Decentralized Finance (DeFi) protocol Bancor, often considered a pioneer in the DeFi space, has come under fire after it paused the impermanent loss protection program. The pause was done citing extreme market conditions and comes at a time when liquidity providers need the protection the most.
Hostile Market Conditions Leave Bancor No Choice
Bancor announced that it was pausing the impermanent loss protection (ILP) program for the time being in a blog post posted on Monday. The DeFi protocol cited extremely hostile market conditions for the unprecedented move but stressed that the pause on the impermanent loss protection is only a temporary measure designed to protect the protocol and its users. The post stated,
“The temporary measure to pause IL protection should give the protocol some room to breathe and recover. While we wait for markets to stabilize, we are working to get IL protection reactivated as soon as possible.”
What Is Impermanent Loss?
Once a user provides liquidity to a liquidity pool, the ratio of the assets they have deposited could change later. This could leave some investors with more of the lower-valued token, referred to as impermanent loss. The Bancor protocol used its own liquidity to fund the impermanent loss protection program, staking its native BNT token in pools, and then used the collected fees to reimburse users for any temporary loss they may face.
This process employed by Bancor burned excess BNT tokens when trading fees became more than the cost of impermanent loss on a given stake. ILP was introduced in 2020 and was given several upgrades and refinements with the launch of Bancor 3 back in May 2022. However, the recent market collapse had a significant impact on the DeFi space as well, leading to several measures taken by DeFi protocols, such as Bancor pausing the ILP.
An Unhappy Community
While Bancor has stressed that the pause is temporary and done only to protect the users and the protocol, the larger crypto community was quite unhappy with the decision, taking to Twitter to criticize the protocol. Many felt that it was unfair to pause the impermanent loss protection when liquidity providers need it the most. The host of the crypto podcast, UponlyTV criticized the decision, tweeting,
“What is the point of impermanent loss protection if it just disappears when u most need it? LOL.”
A Research collaborator at Paradigm, a Web3 investment-focused firm, painted a much more dire picture after doing a little more research into the claims around impermanent loss protection by Bancor and stated that it could lead to another spiral collapse. He also questioned the strategy behind the LIP compensations and stated that Bancor’s game of impermanent loss is collapsing.
“They print new BNT to compensate underwater LPs and call it ‘IL protection. The cost is transferred to BNT holders via inflation, which causes further IL to all other BNT pairs, and leads to further inflation. A death spiral. “Except Bancor doesn’t *actually* reduce IL in any way. Like SUSHI, they just throw more incentives at the problem to compensate LPs. this strategy will always collapse at scale.”
BNT Token Value Plummets
Meanwhile, the turmoil has significantly impacted the value of the BNT token, which has plummeted 65% in just over a week, with the token price down 95% since hitting its all-time high. The crisis and liquidations at Celsius and Three Arrows Capital have had a significant impact on the DeFi space, with companies liquidating their assets to pay back lenders.
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.