How ERC-4626 could fuel the next DeFi wave

If you are familiar with NFTs, you are familiar with the ERC-721 token standard. But have you caught up with ERC-4626?

The TVL (Total Value Locked) of all DeFi protocols is close to $193 billion according to data DeFi Llama. Since the explosion of decentralized finance in the summer of 2020, a concept called “yield farming” has emerged. Users deposit funds on a platform like the Compound lending protocol and are rewarded with a share of profits when their deposits are lent out, reminiscent of a traditional bank’s interest payments.

However, yield farming was less attractive to individual users without significant capital or knowledge of the concept, leading to the introduction of “yield aggregators” – sets of smart contracts that pool user funds and optimize yields. These quickly became known as vaults.

However, these vaults lacked implementation standards, leading to several complexities. Yield aggregators, vaults, credit markets, and native yield tokens have always been implemented with minor variations. It was difficult to build apps on the vaults and the potential for security vulnerabilities emerged. Scaling was also limited.

With vaults based on smart contracts, general users could not interact with them directly, which only increased the importance of potential decentralized apps (DApps) that could be built on top of the vaults.

The vault standard

A Ethereum Improvement Proposal (EIP), formed on December 22nd led by Fei Protocol founder Joey Santoro, set out to change that. Enter ERC-4626.

While the main goal of the proposal was to establish robust implementation standards for the vaults, it also outlined the potential security implications of vaults without a specific standard.

EIP-4626 was approved on March 18th. Since then, a large number of DeFi protocols — including Yearn Finance, Balancer, Rari Capital, and mStable — have started implementing ERC-4626 in their vaults. (Approved EIPs are called ERCs or Ethereum Requests for Comment.)

All applications built on top of ERC-4626 vaults work with all other revenue-producing ERC-4626 vaults, so with these contracts now easy to integrate, new innovations have emerged around revenue strategies.

With ERC-4626, safes are now divided into two main categories: transferable and non-transferable.

In transferrable vaults, the user is issued with a representative ERC-20 token. This token would represent the fraction of the vault pool owned by the user. Non-transferrable vaults do not use tokens.

The establishment of standardized vaults opens up new possibilities for interoperability between different protocols. This could also pave the way for increased compatibility of protocols across multiple blockchains.