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DeFiSeptember 27, 2020

How Does Bancor v2 Work?

Shubham Goyal
Product Specialist
September 27, 2020

What is Bancor v2?

Bancor is a liquidity protocol that sanctions automated and decentralized exchanges over Ethereum and across blockchains. Users can deploy and customize AMM (Automated Market-Maker) liquidity pools, trade tokens, and provide liquidity to the reserve pools. Since liquidity providers can add or extract liquidity very easily and without requiring the authorization of a central figure, Bancor is a decentralized exchange platform (DEX).

Back in 2017, Bancor launched some of the first AMMs on the Ethereum blockchain. Bancor v1, or Bancor version 1, set sail with the initiative to let tokens on the decentralized exchange (DEX) platforms be liquidated quickly using smart contract-based and algorithmically-managed token pools, as opposed to the general order-book based system. An AMM liquidity pool is profitable for two primary reasons:

  1. It’s easy for everyday users to access the network through a liquid on-and-off ramp.
  2. Along with the liquidity provider rewards, liquidity providers can also acquire yield on the tokens they provide in the form of AMM fees.

Now with the upgraded version 2, Bancor plans to fix the shortcomings v1 had.

Bancor v1 vs v2: The Difference

Before the introduction of AMM, the general DEX platforms received only a meager percentage of the total cryptocurrency trading volume. But Bancor v1, being an AMM-powered decentralized exchange, had the objective to generate a considerably larger share of the total crypto trading volume. True to its word, since its launch Bancor v1 has yielded billions of dollars in trading volume. However, the initial AMM model used in Bancor v1 also has some disadvantages, namely:

  • Multiple Token Exposure: In the Bancor v1 AMM pools, one must provide every single token present to be a liquidity provider.
  • Slippage: Slippage is the price distinction between the expected price and the execution price of a trade. As Bancor v1 uses AMM pools with fixed coin ratios, the larger the trade you make, the higher your chances of suffering negative slippage are.
  • Impermanent Loss: Whenever the market rate of a particular coin in an AMM pool moves away from the rate at which the liquidity provider staked it, the amount the provider can extricate also drops lower than the amount they provided.

With both the liquidity providers’ and the general traders’ interests at heart, Bancor v2 is specifically designed to provide solutions to those exact problems. In contrast to Bancor v1, the Bancor Protocol’s second version is built on an AMM model that offers the following features and opportunities.

Features and Functions of Bancor v2

  1. Singular Token Exposure: As mentioned before, with Bancor v1 all liquidity providers were obligated to provide equal amounts of every coin the pool is created with to maintain the pool’s fixed ratio. This kept the liquidity providing opportunities inaccessible for traders who might hold only one of the crypto coins present in the pool or might be interested in adding a specific coin only. But Bancor v2 allows liquidity providers the option to add liquidity with exposure to only a singular token of their choice.
  2. Low Slippage Swaps: The AMM structure used in Bancor v1 needs a provider to stake quite a large amount of liquidity so that it can compare to the trading volume generated by order-book based exchange platforms. These large trades also come with a fairly high slippage. But Bancor v2 provides more pliability on its pricing curve, magnifying capital efficiency in a token pool. By using a larger amount from the pool reserve within a definite range of conversion prices, the Bancor v2 bonding curve reduces slippage by a significant margin while increasing the trading volume.
  3. Mitigation of Impermanent Loss: The older AMM model always maintains a fixed weight ratio of tokens in a liquidity pool. So when, due to market volatility, the price of a particular token falters, the weights still stay fixed, which means the liquidity providers in an AMM pool also run the risk of losing out on their money, even though the loss is theoretically temporary.

By using prices from Chainlink’s oracles, Bancor v2 AMMs keep the value of its tokens steady. A v2 liquidity pool is programmed to sustain the ratio of tokens in it, thus alleviating the risks that come with token price fluctuation. And with the threats of impermanent loss removed, major institutions and the common users alike can confidently stake their assets in an AMM pool.

Is the Bancor v2 Platform Safe to Use?

It’s very important to remember that Bancor v2 is still in the beta phase. So, while v2 has largely succeeded in doing away with the issues an AMM-based DEX might face, there are still a few flaws to it that the team is working on fixing. For example, while associating with oracles does allow the risks of impermanent losses to be lessened, for the most part, there is still the factor that an oracle can turn out to be incorrect or fail at times. It’s true that when that happens, a Bancor v2 pool would switch to functioning as a v1 pool does until the oracle gets back on track, but you’d still be facing the smallest risk of losing a portion of your staked assets.

With that being said, though, Bancor v2 is still one of the best DEX platforms you can opt for, with the returns being fairly high. Plus, the singular token exposure feature of v2 allows traders from all backgrounds to try their hand at adding liquidity to the AMM pools. And as a liquidity provider, you’d get to profit off of the trading fees a pool obtains, along with voting rights in the BancorDAO. So all things considered, if you’re willing to take a risk, Bancor v2 is definitely worth trying out.

To find out more about the v2 protocol, and about the Bancor network in general, you can keep an eye on their blog here, and their official Twitter here.

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