The world of crypto may have just become apparent to most ordinary people, but for those truly behind the support and innovation, the world has become evident. However, do you really know the history of how a lot of the systems you enjoy the benefits of today came to be? This article will take a deep dive into parts of the history of de-fi, further creating automated money market makers.
Due to mass adoption, the majority of crypto users is seen since 2019, which was further incentivized by distrust within the traditional finance system after the Covid-19 pandemic. A mass influx to major exchanges such as Coinbase, Kraken, Binance, crypto.com, Gemini, Gare.IO, etc. Due to the mass adoption of crypto’s general front-end, service providers have to offer further services to incentivize new client group demographics to join this new wave of investors and users within the crypto ecosystem. This has further lead to the mass adoption of DeFi products worldwide, either through single service providers that purely focus on the following through LPs (liquidity pools) and AMM’s (automated money makers), or through changes, and crypto banking services providers such as Nexo, crypto.com.
The general prospect of users earning consistently between 6-12% on most of their stablecoins is a much more attractive prospect than marginal rates or negative rates being offered worldwide in the traditional banking system. Unfortunately, as general consumers, we have become incredibly impatient relative to our expectations of service. The following has lead =to a user mentality to expect magic at the click of a button.
I hope all readers are asking themselves where the interest gained is produced, further, the sustainability of the system, and where the idea originated, who were the key founders/companies that started sub down this track.
To understand Defi, we first need to understand what came before and the technological complications and innovations that we’re made to arrive at the services we use today. The concept of market makers originated within traditional finance. The following was created to solve an event that would stop trading a specific exchange, which would prohibit regular traders from accessing the general markets. Buyers (Bidders) want to buy at the lowest price, and Sellers want to sell at the highest price, and the median cost cannot be met. This is why market makers, liquidity pools were created to buy and sell at all point of the market to provide liquidity for all traders. You may be wondering what the incentive for such parties is to provide liquidity for the market constantly.
Market Makers charge a spread on the buy and sell price, further transact on both sides of the market. They further establish quotas for the purchase and sell prices of any security associated. Market makers also earn commissions by providing liquidity to their client’s firms. However, taking the following concept and translating it over to the crypto ecosystem is not simple; further, the general costs associated with the order book model would cripple market makers.
So what solution was provided, one of the earliest and most innovative solutions proposed, was by Bancor, the following became mass affluent throughout the increased popularity and use of UNI (Uniswap), before I explain, let me create a comparison for those unfamiliar to the scene. “Bancor in some senses was the engine under the of the car for Uniswap”. AMM’s provided the liquidity that allowed the majority of indexes we freely enjoy using today to function consistently at all times.
How do liquidity pools function?
In a simple explanation, two tokens are added and held in a pool, an example being ETH/FLUID; this could be an excellent example of future widespread liquidity on uni swap. When the pool is created, the liquidity provider sets the pool’s initial price. The LP is further incentivized to keep an equal supply value of both tokens. If the costs of the tokens in the pool diverge from the global market, this will lead to an instant opportunity for arbitrage, ultimately leading to a loss of capital for the LP. The result of keeping a constant supply of equal liquidity from both sides leads to an incentive for further LPs who join the pool to add additional funds.
When liquidity is supplied to a pool, the liquidity provider (LP) receives unique tokens called LP tokens in proportion to how much liquidity they provided to the collection. When a trade is facilitated by the pool, a 0.3% fee is proportionally distributed amongst all the LP token holders. If the liquidity provider wants to get their underlying liquidity back, plus any accrued expenses, they must burn their LP tokens.
Each token swap that a liquidity pool facilitates results in a price adjustment according to a deterministic pricing algorithm. This mechanism is also called an automated market maker (AMM) and liquidity pools across different protocols may use a slightly different algorithm.”
“X (Token A quantity) x Y (Token B quantity ) = K (Constant)”
The majority of liquidity pools focus on this basic principle, such as Uniswap, however due to the vast amount of main nets now available, further digital wallets such as Meta mask.IO that culminate all tokens from each main net into one wallet. Allowing users to further diversify the services they use and the Main networks they operate on. This has further given the rise to multiple Automated Market Markers.
Here is a list of the following: (AMM`s)
- Uniswap V3 :
Striving for an open and accessible marketplace for all, Uniswap utilizes an AMM mechanism to calculate the price of tokens based upon the ratio of the tokens in the liquidity pools. Any user can provide liquidity.
- Balancer :
Balancer is comparable to Uniswap but hosts a broader range of features including multi-token pools, dynamic pool fees, and custom pools ratios. Multi-token pools are a unique feature that can behave like an index in the cryptocurrency space.
- Curve Finance:
A decentralized exchange focused on the trade of stablecoins. By focusing on stablecoins, Curve Finance is able to offer minimal fees and a low amount of slippage on trades.
- Sushi swap:
This decentralized exchange is known for its community governance model and innovation of DeFi projects such as Onsen.
- Kyber Network:
One of the original AMM protocols in the marketplace, Kyber Network’s liquidity pools are managed by professional market makers instead of a set algorithm, allowing for control of liquidity pools when volatility strikes. Entry to liquidity pools is more restrictive.
One of the original AMM protocols in the marketplace, Bancor created the inspiration for a lot of the companies mentioned above. Bancor had originally pioneered the first AMM back in 2017 to help solve the liquidity problem that arises due to sparse order books that did not always guarantee liquidity to investors. Despite developing and creating the first AMM, v1 exposed two crucial downsides in the original ecosystem.
Bancor deep dive:
So how about we take a deep dive into Bancor, further how it opened the road to the AMM market within the crypto eco-sphere. The original motivation of Bancor, was to provide an alternative to the order book model seen in centralized and decentralized finance, whilst allowing tokens to achieve on-the-spot on-chain liquidity through the use of algorithmically managed token reserves within smart contracts.
One of the attractive market segments found early by Bancor were new token projects that were growing fast but didn’t necessarily want to spend the time or money listing on an exchange and pay market-makers to create liquidity. They clearly understood that a healthy AMM liquidity pool is beneficial to users of a token-based network.
Over the last 4 years, since the real public inception into AMM’s LPs, Users have become increasingly “exchange-agnostic”, which results in them mostly relying on aggregators to find the best liquidity source in real-time for a trade.
After years of only capturing a small volume relative to the general market, AMM-based DEX such as Bancor have now begun to see a significant increase in volume, and are steadily gaining more and more relative to the total share of crypto volume. In the process of doing so, are pioneering a new form of community-sourced liquidity governed under a DAO structure. This allows for everyday users to act as market makers, not just experienced crypto Gurus & Pros.
General Overview of the BANCOR V2.1 ecosystem features:
The main features that are incredibly appealing to users of the Bancor ecosystem are the following:
Contrary to other AMM protocols, Bancor uses its protocol token, BNT, as the counterpart asset in every pool. Using an elastic BNT supply, the v2.1 protocol co-invests in pools alongside LPs to support single-sided AMM exposure and to cover the cost of impermanent loss with swap fees earned from its co-investments.
Further the diversification of tools available for free within the user platform, one of which is the access to the Dune Dashboard & Dune analytics. A webpage consolidating analytics and financial analysis tools relevant to all LP’s & sides of the ecosystem such as trading metrics, token metrics, burn metrics, governance metrics, etc. The following metric provision will allow for Bancor to highly segment itself as a true alternative in the DEX`s marketplace in relation to competitors in the coming years.
In addition to what I have mentioned above, I think it wise to mention another milestone the Bancor ecosystem has achieved in the last year, the introduction of the Bancor Vortex, further bringing it to live successfully on the ethereum mainnet. The following has drastically changed the way LPs, AMM’s interact through the Bancor eco-system. The Vortex Burner collects 5% of swap fee revenue within the depth of its liquidity pools and uses the following to buy and burn BNT & vBNT. vBNT Will now be burned with every swap, – locking BNT in the protocol permanently. The following actions lead to deflationary pressure on the circulating supply of BNT, lowering the volatility for LP’s.
vBNT burning further lowers the risk for users who wish to take leverage on their staked BNT. vBNT burn rate will become a critical part of BancorDAO’s flexible monetary policy and may be adjusted to collect up to 15% of the swap fee revenue.
The following is an example as to how the Vortex Burner functions:
The Vortex Burner introduces an adjustable-fee taken from swap revenue generated by liquidity providers (BIP9 and addendum). For example, if a $100,000 trade is executed on a pool with a 0.2% pool fee, $200 is collected by the liquidity providers as commission. The vBNT burner takes a 5% portion ($10) and uses it to buy vBNT and burn it.
The following further Diversify’s the offer that Bancor presents to LP`s and wallet holders worldwide, and is one of the reasons I have personally chosen to take a keen interest in the progress of the BancorDao’s ecosystem, and where it will grow to be in the coming years, I already have some predictions as to Bancor V3.0., what do you believe the Bancor Dao ecosystem will look like in the following years, and how the market of AMM`s will change, as well as the crypto-ecosystem.