Bancor V2.1 will support the injection of unilateral assets and adopt a new plan to deal with impermanent losses.
The so-called impermanence loss refers to the loss of value incurred by the liquidity provider after a period of time, compared to simply holding the initial number of tokens.
In my opinion, this is actually a concept similar to opportunity cost. Opportunity cost is a kind of income that must be considered when making decisions; but it often gives people the illusion of “what I did not earn is my loss” after bad results occur.
Impermanence loss is an option. When a liquidity provider makes a market in AMM, it chooses to hold another asset, namely LP Token, and he predicts that holding LP Toekn plus the fee income will get more benefits than just holding the original token.
LP Token actually represents an interest-bearing asset portfolio with strategy. However, in the current AMM protocol, the strategy supported by most protocols is automatic rebalancing, that is, for the A/B liquidity pool, A will be automatically sold to B when it rises, so that A and B in the pool The value is 1:1.
If there is an AMM agreement, a better strategy can be established to enable liquidity providers to obtain profits through market making while reducing impermanence losses, it will indeed be an additional value.
Bancor V2 is an attempt. In its strategy, the protocol learns the exchange rate of A/B through the oracle feeding the price, and increases the proportion of A in the pool when A rises, so that A is less passively sold.
This strategy has two obvious shortcomings: 1/ abandoning the pricing power; 2/ the delay of the oracle feeding price may lead to more arbitrage.
Has Bancor V2.1 made any improvements on this basis?
From the version number, V2.1 has brought a certain amount of misleading, people mistakenly think that it is an iteration of V2-not at all, Bancor V2.1 is a brand new solution.
As mentioned earlier, Bancor V2.1 will support the injection of unilateral assets into the market and adopt a new solution to deal with impermanent losses.
Let’s talk about unilateral asset market making first. We have some examples of market making by injecting a single asset into a liquidity pool, such as Balancer, which actually helps users convert a single asset into multiple assets through the liquidity pool itself, and then make market. Bancor V2.1 is different from this type.
Bancor V2.1 only supports BNT/ERC20 liquidity pools. This is to implement flexible supply to support unilateral market making. How did you do it?
When the liquidity provider provides ETH for unilateral market making, Bancor V2.1 will issue additional BNT of equal value at the market exchange rate to enter the liquidity pool and pair with the user’s ETH.
When the liquidity provider provides BNT for unilateral market making, Bancor V2.1 will deposit the user’s BNT into the liquidity and destroy the equivalent amount of BNT owned by the agreement in the pool.
Of course, Bancor V2.1 also supports liquidity providers to simultaneously inject bilateral liquidity for market making. In addition to supporting unilateral market making through flexible supply, the curve of Bancor V2.1 trading is the same as Uniswap, which maintains the value of bilateral assets at 1:1. The same strategy means that liquidity providers will have Uniswap has the same impermanence loss. How does Bancor V2.1 deal with it?
Bancor V2.1’s approach is to issue additional BNT to compensate liquidity providers for their impermanent losses.
When the liquidity provider injects assets for market making, Bancor V2.1 will record key data to calculate the liquidity provider’s impermanent loss during market making when the user obtains the liquidity. When the user retrieves the liquidity, the agreement will issue additional BNT to compensate the liquidity provider’s impermanent loss.
Investors need to think about two issues:
Non-BNT unilateral market making and compensation of impermanent losses will cause the issuance of BNT. What is the impact?
In fact, when depositing non-BNT assets for unilateral market making, the additional BNT issued by the Bancor agreement will basically not overflow to the market (when the BNT/ERC20 exchange rate increases, the BNT in the pool will partially overflow to the market); but to compensate for the flow The additional BNT issued by sex market makers can be understood in terms of popular mining, and will cause inflation just like UNI and SUSHI, but its value proposition is clearer by comparison—compensating for the impermanent losses of liquidity providers.
From the perspective of BNT risk-taking, we can understand that BNT holders bear all the impermanent losses of the whitelisted ERC20/BNT liquidity pool. If the value capture of BNT enables BNT to maintain relatively equivalent competitiveness compared to other ERC20 tokens, it can keep the impermanence loss low; if unfortunately BNT loses competitiveness, the increase in impermanence loss will make it worse.
How does BNT capture value?
The value capture of BNT comes from part of the fee income. The process is somewhat obscure:
When a liquidity provider conducts unilateral market making with non-BNT assets, the agreement will issue a part of BNT for matching market making. Assuming that 100 BNT is issued, this part of the BNT owned by the agreement will receive the same fee income as other assets. After a period of time, it becomes 110 BNT. When the liquidity provider injects 110 BNT for unilateral market making, the 110 BNT owned by the agreement will be destroyed. In this case, the circulation of BNT is reduced by 10 (additional 100 BNT-destruction 110 BNT = -10 BNT) that is, the protocol’s own fee income will be distributed to all BNT holders in the form of destruction
How much will this part of fee income be?
The transaction of buying other ERC20 tokens with BNT will incur a BNT fee. Since Bancor V2.1 only supports other ERC20/BNT transaction pairs, when ERC20/ERC20 transactions occur, they must be routed through BNT, which will incur BNT fees.
Since the proportion of BNT held by the agreement cannot exceed 50% of the total BNT in the pool, the transaction fee income of the agreement itself is 25% of the total transaction fee. The commission rate of Bancor V2.1 is 0.1%, so BNT can capture up to 0.025% of the transaction volume.
We compare this with Uniswap:
It can be seen that the core difference between the two is the level of the commission rate and who bears the impermanent loss, and the important variable is the transaction volume.
Bancor V2.1 hopes to attract liquidity providers by transferring impermanent losses to BNT holders, and to attract traders with lower transaction rates, so as to build a competitive market and increase the transaction volume. On this basis, BNT therefore remains competitive, maintains low impermanence losses and obtains returns.
The essential difference between Bancor V2.1 and Uniswap can be attributed to the difference in the benefit distribution mechanism.
So, which benefit distribution mechanism is more likely to win the market? If Bancor V2.1 is more competitive in the distribution of benefits, will the competitiveness be enough to support it to compete for market share from Uniswap’s accumulated advantages?
I think Bancor V2.1’s unilateral market making and impermanence loss compensation will indeed be attractive to liquidity providers, and its team also has strong R&D capabilities, but when it comes to market competition with complex factors, I can only Delay judgment and keep observation.
