, or anything else it deems necessary.
  • Slippage: The difference between advertised share prices and economic realities of depositing into or withdrawing from the Vault that is not accounted for by fees.

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Benefits of the ERC-4626 Tokenized Vault Standard

Interoperability between different protocols will be affected by this new Ethereum token standard. Using a single API, the ERC-4626 token standard can significantly reduce the time and effort required to implement new yield vaults into an application. Moreover, standardization allows centralized innovation and security auditing. Developing a contract standard with this approach ensures that it has been thoroughly tested before being released.

The introduction of a standard for yield-bearing vaults will promote the growth of yield-bearing instruments in the crypto sector. If the ERC-4626 standard experiences the same sort of rapid growth that ERC-20 has, we could expect a similar adoption curve. As a result, developers will be able to access yield across a wider range of applications with a lower degree of specialization.

Final Thoughts

The advent of ERC-4626 heralds a resurgence of sorts for DeFi. It makes it possible to have details of yield-bearing tokens with one API call. Using this battle-tested standard, we can go the extra mile to enhance the security of DeFi applications with yield-bearing tokens. Over the next couple of years, multiple DeFi protocols will become more composable and interoperable. In fact, it is even possible that this standard will serve as a platform for creating and shipping entirely new products.

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