Shalini Nagarajan

<div id="highlights-block_62b57931f6d18" class="highlights">
 <ul>
 <li>After Bancor paused a key feature, wallets linked to Celsius and Nexo withdrew large positions</li>
 <li>The team exercised emergency powers to prevent “a small handful of large players” from causing catastrophe, Bancor’s Nate Hindman told Blockworks</li>
 </ul>
 
</div>



Bancor, a pioneer in Decentralized Finance, temporarily <a href="https://cms.blockworks.co/bancor-halts-impermanent-loss-safeguard-to-fight-off-hostile-antagonist/" target="_blank" rel="noreferrer noopener">halted</a> its popular impermanent loss (IL) insurance feature last weekend, raising concerns that the protocol isn’t truly “decentralized.”



Impermanent loss refers to the unrealized amount that occurs when you provide liquidity to a pool in the form of cryptocurrency, and the value of those tokens changes since you deposited them.



Ever since the automated market maker said it wants to give the protocol room to breathe, it has observed wallets linked to crypto lenders Celsius and Nexo remove liquidity from the system while taking a haircut.



Blockworks spoke to Bancor’s Head of Growth Nathaniel Hindman and Head of Research Mark Richardson to understand what they saw as “manipulative behavior” that made them safeguard the protocol. The pair identified two major factors: large short positions taken out against the protocol’s BNT token, while at the same time a surge in withdrawals and selling of the liquidity mining rewards, which are paid out in BNT by the protocol.



<h3 class="wp-block-heading">Large short positions</h3>



In a June 19 <a href="https://blog.bancor.network/market-conditions-update-june-19-2022-e5b857b39336" target="_blank" rel="noreferrer noopener">blog</a>, Bancor said it would temporarily pause IL for liquidity providers (LPs) due to an ongoing “attack” and a “hostile antagonist.” The attack, they believe, relates to wallets linked to Celsius’ attempt to exit large positions in the protocol. They found accounts on two exchanges, FTX and OKX, that held short interest worth $2.5 million in total against the platform’s BNT token.



“It’s not catastrophically large,” Richardson said in an interview. “But whoever is sustaining these positions is borrowing the maximum daily limit every day.” He assumed the rapid withdrawals were made to cover liquidations or debt.



“Because of the financial situation that they&#8217;re in, they are being a lot more reckless in the way that they&#8217;re managing their exit from the market,” he said.



Additionally, they believed someone spread misinformation on the message board 4chan about the way Bancor runs its protocol. That drove panic and led to a number of active withdrawals piling up, similar to a bank run, encouraging other people to follow — until a majority of the protocol’s Total Value Locked (TVL) was queued up to leave, according to the product architect.



Large withdrawals end up making BNT less liquid, which means the token is less able to absorb the selling pressure. But Bancor was built to deal with short interest, Hindman said — emphasizing that it wasn’t just this incident that led to the IL pause.



<blockquote class="wp-block-quote is-layout-flow wp-block-quote-is-layout-flow">“It’s been this perfect storm of events.&#8221;</blockquote>



It&#8217;s not just the shorts,” he said. “It&#8217;s also having some of the largest centralized players in the industry utilizing our system, and then having them go insolvent at the same time and withdrawing and dumping large amounts of liquidity mining rewards.”



<h3 class="wp-block-heading">Bancor LP&#8217;s liquidity mining rewards &#8220;went on too long&#8220;</h3>



While decentralized exchanges like Uniswap don’t protect against impermanent loss, Bancor pitched such compensation as a unique selling point. LPs receive BNT tokens as rewards for committing their capital to Bancor pools. This was the “original sin” that caused headaches for the protocol, Hindman said.&nbsp;



“BNT liquidity mining rewards really went on too long,” he said, adding that large stacks have been accumulated in the hands of some people who are now rapidly dumping them, “putting this maximum strain on the system.”



So the combination of a market meltdown, substantial short positions and tons of BNT rewards being dumped simultaneously caused the team to intervene.



<blockquote class="wp-block-quote is-layout-flow wp-block-quote-is-layout-flow">“We could see very easily that we weren&#8217;t going to be able to withstand that for much longer,” Richardson said.&nbsp;</blockquote>



There have been some <a href="https://twitter.com/cobie/status/1538671298129416192" target="_blank" rel="noreferrer noopener">concerns</a> that Bancor simply mints new BNT to compensate liquidity providers under its ILP mechanism.



<figure class="wp-block-embed is-type-rich is-provider-twitter wp-block-embed-twitter"><div class="wp-block-embed__wrapper">
<blockquote class="twitter-tweet" data-width="550" data-dnt="true">Does Bancor &quot;impermanent loss protection&quot; just pay out newly minted BNT tokens in order to cover the loss if there wasnt enough made in fees&#8230;&#8230;???&mdash; Cobie (@cobie) <a href="https://twitter.com/cobie/status/1538671298129416192?ref_src=twsrc%5Etfw">June 19, 2022</a></blockquote><script async src="https://platform.twitter.com/widgets.js" charset="utf-8"></script>
</div></figure>



Hindman denied this by calling it a misconception. “Some of these criticisms have come from the biggest investors of some of our competitors and folks in the industry that just haven&#8217;t taken the time to understand this system,” he said.



He said Bancor operates similar to an insurance company, by offering the IL insurance in exchange for a percentage of trading fees on the network.



“Currently about 15% of trading fees are confiscated from liquidity provider earnings in order to fund the insurance, and that&#8217;s also on top of Bancor co-investing its BNT inside our own pools in order to generate protocol fees that offset this cost,” he said.



Minting of BNT is a last resort, only employed when the protocol fees, from trading activity, are not enough.



<h3 class="wp-block-heading">DAO emergency powers vs. centralized authority</h3>



Bancor said it had to activate its “emergency powers” in order to respond to the crisis, raising eyebrows about whether that goes against the fundamentals of a Decentralized Autonomous Organization. Technically, there isn’t supposed to be a centralized leadership group within a DAO.



But the Bancor team says they felt it necessary to assign emergency rights to certain people who can take decisions in a crisis. 



They were able to take the initiative because of a <a href="https://gov.bancor.network/t/bip21-dao-multisig-intervention-policy/3504">proposal</a> four months ago, which was ultimately voted on and ratified by the DAO. That granted emergency powers to the DAO’s <a href="https://docs.decentraland.org/decentraland/how-does-the-dao-work/">multi-sig</a> to implement such actions.



“In these early days of decentralized protocols, especially those that are as complex as Bancor, we think it&#8217;s only responsible that the DAO give emergency rights to a multi-sig,” Hindman said, referring to a multi-signature wallet that manages protocol upgrades and parameters, providing a measure of centralized control.



<blockquote class="wp-block-quote is-layout-flow wp-block-quote-is-layout-flow">“We weren&#8217;t going to sit by and watch as a community what we think was a small handful of large players suck the system dry.”</blockquote>



Bancor is now working to propose stronger protections for its IL insurance system to the DAO, even as independent observers <a href="https://twitter.com/hasufl/status/1538778386285441025" target="_blank" rel="noreferrer noopener">question the viability</a> of the whole system.



“We understand that it&#8217;s certainly controversial, but we do think it was the right decision to make,” said Hindman.



<hr class="wp-block-separator has-alpha-channel-opacity"/>



Get the news in your inbox. Explore Blockworks newsletters:



<ul class="wp-block-list">
<li><a href="https://blockworks.co/newsletter/the-breakdown">The Breakdown</a>: Decoding crypto and the markets. Daily.</li>



<li><a href="https://blockworks.co/newsletter/0xresearch">0xResearch</a>: Alpha in your inbox. Think like an analyst. </li>
</ul>

Bancor

Bancor Uses ‘Emergency Powers’ to Fight ‘Hostile Antagonist’

Macauley Peterson

<div id="highlights-block_627befabd8d8c" class="highlights">
 <ul>
 <li>Focus on providing sustainable liquidity for DAOs and token treasuries</li>
 <li>Revamps impermanent loss protection and single-sided staking from V2.1</li>
 </ul>
 
</div>



The latest version of an automated market maker for cryptocurrencies launched on Ethereum’s mainnet Wednesday with a host of features for liquidity providers.&nbsp;



Bancor AMM has dubbed the new trading platform V3, an evolution for the company that invented the automated market maker (AMM) liquidity pool concept <a href="https://www.forbes.com/sites/rimmaboshernitsan/2018/10/23/this-blockchain-entrepreneur-is-reimagining-value-by-putting-empathy-first/" target="_blank" rel="noreferrer noopener">in 2017</a> — which Uniswap later iterated upon to become the dominant decentralized exchange protocol with <a href="https://defiprime.com/dex-volume" target="_blank" rel="noreferrer noopener">more trading volume</a> than its competitors combined.&nbsp;



The latest edition improves upon the prior version’s two key innovations — impermanent loss protection and single-sided liquidity provision.



“With regard to the functioning of the protocol, the product and the user experience, we were looking to alleviate basically all of the major pain points that we could find,” Bancor Head of Research Mark Richardson told Blockworks.



One of the risks of providing liquidity in a DEX, or decentralized exchange, is the change in the relative value between the tokens in a given pair — known as impermanent loss, or IL. To be profitable, a liquidity provider must earn swap fees from trades on the exchange sufficient to compensate for the IL disparity.&nbsp;



Bancor debuted a novel IL protection feature in a previous version, but it had one major shortcoming: An LP needed to provide liquidity for at least 100 days for full protection.



V3 eliminates that delay, replacing it with a “cooldown period” of seven days to withdraw from a position, plus a new 0.25% withdrawal fee, but in exchange, the IL coverage kicks in immediately.



“Our chief economist Stefan Loesch ran a bunch of Monte Carlo simulations using 14 months of data from version 2.1 and concluded that something like a seven-day cooldown period is going to be sufficient for that,” Richardson said.



Single-sided liquidity — adding only one token to a pool — was a key component of earlier versions, as each pool is paired with Bancor’s native BNT token.&nbsp;



The problem: a limit on the amount of deposits the protocol could handle. Once a cap was reached, more BNT had to be added to a pool to open up space for additional token deposits.&nbsp;



That led it to become a sort of “exclusive club,” according to Richardson, stunting growth.



“For a DeFi protocol to unnecessarily restrict your [total value locked] is kind of shooting yourselves in the foot.”



As a salve, V3 introduced what the team calls “the first-ever fungible Single-Sided Pool Tokens.” Unlike normal pool tokens, these LP positions incorporate an auto-compounding feature, aimed at decentralized autonomous organization (DAO) treasuries, which allows token teams to incentivize liquidity.



Previously, when a new Web3 project wanted to incentivize the formation of a pool, it tended to attract so-called mercenary capital, which would farm and sell the project’s tokens, reducing the treasury’s holdings&nbsp;



Now, DAOs and individual decentralized finance (DeFi) users can deposit capital into a Bancor pool, and see their token incentives auto-compound. That alleviates the need to manually claim them and saves on Ethereum gas fees — transactions that power the blockchain.



Uniswap’s V3 lacks a way for third parties to incentivize liquidity, explaining why many teams continue to offer incentives for market makers on the older Uniswap V2, which — more than a year after Uniswap V3’s launch — remains among the top 10 DEXes by trading volume, <a href="https://www.coingecko.com/en/dex" target="_blank" rel="noreferrer noopener">according to CoinGecko</a>.



Also, unlike Uniswap V3, which uses non-fungible tokens (NFTs) to represent an LPs share of a pool, Bancor’s new LP tokens are easily composable in other DeFi products — for instance they might be used as collateral in <a href="https://makerdao.com/en/" target="_blank" rel="noreferrer noopener">Maker</a> to mint DAI or supplied to Aave.



“Uniswap V3 has a completely different philosophy and objective,” Richardson said. “It doesn’t care about continuous liquidity. It doesn’t even espouse that markets should function correctly. It’s basically just a limit order protocol — it has all the shortcomings of an order book, and that makes it very difficult for things like natural price discovery.”



<hr class="wp-block-separator has-alpha-channel-opacity"/>



Get the news in your inbox. Explore Blockworks newsletters:



<ul class="wp-block-list">
<li><a href="https://blockworks.co/newsletter/the-breakdown">The Breakdown</a>: Decoding crypto and the markets. Daily.</li>



<li><a href="https://blockworks.co/newsletter/0xresearch">0xResearch</a>: Alpha in your inbox. Think like an analyst. </li>
</ul>

Mark Richardson

Newsletter

Blockworks Research