Automated market maker exchange Bancor has rolled out a new mechanism that allows users to increase their capital efficiency while providing liquidity in its pools.
Called Vortex, the solution allows users providing liquidity in BNT, Bancor’s utility token, to borrow funds while continuing to obtain yield from swap fees.
The Vortex mechanism reworks the existing mechanism of vBNT, a special version of the BNT token that entitles users to participate in governance. The voting token is automatically received when staking BNT into a liquidity pool, and it can be defined as Bancor’s pool token.
The Vortex 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 into any other asset.
The vBNT sale mechanism makes Vortex a no-liquidation lending platform, letting liquidity providers receive their future rewards immediately, in a similar manner to Alchemix. Since their principal continues to accrue swap fees, the loan will eventually repay itself.
The “no-liquidation” part of the loan comes from the fact that vBNT and BNT are essentially the same token, and the rise in price of the BNT collateral is very likely to be mirrored by vBNT. BNT staking creates vBNT at a one-to-one ratio, but the price relationship between the two is not straightforward.
Combining protocol revenue and lending results in complex tokenomics
The vBNT token’s price is derived from a BNT/vBNT AMM pool, thus largely being defined by the market. A potential arbitrage mechanism means that vBNT is unlikely to ever be worth more than 1 BNT, as arbitrageurs could simply stake BNT, sell the vBNT and obtain more BNT than they started with. The cycle could be repeated an infinite number of times until the vBNT price returns below 1 BNT.
At the same time, vBNT has no price floor because the arbitrage mechanism cannot work in reverse. As Mark Richardson, the creator of Vortex, explained to Cointelegraph, Bancor uses internal records to define ownership within an AMM pool. This is a significant difference from models like Uniswap’s pool tokens, which are the sole marker of liquidity ownership. The vBNT could be used to redeem a BNT liquidity pool only if that address had already created one.
To guarantee that vBNT maintains some value in the absence of a redemption mechanism, the protocol will be conducting a buyback-and-burn strategy on the token. A governance-defined portion of the protocol’s fee revenue will be diverted to periodically buy and destroy vBNT from the pool with BNT, providing a constant buying pressure.
This has the added result of creating a sink of BNT and vBNT. Since one vBNT unlocks one BNT, destroying vBNT supply creates an imbalance with the tokens contained in AMM pools. A portion of those tokens would thus remain locked in the pools forever, though this should not impact liquidity withdrawal for individual LPs due to the large excess capacity — a similar mechanic occurs with cold wallets on centralized exchanges.
The vBNT token mechanics have a number of interesting ramifications. In addition to the ability to borrow while continuing to receive yield, liquidity providers are also able to 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 this costly and ultimately impractical.
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