ERC-7281: A new Token Standard for a Multichain World
Castle Capital Research Report
The xERC20 represents a new token standard designed to enhance the security and liquidity of bridged tokens.
xERC20 tokens are essentially a rebrand of the ERC-7281 standard à la Musk: whenever referring to xERC20 we are discussing ERC-7281 tokens.
Before we dive in, It is essential to remember that this new standard is still under review and has not been approved yet.
Nonetheless, they represent an interesting improvement over Ethereum’s gold standard, the ERC20.
Today's @MultichainOrg hack is a sad reminder of the systemic risks tokens face from bridges.
We believe these risks stem from a single underlying problem:
We're proposing ERC-7281 (aka xERC20) - an open standard to fix this.
— Arjun | xERC20 arc 🏴 (@arjunbhuptani)
Jul 7, 2023
The crypto realm is becoming increasingly multichain – more and more protocols are building and launching their own L2s, L3s, and app chains.
Accordingly, the increasing complexity of the crypto landscape requires token standards that are more flexible and can accommodate the growing intricacy and security risks of the ecosystem.
While undoubtedly one of the most successful developments in the space, the ERC20 standard might not adequately reflect this rising complexity.
One of the primary concerns lies in the security of bridges, the main infrastructure used to transfer tokens from one network to the other.
As the activity of bridges grows, so does their responsibility to be a secure component of the multichain universe.
Vulnerabilities in cross-chain bridges constitute a significant security risk, with almost 69% of funds stolen in 2022 resulting from attacks on bridges, as reported by Chainalysis.
As more value flows through bridges, the urgency to secure them intensifies.
Why are hackers targeting bridges?
Bridges are like honey for bears.
They are an attractive target due to their centralized storage of funds that back the “bridged” assets on the receiving blockchain.
This leads us to the xERC20 standard: if bridges can’t be fixed, perhaps we can do so by altering the dynamics of storing assets cross-chain.
To sum it up: why do we need xERC20 tokens?
1. Evolving multichain architecture: the ecosystem needs to improve UX given the increased flows of funds between different blockchains
2. “Outdated” Erc20 standard: could be constraining innovation and not reflect the complexity of a multichain world
3. Bridges represent the main venue for hacks: maybe we can think laterally to overcome this?
xERC20 is a standard for bridged tokens. A common interface to be used across different implementations of bridges to keep liquidity concentrated and improve user experience on-chain.
The xERC20 standard proposes a minimal extension to ERC-20 to fix problems with token sovereignty, fungibility, and security.
Configurable rate limited for individual bridges, which will be decided by the token issuers
A mint/burn interface that allowlisted bridges can call
A wrapper contract streamlining liquidity for all existing tokens across chains
Notably, xERC20 tokens shift the ownership of tokens away from bridges into the hands of token issuers.
With this standard, token issuers will be deciding:
Which bridges will be supported
Their rate of risk tolerance per bridge (exemplified by a configurable rate limit for transfers for each bridge)
Token issuers themselves will be able to “allowlist bridges”: they’ll be able to decide which bridges to support, and limit the rate at which they can mint tokens - as well as being able to change permissions accordingly.
This comes in handy in case of a hack or vulnerability: the risk of the issuers would be limited to the “rate limit” previously set on individual specific bridges. Furthermore, token issuers will also be able to delist a bridge in question without having to migrate tokens.
This would also prevent UX problems and cross-chain slippage as all bridges would have the same official token, without the need for native vs. non-native tokens.
According to Arjun, the author of the proposal, the xERC20 approach encourages “open competition and innovation” and gives token issuers the flexibility to update their preferences over time.
By doing so, ERC-7281 tokens create incentives for bridges to compete across the security and quality of their services, or else they might be delisted.
However, shifting this decisional power to token issuers raises concerns about centralization and the degrees to which teams are capable of carrying this added weight on their shoulders.
Some token issuers have already chosen the path of sovereignty for bridging their assets.
A similar implementation to ERC-7281 has been developed by Circle, the USDC stablecoin issuer. They have come up with the Cross-Chain Transfer Protocol (CCTP), which lists the official bridges for their token. The same can be said for Frax Finance, which is developing its own bridge solution, called FraxFerry, and MakerDAO Teleport mechanism.
The xERC20 standard would contribute to:
Introduce competition across bridges: bridges will compete on security to get better rate limits and will be incentivized to improve security over their competitors.
Improve Liquidity: the Multichain hack highlights the importance of not having a single actor that monopolized liquidity. The xERC20 standard unifies liquidity as all minted versions of tokens from these bridges will be fungible with each other.
No Slippage Cross-chain Tokens Swaps: easier to swap tokens as transfers won’t have slippage anymore (better rate predictability and easier cross-chain composability)
Lower Barriers to Entry: new rollups and bridges won’t need to bootstrap liquidity, as it can be easily shared across all interconnected protocols.
Food for Thought
xERC20 is one of the new token standards emerging in the context of bridging assets multichain. Other notable endeavors in this niche include the LayerZero OFT standard.
Nonetheless, the scope of this piece is restricted to xERC20 – a new standard that also raises some issues and necessary reflections.
There is a need to establish a clear pathway and a proper standard to streamline the process. It’s hard to envision smaller protocols and projects having the bandwidth to decide which bridges to trust, setting the right limits, and monitoring them constantly.
This also raises the issue of trust: how can we make sure that token issuers select bridges based on the better product and not based on secondary categorizations? (e.g. personal benefits or close business ties with some bridges rather than others)
It may be increasingly hard for projects to decide on an arbitrary rate limit for bridges as it might not accurately reflect market dynamics and flows: as such they will have to iterate extensively (and always continue doing so) before finding a sweet spot.
Furthermore, selecting trusted bridges may not be enough to avoid hacks altogether. We have recently had both the examples of Nomad and Multichain – two of the most notable bridges that were nonetheless exploited. What’s worth noting here is that xERC20 could indeed, limit the losses to the rate limit approved (however, based on the point above, rate limits may still have to be high, especially for bridges with high volume)
Another point up for debate is that this new standard would introduce governance burdens for tokens: e.g. approval of allowlisted bridges, giving additional governance power to token issuers. This may not fit all tokens, as some tokens for instance lack a governance layer. This means they’ll have either to set up specific governance paths allowing their token holders to have a say in that, or centralize the process based on specific risk analysis.
Last but not least, this could also open the possibility for new vectors of attacks (e.g. where a malicious actor might try to steer governance to allow a high rate for a specific bridge that can be compromised or easy to hack), coming from:
The required efforts and bandwidth to ensure proper rate limits are established
Further governance processes needed
To summarize, ERC 7281:
Removes some of the security concerns with bridging hosting tokens and being hack targets
Alters the dynamics through which token issuers decide which bridges can mint/burn tokens
Creates an open field of competition where bridges can compete based on the validity of their products
Criticism has been raised about issues of trust and centralization
🔔 p.s. You can join the Alpha Assembly Telegram channel to receive notifications of our publications and those of our partners!