- The Bancor Vortex gives BNT liquidity providers a way to borrow against their staked capital, for any purpose.
- Leveraging staked BNT is achieved via the sale of vBNT on the vBNT/BNT pool. Therefore, the depth of liquidity on the vBNT pool will directly impact how much leverage is available to liquidity providers.
- To appropriately manage the risk for vBNT holders to bootstrap the pool with their tokens and allow the pool to flourish, it should be whitelisted. However, the standard whitelist format exposes the protocol to a known exploit.
- The exploit can be mitigated with a special whitelist status for vBNT. The v2.1 vBNT pool will not accept BNT deposits from users - the BNT side of the pool will be 100% provided by the protocol.
- Liquidity providers wishing to earn yields on the pool may only deposit vBNT, which will be protected against impermanent loss.
The Bancor Vortex (BIP9), was submitted to on-chain voting on February 3 2021, and was approved with 28.9% quorum. The decision was unanimously in support of its implementation. The proposal details a new mechanism whereby liquidity providers with vBNT tokens are able to effectively borrow against their staked BNT by selling vBNT, and then buying it back later. The overall process is similar to using vBNT as credit, and the swap has been compared to an interest-free loan, or a liquidation-free leverage position.
The process is powered by a constant-product bonding curve between vBNT and BNT. As LPs swap their vBNT on the pool, the effective price of vBNT depreciates. As a result the incentive to sell vBNT is diminished as debt increases, allowing the pool to automatically regulate the amount of credit that can be bought and sold. The original vortex proposal described a variable fee structure that allocates a small percentage of swap revenue from across the protocol for the purpose of purchasing vBNT debt, and burning it. This creates a positive price pressure on vBNT inside the pool, and should help to maintain a floor value for vBNT.
If the Bancor Vortex becomes an important part of the Bancor ecosystem, then vBNT liquidity providers are even more important. Without vBNT liquidity, the system completely ceases to function. While market participants are expected to create substantial swap volume on the vBNT pool, it stands to reason that the vBNT LPs that support the system should receive the same level of protection afforded to other pools on the v2.1 network.
Standard v2.1 insurance contracts track impermanent loss on both sides of the pool, allowing the protocol to mint BNT to essentially buy-back the loss and compensate the LP at the time of withdrawal. vBNT is an exceptional case, as it is generated upon staking of BNT. This creates an unacceptable exploit vector in the conventional whitelisting arrangement, as follows:
- Deposit BNT and vBNT in the pool.
- Wait 100 days for both sides to become 100% covered from IL.
- Buy a huge amount of BNT from the pool by cycling vBNT through it.
- Withdraw protected BNT deposit.
This allows users with significant capital to force the protocol to mint BNT at will, which cannot be allowed.
This exploit vector is asymmetric. Staking BNT to generate more vBNT is the source of the issue, whereas staking vBNT does not generate BNT. By prohibiting the deposit of BNT to the pool, the exploit vector is completely neutralized. The contract upgrade to support complete protocol ownership of the BNT side of a v2.1 pool is now completed; therefore the special whitelist status proposed here is ready for deployment, pending the decision by the BancorDAO.
Since the protocol will own 100% of the BNT side, this gives the DAO the ability to set exact limits on the total pool depth, and the availability of single-sided vBNT staking. This is an important consideration, as it effectively creates a debt limit that helps to regulate how much leverage is available to LPs. The BNT minting limit for the pool will be adjustable by the DAO forever, but for the sake of an unambiguous proposal, a rough timeline is suggested.
The approval of BIP9 by governance is already complete; the approval of this proposal is the final approval step for the envisioned system. The whitelist status of the vBNT pool is ready for deployment already, and will be implemented with a proposed 250,000 BNT minting limit. Thus begins a short period to observe how users interact with the pool, what the leverage appetite is, optimize the front-end and educate the community on responsible use of this novel feature. During this time, the vBNT burning feature will be in its development and auditing process. After the vBNT burn feature begins, the full Bancor Vortex will be in effect. Another short period for testing and observation is then followed by an increase in the minting limit to 1,000,000 BNT. Thereafter, the minting limits are adjustable pending a DAO decision.