Is the AMM “Impermanent Loss” problem solvable? Understand Bancor’s unilateral liquidity and impermanent loss insurance strategy


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Bancor’s flexible supply model and impermanent loss insurance can effectively cope with AMM’s “irregular loss”, but they are all achieved through the issuance of tokens.

Original title: “Unilateral Liquidity” and “Impermanent Loss Insurance”, How Bancor Solves AMM’s Biggest Pain Points”
Written by: Jeff
Source: Abmedia

In the past, whether in traditional finance or cryptocurrency markets, the order book mechanism was used to match buyers and sellers until the automated market maker (AMM) trading model was born, bringing new trading mechanisms to users in the decentralized financial field. . The Automated Market Maker (AMM) model can reduce the dependence of DEX on the performance of the blockchain. In the case of sufficient liquidity, it can also have lower transaction slippage. Most importantly, token holders can also By providing liquidity to the fund pool of the Automated Market Maker Agreement (AMM) to collect transaction fees, the spot assets are converted into wealth-generating tools.

However, automated market makers (AMM) have a natural flaw, that is, liquidity providers must bear “Impermanent Loss (IL)”. Take Chainlink tokens as an example, from April 2019 to 2020 During the period of August 2008, the price of LINK tokens rose by more than 3,700%, which resulted in a loss of more than 60% in the asset value of the liquidity provider of the LINK / ETH fund pool compared to pure holding.

Source: zumzoom

Since impermanence loss has a significant impact on long-term liquidity providers, many development teams are committed to developing solutions in this area, but among so many AMM projects, the only one that can effectively solve impermanence loss and is easy to use The platform, perhaps only Bancor after the V2.1 version is updated. What this article is going to explore is how Bancor solves the AMM pain point of “Impermanence Loss”.

Bancor introduction and current performance

Bancor is a fairly old AMM project in the market, and it is also a pioneer of the Automated Market Maker (AMM) model. Unlike Uniswap or SushiSwap, all fund pools on Bancor must be valued in BNT assets, such as WBTC/BNT, ETH/BNT, USDT/BNT, which means that BNT is all TKN (ETC20 token, short for Token) The connection or path between, for example: TKN A -> BNT -> TKN B. Due to the lack of incentives for liquidity providers to buy and hold BNT, it was difficult for Bancor to compete with platforms such as Uniswap or Kyber that were able to freely choose the counter currency.

But it is precisely because Bancor has insisted on such a model design from the past to the present that in the recent V2.1 revision, he can solve the “Impermanent Loss” problem that other platforms cannot solve. As can be seen from the platform’s locked assets and transaction volume data in the figure below, Bancor has seen substantial growth in February 2021, and the revision of V2.1 is the main reason for this.

Bancor’s locked assets have increased significantly:

Is the AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Dune Analytics

Bancor’s monthly transaction volume has increased significantly:

Is the AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Dune Analytics

Version update of V2.1

For liquidity providers, the main changes brought about by the V2.1 version update include: “support unilateral liquidity provision” and “irregular loss insurance” (both functions are limited to the whitelist pool).

Is the AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Bancor

Unilateral liquidity provision

In the past, providing liquidity on Bancor required holding BNT of corresponding value at the same time, which caused many liquidity providers to stay away. Therefore, in the version update of V2.1, the development team realized through the flexible supply model. With the “unilateral liquidity provision” function, liquidity providers can choose to only provide liquidity in a single currency of TKN or BNT, without the need to prepare two assets at a time, which cannot be achieved by other platforms.

The so-called elastic supply model means that when the liquidity provider injects TKN liquidity into the TKN / BNT fund pool, the agreement will automatically issue additional BNT to make up for the BNT that should be provided by the liquidity provider. These newly minted BNT BNT will be kept in the fund pool and burned when the liquidity provider withdraws the liquidity of TKN tokens.

On the other hand, in addition to providing TKN liquidity, Bancor holders can also choose to pledge BNT to provide liquidity. When there is an inflow of external BNT in the fund pool (BNT holder pledge), it will replace the BNT position cast by the agreement. , To form a trading pair with TKN, and the BNT minted by the agreement will also be destroyed as it is replaced.

While the flexible supply model realizes the function of “unilateral liquidity provision”, the additional tokens are controlled by the agreement and can only be used as liquidity in the fund pool. In addition, the elastic supply model has a hard cap, and the value is determined by the decentralized governance organization. On the other hand, the elastic supply model can also be regarded as a joint investment between the agreement and the liquidity provider, because providing liquidity can obtain transaction fee income, and the transaction fee income obtained by the agreement will be used to destroy BNT. Therefore, the burning The number of BNT will be greater than the original number of minted BNT, thereby increasing the scarcity of BNT.

Impermanent loss insurance

The elastic supply model is also the core foundation for Bancor to solve the pain points of impermanence loss. “Impermanent loss insurance” enables the provision of TKN liquidity on Bancor, in addition to the “transaction fee income”, the agreement can also compensate for any impermanent losses encountered by users, but the following conditions must be met to obtain 100% insurance claims for impermanent losses .

Only the TKN in the whitelist pool can enjoy the impermanent loss insurance, which can be viewed directly on the Bancor website. The fund pool with the blue shield can enjoy the impermanent loss insurance.

Is the AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Bancor

Provide liquidity for 30 to 100 days. Provide liquidity for less than 30 days and cannot enjoy impermanent loss claims. On the 30th day, you can insure 30% of the loss and add 1% every day after it passes. After the 100th day, you can enjoy 100% of the full claim. In other words, only long-term liquidity providers can enjoy impermanent loss compensation.

Is the AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Bancor

When the above conditions are met, the liquidity provider can simultaneously obtain Bancor’s impermanent loss insurance (without halfway withdrawal) when withdrawing liquidity. The cost of insurance comes from the commission income of the agreement co-investment, but if the income is not 100% to repay the liquidity provider’s impermanent losses, the agreement will issue additional BNT as a claim settlement, which means that the cost of insurance will be held by all BNTs. Some people dilute together.

Is AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Bancor

Inflation problem

Presumably, after reading Bancor’s solution, most people will find that whether it is the “elastic supply model” or “irregular loss insurance”, the solution is through the issuance of additional tokens. Will this cause inflation and dilute the value of the tokens? .

In terms of the flexible supply model, the tokens to be issued are directly managed by the agreement, and the liquidity as a fund pool will not flow into the external market, and it will not cause value dilution to the tokens. Furthermore, the agreement to issue additional tokens as a joint investment fund can increase the income of the agreement, thereby destroying more tokens, which is conducive to the positive cycle of the overall token economy.

In terms of impermanent loss insurance, the additional issuance of BNT as compensation for impermanent losses seems to be detrimental to the price increase of BNT, but in fact, so far this cost has been fully diluted by the transaction fee income of BNT invested by the agreement. According to Deribit’s analysis, due to the design of the whitelist pool and the limitations of long-term liquidity providers, for every dollar of transaction fee income earned by the Bancor agreement, the cost of impermanence in compensation costs only about $0.07, which means that the current The design of the agreement can effectively provide a self-sufficient economic cycle for the ecosystem.

Is the AMM "Impermanent Loss" problem solvable? Understand Bancor's unilateral liquidity and impermanent loss insurance strategySource: Deribit

Judging from various data, the agreement has not moved towards an inflationary trend so far, and the price of BNT tokens has also continued to rise due to the increase in platform lock-up assets, transaction volume and pledge income.

Latent defect

Since “unilateral liquidity provision” and “irregular loss insurance” are the two major functions that can only be enjoyed by the whitelist pool approved by the community, and the approval process of the whitelist pool is cumbersome, new projects or non-whitelist pools Token holders of Bancor must prepare BNT and must bear impermanent losses if they want to build a pool in Bancor. This is a limitation designed by the development team for protocol security, but it is also the biggest weakness of Bancor’s competition with Uniswap and Sushiswap.

future plan

In fact, in addition to the two main functions shared today, Bancor also has functions such as automatic reinvestment of mining revenue and Bancor Vortex (leveraged financing), which creates sufficient token empowerment and holding motivation for BNT tokens. In addition, in the face of strong market competition, the Bancor development team also plans to launch more different new products in the future, including: Origin Pools (similar to SushiSwap’s Onsen), Shadow Token stablecoin pools (stable currency trading pools against Curve) , The second-tier expansion plan, cross-chain transactions, etc., this kind of never-ending innovation may be the main reason why Bancor is called the dark horse of DEX.

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