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AMA with Bancor: V2’s Solutions to Improve AMMs

Automated Market Maker (AMM) based Decentralized Exchanges (DEXs) are becoming the hottest thing within DeFi as AMMs power the decentralized exchange of tokens.

Unlike Market Makers (MM) on traditional centralized exchanges, AMMs alter how users swap cryptocurrencies by allowing users to seamlessly switch between tokens on-chain in a completely decentralized and non-custodial manner.

Liquidity is a priority for AMM-based DEXs, and how to encourage liquidity providers to actively participate and achieve the most liquidity is crucial.

AMM-based DEXs like Uniswap V2, Curve, and Balancer have consistently achieved the most liquidity and the highest trading volume. As the first smart contract AMM platform on Ethereum, Bancor will soon introduce its V2 upgrade.

What edges Bancor V2 has will help it create a “liquidity blackhole”? What is Bancor’s response to the current high gas fee on Ethereum? And Where are we in the current DeFi frenzy?

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On July 20, ChainNode and 8BTC have the chance to invite Nate Hindman, head of growth at Bancor, and the head of product Asaf Shachaf to have an online AMA (Ask Me Anything) with the Chinese crypto community, discussing issues around DeFi and AMM-based DEXs.

Bancor v2 liquidity blackhole

As the first AMM-based decentralized exchange, Bancor v1 has spurred an ecosystem of innovative AMMs meanwhile exposed several key downsides including involuntary token exposure, slippage, and impermanent loss.

With the interests of both traders and liquidity providers in mind, Bancor v2 offers solutions to the three aforementioned problems.

Regarding the slippage issue, Bancor v2 optimizes the pricing curve using “amplification coefficient” to dramatically reduce slippage – 20X amplification on liquidity in the reserves, that means, a pool with $200,000 in reserves can offer prices that are like a $10M pool in terms of slippage.

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“Across the industry we have already seen that using liquidity amplification allows AMM to compete with order-book based exchanges. I wouldn’t be surprised if the majority of crypto trading volume occurs via AMM-based DEXs in the next couple years.

Of course, the two primitives (AMMs and order books) can be combined. Jarvis.exchange is running some interesting experiments in this field.” Said Hindman.

As for the impermanent loss problem, v2’s solution is to use a price oracle provided by Chainlink. As Shacha explained,

“Bancor reduces the opportunity for arbitrageurs to rebalance reserves and extract value from the pool, while allowing for “healthy” arbitrage to occur which does not remove any value from the pool. For each reserve, staked balance indicates the total amount of tokens staked by liquidity providers, and current balance indicates the amount of tokens held in the reserve. The pool updates reserve weights to incentivize market participants to equalize the current balance with the staked balance. Price feeds are used for calculating the weights such that after arbitrage closure, the pool price becomes equal to the market price. The system can be plugged into other oracle solutions, but we believe the best and most resilient solution at this stage is definitely Chainlink.”

Responding to users’ worry about v2’s over-reliance on oracles mentioned above, Hindman added that

The team has developed a robust infrastructure to integrate with any external oracle solution. So that any central point of failures can be eliminated. Though there is some risk that the oracle will fail from time to time, in these rare cases, v2 pools have a failsafe where they revert to v1 pools and operate as before. Once the oracle corrects, the pool will update the weights to return the reserves to their proper state.

Liquidity incentive plan after Bancor v2 is launched

To absorb liquidity, new AMM protocols like Balancer and Curve will distribute governance tokens to liquidity providers, while Bancor has already distributed most of its tokens via its initial coin offering in 2017. Then what solutions does Bancor offer to absorb liquidity? Hindman explained,

“After Bancor V2 is launched we are working on releasing the BancorDAO, which will vote on BNT Saking Rewards (liquidity provider incentives). We already have an initial model and will introduce a full proposal for the community to vote on.

Here is an example of how the system would work:

Bancor liquidity providers (as members of the BancorDAO) receive rewards based on:

  • the pool(s) they’re providing liquidity to
  • their ownership stake in the pool(s)

For example, in a given month:

  • $100K in staking rewards is generated
  • Rewards are distributed to “qualified” pools based on some characteristic (e.g., liquidity depth)
  • The MKR/BNT pool qualifies for 5% ($5K) in rewards
  • A user supplying 10% of the MKR/BNT pool’s liquidity receives 10% of the staking rewards ($500) on top of their share of trading fees.

In this way, liquidity providers on Bancor stand to earn not only from a pool’s trading fees, but also from its staking rewards. The APR from fees and rewards could attract new capital to Bancor from crypto users seeking yield.”

The problem of high transaction gas fee on Bancor

As the liquidity mining boom continues, the Ethereum network has become very congested, which has been accompanied by rising gas fees for transactions. It is clearly a big headache for DEX users. As a DEX platform running on Ethereum, Bancor users are also plagued by the problem. Hindman replied,

“It is an industry wide issue. We are constantly optimizing our contracts to make them as gas efficient as possible, such as the recent v0.6 release which brought down average gas costs by 30-40%.

As they stand, Bancor contracts are among the most gas efficient compared to other DEXs and we will continue to optimize them and explore Layer 2 solutions that reduce costs for traders and liquidity providers.”

Is the current DeFi boom sustainable

Apart from discussions on technical issues, users on ChainNode are also concerned with the trend of DeFi. Is the current DeFi boom sustainable? and what are the challenges ahead?

Hindman believes it is sustainable given the large amount of institutional liquidity flowing into DeFi.

“This is creating even more retail users as well. It seems likely there will be a crash at some point. The crypto analyst Andrew Kang recently shared a great thread on this.

Particularly this image stuck out:

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I have also been revisiting Carlota Perez’s work on technological revolutions:

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And I would say DeFi is very much in the frenzy stage. But in short, over the long term, I believe it is here to stay.”

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