Automated market maker exchange Bancor has implemented a new mechanism that allows users to increase the efficiency of their capital while providing liquidity in their pools.
Called Vortex, the solution allows users providing liquidity in BNT, Bancor’s utility token, to borrow funds while continuing to earn return on swap fees.
The Vortex mechanism reworks the existing vBNT mechanism, a special version of the BNT token that allows users to participate in governance. The voting token is automatically received when staking BNT in a liquidity pool, and can be defined as the token of the Bancor group.
Vortex’s proposal adds functionality to vBNT, creating an infrastructure that allows users to sell the token for the original BNT. Once vBNT is converted, users can exchange it for any other asset.
The vBNT sale mechanism turns Vortex into a no-settlement lending platform, allowing liquidity providers to receive their future rewards immediately, similar to Alchemix. Since your principal amount continues to accumulate interchange fees, the loan will eventually pay itself off.
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The “non-liquidation” part of the loan stems from the fact that vBNT and BNT are essentially the same token, and vBNT most likely reflects the increase in the price of BNT’s collateral. BNT’s stake creates vBNT in a one-to-one ratio, but the price relationship between the two is not straightforward.
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The vBNT token price is derived from an AMM pool of BNT / vBNT, so it is largely defined by the market. One possible arbitrage mechanism means that vBNT is unlikely to be worth more than 1 BNT, as arbitrageurs could simply stack BNT, sell vBNT, and get more BNT than they started with. The cycle could be repeated an infinite number of times until the price of vBNT returns below 1 BNT.
At the same time, vBNT has no floor price because the arbitrage mechanism cannot work in reverse. As Mark Richardson, the creator of Vortex, explained to Cointelegraph, Bancor uses internal registers to define ownership within an AMM pool. This is a significant difference from models like Uniswap’s pool tokens, which are the only marker of liquidity ownership. The vBNT could be used to redeem a BNT liquidity pool only if that address had already created one.
To ensure that vBNT holds some security in the absence of a redemption mechanism, the protocol will carry out a token buyback and burn strategy. A governance-defined portion of the protocol fee revenue will be diverted to periodically buy and destroy vBNT from the pool with BNT, providing constant buying pressure.
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This has the additional result of creating a sink for BNT and vBNT. Since a vBNT unlocks a BNT, the destruction of the vBNT supply creates an imbalance with the tokens contained in the AMM pools. Therefore, a portion of those tokens would remain locked in pools forever, although this should not affect the withdrawal of liquidity for individual liquidity providers due to large excess capacity – a similar mechanic occurs with cold wallets on exchanges centralized.
The mechanics of the vBNT token have a number of interesting ramifications. In addition to the ability to borrow while still receiving returns, liquidity providers can also leverage their liquidity to receive more swap fees. The price of vBNT directly affects how leveraged the system can be, as prices close to 1 BNT could support an almost infinite leverage factor. At the same time, as more LPs enter leveraged positions, the price of vBNT is likely to decrease and limit the leverage multiplier. An infinite leverage situation would extract value from the protocol, but Richardson is confident that the market-based pricing mechanism quickly makes it costly and ultimately impractical.
Liquidity is no longer an issue, but volume is lagging behind
The Bancor protocol has deployed all the resources it has to attract liquidity to the protocol. Among the innovations of unilateral liquidity provision and temporary loss insurance, introduced with V2.1, it has also launched aggressive liquidity withdrawal programs. The Vortex proposal is another tool that could attract liquidity by introducing leverage in AMM pools.
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Bancor’s liquidity campaign has been a demonstrable success. With $ 1.8 billion in total value locked in, it broke into the “billion dollar TVL club” to become 8th in the ranking of decentralized exchanges on DeFi Llama. While trailing most of its direct competitors like Uniswap or SushiSwap, Bancor has grown much faster as it started the year with just $ 140 million in total locked value (TVL).
However, the growth in liquidity has not automatically translated into higher volume. Although Bancor is in the top five by volume on Ethereum at $ 430 million per week, Uniswap dominates the market and attracts almost 17 times more volume despite having just a little more than double the TVL. In Richardson’s view, the Bancor team may have had the wrong expectations in their quest for liquidity:
“I would say that this assumption existed, and we may not even know it was an assumption, that if the TVL rises enough, it will only attract traders […] And if everyone uses aggregators, then that is really good for us because we just have to offer the best product at the lowest rates and the traders will just use us. “
The reality turned out to be less idealistic than expected when the team found out. “It turns out that no one uses aggregators and traders almost never use the pools with the best rates,” Richardson added. “They just do whatever they are going to do.” Nate Hindman, Bancor’s chief growth officer, had his own take on why Uniswap is so dominant:
“I think a big part of that has been this kind of ‘Uniswap gem’ move that was a DeFi summer thing, where are all these new tokens that are launching pools on Uniswap. Therefore, Uniswap is the only place to get these ‘gems’. “
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Hindman’s assessment appears to be in line with Uniswap’s volume data. According to his statistics, the volume distribution is heavily skewed towards smaller tokens. The pairs between Ether (ETH), Bitcoin (BTC) and stablecoins take around 25% of the total volume, while the rest of the list is mainly populated by small-cap tokens that are difficult to access on other platforms.
As Hindman revealed, capturing the “long tail of tokens” will be Bancor’s next big goal. One potential proposition for that is the Origin Pool, which allows you to create “synthetic” pools paired with ETH, which the protocol seamlessly replaces with BNT. This would resolve Bancor’s long-standing onboarding friction, as projects wishing to be listed were required to have BNT in addition to their own token.
After the announcement of Uniswap V3 and its strong focus on swap efficiency, in part at the expense of automating the liquidity pool, it became clear that AMM’s projects are beginning to diversify into different niches. With SushiSwap’s focus on additional features like margin trading, Balancer’s push for composability, and Bancor’s focus on LP and BNT token, the AMM space is becoming increasingly diverse.