Bancor, a decentralized AMM and exchange, has temporarily suspended its temporary loss protection feature to protect the protocol and its users from “manipulative behavior.” AT ad published on June 19, Bancor said it was confident the measures would secure the protocol while it worked to implement better safeguards.
However, the announcement was soon followed by rumors of a possible solvency crisis for Bancor, which was framed as a “precautionary measure for users”. The crypto industry, still suffering from the effects of Terra/LUNA and the ongoing Celsius crisis, is rife with rumors about how Bancor will solve its liquidity problems.
Cryptooshala discussed with the Bancor team the veracity of these claims, the events that led to their decision to suspend non-permanent loss protection, and the steps they are taking to prevent similar issues in the future.
Bancor tries to prevent the consequences of the Celsius crisis
On June 19, Bancor announced that it was temporarily suspending its Intermittent Loss Protection (ILP) feature. Trading will remain active across all liquidity pools on the network, and users who remain on the protocol will continue to generate income. Once the ILP is reactivated, they will be able to withdraw their fully secured funds. While withdrawals from the protocol were not affected, Bancor said it has suspended new deposits in its liquidity pools to “prevent confusion.”
According to a company blog post, Bancor has registered anomalies in its data and has reason to believe they are the result of manipulative behavior.
“Therefore, we are taking bold steps to protect the protocol by temporarily suspending IL protection and other steps to limit further impact,” the post reads.
However, rumors of a possible liquidity crunch at Bancor spread like wildfire shortly after the announcement. The platform was accused of buying time to figure out how to stay solvent after suffering losses on its own BNT token and downplaying the severity of the problem.
what’s the point of non-permanent loss protection if it just disappears when you need it most lol pic.twitter.com/GAJyhr6Tib
— Cobie (@cobie) June 19, 2022
Some even believe that Bancor will inevitably fall into a death spiral as its ILP mechanism compensates liquidity providers by minting new BNT, passing value to BNT holders through inflation.
Bancor’s pretend play to cover up IL is failing. They print new BNTs to compensate for underwater LPs and call it “IL protection”. The value is passed on to BNT holders through inflation, which causes further IL for all other BNT pairs and results in further inflation. Death spiral. https://t.co/MbqPiL3sKB
— Hasu⚡️🤖 (@hasufl) June 20, 2022
Bancor confirmed rumors that the recent Celsius crisis was at least partly responsible for the platform’s IL issues. The company said the cost of providing BNT rewards to liquidity providers has been increased due to the recent insolvency of “two large centralized entities” that many believe are Celsius and Three Arrows Capital.
These two entities were the “key beneficiaries” of the BNT liquidity mining rewards as they were the long-term liquidity providers in Bancor v2.1. To cover their liabilities, these institutions unexpectedly liquidated their positions in BNT and withdrew large amounts of liquidity from the system. At the same time, an “unknown person” opened a large short position in BNT, Bancor explained in a post.
While this would be a solvable problem for a protocol with diversified liquidity pools, it is a major risk for Bancor as all liquidity pairs in the protocol are in conflict with its own BNT.
The decision to keep trading while hating deposits was also scrutinized. Some critics have stated that this allows BNT holders to dump tokens, causing even more disparity in liquidity pools, which now lack IL protection.
Bancor responds to disputes
The Bancor team was quick to respond to the controversy surrounding its decision to suspend IL protection. Nate Hindman, head of protocol development, said the announcement was not meant to downplay the severity of the situation facing Bancor. June 20 Bancor Product Architect and Head of Research Mark Richardson discussed the aftermath of a long pause in the Twitter AMA.
Richardson explained that the decision to leave trading open was practical, as reactivating IL protection would require over 150 liquidity pools to be rebalanced. However, closing new deposits was an ethical decision – Richardson said it would be unfair to accept new liquidity from users while the situation remains unresolved.
Nate Hindman, Head of Growth at Bancor, told Cryptooshala there is no room for speculation about Bancor’s solvency.
“Everything is online. You can see how much the protocol has to pay out on IL insurance. We are not a centralized protocol where it is a black box and a person can risk the user’s funds. This transparency on exactly how much IL insurance is due has helped us quickly identify the situation and take emergency action provided by the DAO to suspend the withdrawal insurance feature.”
When it comes to allegations of the stability of IL Bancor’s protection mechanism, Hindman said there has been a lot of confusion around his insurance model.
“Some people think we’re making up for the fickle loss by simply printing more BNT. This is not entirely true. In fact, Bancor offers its liquidity providers irreparable loss insurance in exchange for a share of the trading fees earned on the platform.”
The protocol has two ways to generate these fees, the first of which is the liquidity owned by the Bancor protocol. Bancor stakes BNT in its pools and uses the commission generated from staking to compensate users for any IL they carry. The second way to generate fees is through a protocol-level fee that confiscates 15% of all trading revenue on the network and uses the fee to buy and burn vBNT.
The decision to suspend withdrawals was the result of a “perfect storm of macroeconomic events,” culminating in the rapid reset of BNT liquidity mining rewards that had been “overissued” for 18 months. Hindman said Bancor has decided to stop a handful of big players from dumping their BNT reward holdings and withdrawing their large stakes of liquidity in order to protect individual users of the protocol.
“Excessive spending on BNT liquidity mining rewards during the term of Bancor v2.1 has placed a huge strain on IL’s defenses amid a perfect storm of macro events. It was the original sin of overspending on liquidity mining rewards,” Hindman told Cryptooshala.
He noted that while Bancor remains confident in the strength of its IL protection model even under these extreme conditions, the protocol needs to protect itself from excessive BNT dumps and large short circuits on its native token.
Bancor’s team is working around the clock to bring IL’s security system fully online with enhanced security, Hindman said, but could not provide any details on when that would happen. Bancor also recognized the need for improved open source analytics that would allow the community to assess emerging risks and respond in time to avoid feature shutdowns.
Credit : cryptoslate.com