Swap fees exceed impermanent loss insurance costs

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Bancor has published a status report for the upgrade of the decentralized switch v2.1, which covers the performance of the decentralized switch in the last three months.

According to the document, total liquidity increased nearly 100%, which resulted in the platform generating cumulative swap fees of around $ 1.12 million.

Bancor’s report found that fee income was more than five times the cost of inconsistent loss compensation for liquidity providers.

In fact, inconsistent loss management was a major focus of the upgrade from version 2.1, as Cointelegraph discovered back in October 2020. While Bancor initially attempted an oracle-based solution, it quickly found that this was impractical due to front-running issues. The new approach uses economic incentives to cover the cost of volatile losses, a phenomenon caused by the constant realignment of the portfolios of liquidity providers. Since two tokens differ in price, LPs will experience smaller gains and larger losses compared to a benchmark 50-50 portfolio.

At this point, Bancor announced that it would introduce an insurance mechanism against inconsistent losses in its second iteration. As part of the solution framework, the project has established a vesting schedule for liquidity providers in order to create incentives for long-term involvement.

Swap fees exceed inconsistent loss. Source: Bancor

According to the vesting schedule, the protocol provides coverage of 1% of the liquidity capital, which is made available for up to 100 days to cover an inconsistent loss. However, liquidity providers who withdraw their money prior to 30 days will not receive any compensation for losses incurred during the period.

With swap fees far exceeding insurance costs for compensating inconsistent losses, Bancor found the platform to be profitable for both the protocol holders and the Bancor Network Token (BNT) holders.

Commenting on the potential impact of such a situation on unused altcoin capital, Nate Hindman, head of growth at Bancor, told Cointelegraph that more altcoin holders will be incentivized to become liquidity providers rather than a buy-and-hold strategy track, adding:

“With Bancor v2.1, AMM LPs can stay on their tokens for a long time while providing liquidity without the risk of inconsistent loss. We believe this will bring a new wave of users participating in the AMM mission. As we’ve seen so far, many of these users are more likely to be long-term owners (rather than farmers with opportunistic yields) who seek high, low-risk yields for their favorite brands. “

Hindman also noted that a viable solution to volatile losses could also encourage projects to use their treasuries to provide liquidity to AMMs. Similar to proof-of-stake rewards, projects with large token reserves could finance themselves while increasing the liquidity of their token pairs.

Bancor liquidity providers will also earn BNT as a reward. In fact, the protocol is starting its liquidity mining program, which gives liquidity providers BNT rewards retrospectively. The BNT rewards can either be claimed or used on the platform.