As a decentralized exchange (DEX) built on Ethereum, Bancor is designed to make DeFi popular by providing the easiest and safest way to trade and earn passive income in DeFi.

Introduction

Dated back to the summer of 2016 when there was no DeFi, Bancor was the first to propose AMM. In 2017, Bancor raised $153 million in financing from multiple investment institutions including KR1, Hyperchain capitalai, SNZ hoinding, draper associates, etc.

In the same year, the Bancor mainnet was launched. BNT is the native token to the Bancor protocol. Serving as the reward token as well as the governance token of the protocol, BNT can be used to vote on the proposals put forward by the Bancor DAO.

In 2019, BNT also gained popularity for a while along with the booming of DeFi, and its price reached 100 USDT at the highest price.

In 2020, Bancor was upgraded to V2, launching a single currency staking to provide liquidity and impermanent loss protection functions.

In 2022, Bancor officially launched its V3, called Bancor V3, which is also the latest version, which has simplified the process and improved efficiency. In addition, this version has also modified and enhanced the unilateral staking and the function to avoid impermanent loss in the V2 version.

Advantages of Bancor

Automated Market Maker (AMM)

Introduced by DEX Bancor for the first time, AMM later became public knowledge thanks to UniSwap. By virtue of smart contracts and prefabricated algorithms, AMM allows users to only stake certain tokens to continuously provide liquidity for trading pairs. Therefore, compared with traditional centralized platforms, Bancor can still produce sufficient liquidity to support transactions without a large number of traders and market makers, which is one of the greatest innovations of the Bancor protocol.

Read more about AMM: Gate learn: What is an AMM?

Use single currency staking to provide liquidity

Most liquidity providers (LP) of AMM have to stake two types of assets for trading pairs (such as ETH/USDT). However, Bancor was the first to allow users to stake a single currency to provide liquidity. When users add ETH to the liquidity pool, the protocol will automatically mint the same amount of new BNT as the other half of the liquidity pool. When the liquidity of ETH is withdrawn, the corresponding BNT will also be retrieved and burned.

The liquidity of ETH is aggregated in a pool. When a user wants to exchange Token B with ETH, the protocol provides BNT to convert. Actually, there are two transactions in this process: ETH is converted to BNT, and then BNT is converted to Token B.

Solutions to avoid Impermanent loss

If you don’t know impermanent loss well, you need to first get to know about liquidity mining on Gate.io before you start learning the concept of impermanent loss. You can read this article: Gate.io “What is Liquidity Farming?”

In simple terms, users get rewards by providing liquidity. Essentially, they deposit two or more tokens of equal value into the fund pool. When users withdraw their assets from the pool, users may receive less actual income than holding a single token due to fluctuations over time. We call this relative loss the “impermanent loss”.

Basically, liquidity providers (LP) will face the risk of impermanent loss. Bancor, the first protocol that proposed a solution to 100% avoid impermanent loss, provides users with BNT tokens owned by the protocol to make up for losses.

Starting from the liquidity pool on the Bancor V2 version, the protocol mints BNT to provide the other half of the liquidity for LP. Hence, half of the reward is distributed to the protocol. The handling fees obtained by the protocol will be used to compensate for the impermanent loss of LP. When the amount of impermanent loss is greater than the income earned by the protocol, a new BNT will be created to compensate for the loss.

Bancor’s function on avoiding impermanent loss aims to compensate users in a more cost-effective and friendly way. In the Bancor V3 version, LPs need to wait 7 days after they click to withdraw liquidity, and there is a 0.25% withdrawal fee. The handling fees generated during these 7 days will be distributed to the remaining LPs.

Please note that Bancor suspended its impermanent loss protection program in light of current market conditions, which was announced by Bancor on June 19, 2022. A restart is expected once market conditions are improved and become relatively stable.

Token economy

BNT is the native token to Bancor. The current circulation of BNT is 198,857,636 pieces, according to CoinMarketCap data.

The supply of BNT is flexible. As mentioned above, when LP provides liquidity for the fund pool, the BNT minted by the protocol is used as the other half of the liquidity of the fund pool. Therefore, when LP withdraws liquidity, the other half of its liquidity, BNT, will also be burned accordingly.

Moreover, revenue gained by the protocol from transactions is used as the source of funds to offset the impermanent loss. If there is any surplus after compensation, the excess BNT will be burned. However, if the revenue is not enough to make up for the impermanent loss, new BNT will be continuously minted to compensate user’s loss. Therefore, the supply of BNT is not constant but changes with the liquidity pool.

Constant Reserve Ratio (CRR)

ETH is used as the reserve fund for BNT, and BNT is issued by sending ETH to the smart contract that holds reserve funds for Bancor. Then, these ETH become Bancor’s reserve funds, making BNT valuable. Other tokens use BNT as a reserve fund and connect it to the Bancor system. Bancor’s constant reserve ratio (CRR) is set and maintained at 20%.

If the price of ETH rises, the price of BNT will go up, and so will the prices of other tokens. Hence, in the network established by BNT, it is possible to increase the demand for BNT of other network tokens, and the token price can be calculated. Thus, it can help reduce volatility, and the transaction can be done to exchange for reserve tokens without going through the exchange or the second party participating in the transaction.

Bancor protocol adopts the preconditions of the pricing strategy, which can be presented using the following formula:

In this formula, Price refers to the price of the new token, Balance is the current reserve token balance, Supply is the current supply of the new token, and CRR is the constant reserve ratio.

This pricing strategy ensures a constant ratio (i.e. constant reserve ratio, CRR) between the “reserve token balance” and the “market cap of new tokens”. Every transaction made by users can affect the value of Balance and Supply, thereby ensuring the constant reserve ratio of new tokens. This is also one of the highlights of Bancor.

Application Scenarios

Create tokens

Users build their own digital currency network on the Bancor protocol. Meanwhile, the token price is bound by Bancor’s reserve system, so that token transaction does not need to achieve the double matching, and make it possible to exchange other tokens on the platform without a second party to trade.

Currency swap

When users set the “constant reserve ratio” to 100% (meaning that the “reserve balance” is equal to the “token circulation”) and put two different digital currencies X and Y in the reserve, users have the ability to exchange these two currencies and are called a “currency swapper”.

Make a basket of currencies decentralized

Similar to “currency swap”, when users set the “constant reserve ratio” to 100% and put multiple digital currencies in the reserve, the function of the Exchange Traded Funds (ETF) or something like Index Funds can be achieved.

Conclusion

With the Bancor protocol, new or small amounts of cryptocurrencies can solve the liquidity problem effectively. These currencies can be directly swapped between tokens without an exchange or a third party. The protocol lowers the barrier to entry for cryptocurrencies. Moreover, its unique application of a basket of currencies also allows Bancor to gain a share in DEX.

Although Bancor is widespread, its native token BNT has been falling. Investors should make judgments in an all-round way on its future development trend and entry time, and invest cautiously.