Bancor is a DEX which aims to solve the problem of illiquid markets by incentivizing users to provide liquidity for a share of trading fees. Trading with Bancor requires no buyer and seller matching, users can simply exchange their tokens as long as there is liquidity available.
Bancor Network Token (BNT) is an ERC20 token used as an intermediary between pools in the network and across blockchains. For example, a trade from ETH to DAI would consist of two parts executed automatically; ETH to BNT followed by BNT to DAI. Using BNT as an intermediary allows users to convert between any tokens supported on the Bancor Network.
It is not required to hold BNT when making a trade, but users must have BNT (or its stable derivative USDB) in order to create a new liquidity pool or contribute to an existing one. When users add liquidity to a pool, they automatically receive a proportional number of pool tokens. These tokens are used to track the percentage of liquidity provided compared to the entire pool, and are used for distributing the trading fee rewards. The relationship between traders and liquidity providers for a DAI/BNT pool is shown below:
Bancor launched in June 2017 with an ICO that raised $153 Million from over 10,000 contributors. They distributed half of all BNT tokens and reserved the other half for future use and team allocation.
The original whitepaper was released in May 2017 and written by Eyal Hertzog, Guy Benartzi, and Galia Benartzi. Eyal is now a Product Architect for Bancor while Guy serves on the Foundation Council and Galia leads Business Development. Bancor also has a strong advisory board that includes Tim Draper among other big industry names.
Since its launch, Bancor has released a wallet platform for storing, managing, and trading both ERC20 and EOS tokens. Their decentralized liquidity pools support both token types and traders can seamlessly switch between token types straight from their wallet. Additionally, Bancor’s permission nature allows for users to create liquidity pools for any ERC20 or EOS token with as little as $1.
Every token in the Bancor network maintains a formulaic relationship with all other tokens, which is the magic that allows for seamless on-chain token conversions. The formula for price calculation is simple and shown below:
USDB is a stablecoin created for the Bancor network by PEG Protocol that holds a value of $1 USD. The introduction of USDB was impactful because it allowed users to provide liquidity in stable pool pairs to reduce risk. When providing liquidity for a token pair, the provider is essentially staking that token to receive rewards over time while remaining susceptible to the price movements of that token. If the token loses value during their staking period, there’s a chance the losses will outweigh the rewards generated. However if they provide liquidity to a pool with two stable assets in its reserves (e.g. DAI/USDB) they can reap the rewards without remaining exposed to price fluctuations.
Bancor V2 is the second major version of Bancor Protocol and is set to release in July 2020. Bancor V2 will include:
- An Automated Market Maker (AMM) liquidity pool integrated with Chainlink price oracles that will eliminate the risk of impermanent loss for stable and volatile tokens
- The ability to provide liquidity with 100% exposure to a single token (currently need to hold both tokens in a pool pair)
- A more efficient bonding curve to reduce price slippage
- Support for DeFi lending protocols
These features are addressing 4 key issues regarding the widespread adoption of AMMs – exposure to impermanent loss, exposure to multiple assets, capital inefficiency (high slippage), and the opportunity cost of providing liquidity.
In short, impermanent loss is the difference between holding tokens in an AMM vs. a wallet. Because users are required to hold tokens on both sides of the orderbook, price movement and buy or sell pressure from one side will alter the liquidity provider’s balance of tokens, resulting in a value loss compared to holding the initial token amounts in a wallet. This loss is ‘impermanent’ in the sense that there’s a chance the market will swing back and restore the initial balance of tokens, although this is rarely the case.
Regardless of which way the market moves, the liquidity provider will suffer from impermanent loss proportional to the size of the movement. This is because current Bancor AMMs do not automatically reflect external market prices, instead relying on arbitrageurs to come in and buy the underpriced asset or sell the overpriced asset. For example, let’s say a BNT/DAI pool has an exact 50/50 split of tokens. If BNT goes up relative to DAI on external exchanges, the AMM will not reflect the proper price until someone buys BNT from the pool. This leaves the pool with more DAI than BNT, and if a liquidity provider withdraws their stake they will receive more DAI and less BNT than they initially contributed, losing out on the more valuable asset. This loss would be the same for market movements in either direction.
Bancor V2 eliminates the risk of impermanent loss by enabling the creation of AMMs that hold the relative value of their reserves constant using prices from Chainlink oracles instead of relying on arbitrageurs. In addition, the option to provide liquidity with a single token instead of two means users holding long positions can earn rewards on those tokens without needing to expose themselves to another asset. A great resource on how Bancor is dealing with impermanent loss can be found here.
Another impressive feature rolling out with Bancor V2 is the ability to create AMMs that are integrated with existing DeFi lending protocols. This will increase profitability for liquidity providers as they can earn lending interest on top of trading fees and shows the impressive interoperability of open source DeFi protocols.
Check out Bancor’s blog post announcing V2 for more information.
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