• How ERC-4626 Could Power the Next DeFi Wave

  • Applications created on top of ERC-4626 vaults are compatible with all yield-bearing ERC-4626 vaults, simplifying integration and innovation.

    If you’re familiar with NFTs, you’re familiar with the ERC-721 token standard. But are you up to date on ERC-4626?

    According to DeFi Llama data, the total value locked (TVL) across all DeFi protocols is almost $193 billion. A concept known as “yield farming” has evolved with the advent of decentralized financing in summer 2020. Users deposit cash to a platform, such as the lending protocol Compound, and are rewarded with a portion of the earnings as their deposits are leased out, similar to interest payments from a typical bank.

    Individual users without considerable wealth or expertise of the concept found yield farming less appealing, which led to the emergence of “yield aggregators”—sets of smart contracts that aggregate user funds and optimize yields. These were quickly dubbed vaults.

    However, these vaults lacked implementation guidelines, resulting in a slew of complications. With minor differences, yield aggregators, vaults, lending markets, and native yield tokens were all implemented. It was difficult to construct programs on top of the vaults, and it introduced security concerns. Scaling was also restricted.

    Because vaults were based on smart contracts, normal users couldn’t interact with them directly, which elevated the relevance of possible decentralized apps (dapps) that could be created on top of the vaults.

    The vault requirement

    On December 22, an Ethereum Improvement Proposal (EIP) led by Fei protocol founder Joey Santoro set out to change that. ERC-4626 comes into play.

    While the major purpose of the proposal was to set robust implementation criteria for vaults, it also detailed the potential security implications of vaults that did not meet a certain standard.

    On March 18, EIP-4626 was accepted. Since then, many DeFi protocols, including Yearn Finance, Balancer, Rari Capital, and mStable, have begun adopting ERC-4626 in their vaults. (An approved EIP is referred to as an ERC, or Ethereum Request for Comment.)

    Because all applications built on top of ERC-4626 vaults are compatible with all other yield-bearing ERC-4626 vaults, new developments centered on yield methods have emerged.

    Vaults are now divided into two types under ERC-4626: transferable and non-transferable.

    A representative ERC-20 token is issued to the user in transferrable vaults. This token would reflect the user’s share of the vault pool. Tokens are not used in non-transferable vaults.

    The establishment of standardized vaults opens up new avenues for protocol compatibility. This could also pave the path for enhanced protocol compatibility across many blockchains.

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