On October 12, 2020, Bancor – the popular on-chain liquidity protocol for the automated decentralized exchange of digital assets – proposed an improved version of itself called Bancor v2.1.
Bancor v2.1 is a major improvement proposal that introduces single-sided exposure & impermanent loss protection to AMM pools via an elastic BNT supply. The proposal was successfully passed on October 18, 2020, with a minimum quorum of 20% of staked vBNT.
Today, I’ll explain in detail why this Bancor v2.1 upgrade is such a big deal.
Let’s dive in.
Automated Market Maker (AMM) protocols provide liquidity providers (LPs) with lucrative opportunities to earn liquidity mining rewards, airdrops, and fees from trades that pass through the pool they’re providing liquidity to.
These types of pools have become quite popular in the Ethereum DeFi space and have yielded significant sums of money for a lot of LPs.
However, being an LP isn’t always sunshine and rainbows.
The problem is, every liquidity provider faces the issue of impermanent loss, and the awareness of that issue has increased among the DeFi community, leading many LPs to question whether the risk is worth it.
So, what exactly is impermanent loss?
Simply put, an impermanent loss is a difference between holding tokens in an AMM and holding them in your wallet.
The price of crypto assets is volatile and when the price of a deposited asset in an AMM diverges in either direction from what the price was when it was deposited, the LP experiences impermanent loss.
The reason the loss is “impermanent” instead of “permanent” is because the loss isn’t realized until you withdraw the tokens. That said, if the price divergence dissipates before you decide to withdraw your tokens, you will not experience any impermanent loss.
However, this is rarely the case. More often than not, impermanent loss becomes permanent, eating into your trading fee income or even leaving you with negative returns.
As you can imagine, impermanent loss is a serious problem that detracts many LPs from participating in AMM protocols like Bancor.
And since users that provide liquidity are at the core of DeFi, it is critical to help them mitigate their losses as much as possible to keep the liquidity that powers the whole decentralized finance space pouring in.
How Bancor Solves This
Bancor v2.1 vastly mitigates the issue of impermanent loss by introducing two key features to their AMMs:
- Liquidity Protection (i.e., Impermanent Loss Insurance)
- Single-sided exposure
Liquidity Protection Interface (Source)
This feature essentially allows liquidity providers to stay long on their tokens while collecting swap fees in a Bancor AMM.
The key fact to note is the fact that liquidity protection only applies to the pools with BNT as the second token. However, it's up to you whether you want to provide liquidity just to one token or two, whereas the second will be BNT.
For example, say you add single liquidity with 50 Basic Attention Tokens (BAT).
The Bancor protocol will protect the initial value of your 50 BAT, regardless of their price goes up or down once you withdraw, giving you 100% exposure to BAT during the whole process of liquidity provision.
That said, if you enter a pool with 50 BAT valued at $50 and the price of said token doubles to $2.00 giving you $100 worth of BAT, you can withdraw tokens worth $200 plus any trading fees earned. Fantastic!
Alternatively, if BAT drops in value to $0.50 giving you $25 worth of BAT, Bancor’s liquidity protection will protect your initial BAT value worth $50 if you have accrued enough liquidity protection.
Liquidity providers accrue liquidity protection over time, so the longer you stay in a pool, the more protection against impermanent loss you will receive.
Moreover, if an LP does experience impermanent loss during the protection period, then they’ll receive the value lost in BNT.
How it works:
In comparison to other AMM protocols, Bancor is uniquely positioned to offer liquidity protection against impermanent loss because Bancor uses its protocol token, BNT, as the counterpart asset in every pool eligible for protection.
Now, by using an elastic BNT supply, the Bancor protocol co-invests BNT in pools alongside LPs and earns trading fees for doing so. These earned trading fees are then used to cover the cost of impermanent loss for protected LPs.
Mechanics of elastic BNT supply to facilitate Liquidity Protection and single-sided exposure. (Source)
In Bancor v2.1, liquidity providers have the ability to contribute to pools with single-sided staking (ie. with 1 token).
Also, just like traditional 50/50 Bancor pools (ie. 2 tokens), single-sided staking pools feature liquidity protection for impermanent loss as well.
Bancor’s single-sided AMM staking pools give LPs the option to choose 100% exposure to the base ERC-20 token (currently around 60 assets supported) they’re contributing liquidity for or 100% exposure to BNT.
Regardless of which token you choose to expose yourself to, if the pool ratio is changed during the protection period, you’ll receive change value in BNT.
Bancor.Network interface (Source)
The most important part to note in liquidity protection with Bancor is that it kicks in overtime. Currently, it's 1% protection a day. So in order to protect your assets from IL upon withdrawing from the pool, you'd need to keep them in there for at least 100% to receive full coverage.
How Investors & Community Reacted?
The Bancor v2.1 release was very well received by the Bancor community and BNT investors.
Liquidity providers across the board appear to be happy with the newly added impermanent loss insurance solution and single-sided token exposure.
A fellow LINK marine had this to say about Bancor v2.1 and its newly launched liquidity protection feature:
“I am now longing my LINK with protection from impermanent loss & collecting fees. What Bancor has built is truly groundbreaking. #4IR”
Replying to questions from the tweet above, the LINK marine posted informative details regarding his impermanent loss protection:
Not only are Bancor users excited about the Bancor v2.1 release, but Bancor (BNT) investors are as well. The day Bancor v2.1 was announced (October 12, 2020), the price of BNT rocketed upwards from $1.13 to $1.40.
Unfortunately, the price has since retraced as speculators treated the upgrade as a “buy the rumor, sell the news” type of event.
Nevertheless, the Bancor community is ecstatic about Bancor’s major v2.1 upgrade and the future is looking bright for Bancor’s unique AMM protocol in the long run. This news has been overshadowed with PayPal news on crypto integration.
What do you think about Bancor’s v2.1 upgrade? Will liquidity providers flock over to the newly improved AMM protocol? Let me know what you think in the comment section below.