Mastering ERC-20 Token Allowances and Transfers in Ethereum Smart Contracts

Working with ERC-20 tokens in Ethereum smart contracts often leads developers into a common yet complex area of token allowances and transfers. This issue is particularly seen with tokens like USDT (Tether), demanding a particular approach to allowance management. In this article, we'll dissect this problem and propose simple yet effective solutions, supplemented by code examples and visual diagrams.

Understanding the ERC-20 Allowance Mechanism

ERC-20 tokens, a standard for fungible tokens on the Ethereum blockchain, employ an allowance mechanism. This mechanism is vital for decentralized applications (Dapps) that interact with tokens for various functionalities such as staking, swapping, or lending.

The Core Challenge

A significant challenge surfaces when modifying token allowances. Tokens following the ERC-20 standard, like USDT, necessitate resetting the allowance to zero before assigning a new allowance. This situation becomes problematic under the following circumstances:

1. An allowance is successfully established.
2. The user's token balance diminishes before the transfer action, resulting in a failed transfer due to inadequate funds.
3. Any further attempts to modify the allowance without resetting it to zero result in failure.

ERC-20 Allowance and Transfer Process

The following figure illustrates the two-step process (approval and transfer) necessary for ERC-20 token operations in decentralized applications. It emphasizes the importance of setting allowances and checking balances to ensure successful token transactions.

Approval Initiated by User:

The user initiates the process by invoking the approve function on the ERC-20 Token Contract. This is typically done through a user interface provided by the Dapp. The approve function call authorizes a specific amount of tokens to be spent by another address, in this case, the Dapp contract.

Allowance Set for Dapp Contract:

Once the approve function is executed, the ERC-20 token contract sets an allowance for the Dapp contract. This allowance is the amount of tokens that the Dapp contract is permitted to transfer on behalf of the user.

Balance Check Before Transfer:

Before the actual transfer of tokens can occur, the Dapp contract (or the Dapp's backend) checks if the user's balance is sufficient to cover the transfer. This is important to ensure that the transfer does not fail due to insufficient funds.

Transfer Execution:

If the user has enough balance and the allowance has been set, the Dapp contract then executes the transfer of tokens. This is typically done using the transferFrom function, which moves the allowed amount of tokens from the user's address to another address as specified by the Dapp contract.

Possibile Solutions

1- Verifying Balance Prior to Transfer
Before initiating a transfer, the Dapp should validate the user's token sufficiency. This verification can be executed using the balanceOf function.

const userBalance = await tokenContract.balanceOf(userAddress);
if (userBalance < transferAmount) {
    throw new Error('Insufficient token balance');
}

2- Managing Allowance Reset

In instances where an existing allowance is detected, it should first be reset to zero before setting a new value. This step is critical for tokens like USDT.

const currentAllowance = await tokenContract.allowance(userAddress, DappAddress);
if (currentAllowance > 0) {
    await tokenContract.approve(DappAddress, 0);
}
await tokenContract.approve(DappAddress, newAllowanceAmount);

3- Employing a Smart Contract for Allowance Handling

Develop a smart contract that orchestrates both the allowance configuration and the token transfer. Users initially transfer their tokens to this contract, which then internally manages the allowances.

contract TokenManager {
    IERC20 public token;

    constructor(address _tokenAddress) {
        token = IERC20(_tokenAddress);
    }

    function transferTokens(address to, uint256 amount) public {
        token.transferFrom(msg.sender, to, amount);
    }
}

Here is the a simple workflow where a dedicated smart contract, Helper Contract, acts as an intermediary to manage ERC-20 token allowances and transfers. This setup is designed to streamline the process for the user by handling the complexities of ERC-20 token interactions within the smart contract itself, as well as create an atomic operation for both actions.(This requires the user to trust the Helper Contract)

4- ERC-20 permit Function (EIP-2612)

Some modern ERC-20 tokens implement a feature known as EIP-2612, which introduces a permit function. This allows token holders to approve token spending via a signature, rather than a transaction. If the token you're working with supports this, you can collect a signed approval from the user off-chain (just a signature, not a blockchain transaction), and then submit it along with the transferFrom call in a single transaction.

Best Practices

• Optimize for Gas: Be conscious of gas expenses. The operations of resetting and setting allowances are transactional.
• Enhance User Experience: Clearly communicate the requirement for allowance management to users.
• Prioritize Security: Assure that smart contracts handling tokens are rigorously tested and audited.

Common Exceptions

When dealing with allowances and transfers as outlined in the scenarios above, the most common exception you might encounter is the execution reverted error. This error occurs when a transaction fails and is reverted by the Ethereum Virtual Machine (EVM). It's a generic error message that often requires further investigation to understand the specific cause. In our specific context, here are some possible issues to check:

• Insufficient Allowance: If the transferFrom function is called but the allowance set with approve is not sufficient, the transaction will be reverted.

• Insufficient Balance: This occurs if the user (or the TokenManager contract in the second scenario) tries to transfer more tokens than they hold.

Conclusions

Navigating ERC-20 token allowances and transfers demands a strategic and thoughtful approach, especially with tokens like USDT. By integrating balance checks, managing allowances adeptly, and potentially utilizing a specialized smart contract, developers can forge a user-friendly and secure environment, all while adhering to token standards. It's important to remember that each token may exhibit unique behaviors, so thorough testing with the intended token is imperative.