Bancor suspends loss protection and raises fears about protocol liquidity

Bancor, one of the first decentralized finance (DeFi) protocols, has discontinued its impermanent loss protection (ILP) function. According to the protocol, “hostile market conditions” compelled the protocol to take this step.

Also according to Bancor, the pause of the ILP is a temporary measure to protect the protocol and users. Bancor promised to reactivate protection as soon as market losses stabilize.

“The temporary measure to pause IL protection should give the protocol some room to catch up. While we wait for markets to stabilize, we are working to reactivate protection as soon as possible,” the announcement said.

However, the protection speech did not go down well in the community, shaken by the events at Celsius and Three Arrows Capital. The focus has now shifted to Bancor and a user known as Fully Allocated wrote a long thread on Twitter about potential liquidity issues.

What is impermanent loss

When a user lends liquidity to a DeFi pool, their assets do not remain the same. Since the protocols pay income, the amount of tokens tends to increase. This is what is called “passive income” within DeFi.

As the market changes, the proportion of your deposited assets changes at a later time. For example, when there is a bearish moment, investors get more tokens, but their total value drops.

If the investor does not suspend liquidity or sell the tokens, this constitutes an impermanent loss. That is, the value of the tokens is lower, but as there was no sale, there was no loss.

In this sense, the ILP acts as a way of protecting liquidity providers against this loss. The protocol leaves its native token (BNT) in pools and collects the fees in the form of income. Bancor then uses the fees to reimburse users for any temporary loss.

The ILP function was first introduced in 2020 and has been updated with more refinements with the release of Bancor 3 in the second week of May this year. However, the downward trend led Bancor to suspend this mechanism.

Complaint and fears

While Bancor hopes the pause on the IRL will help the protocol breathe, many in the cryptocurrency community were unhappy with the decision.

Cobie, host of the cryptocurrency podcast UpOnly Tv, criticized Bancor for pausing the ILP when liquidity providers need it most.

Hasu, a Web3 researcher at Paradigm, warned that the suspension could send Bancor into a “death spiral”. And the criticisms of Fully Allocated also came in that direction.

“The Bancor makes it sound like they’re doing this as a precaution, but I’m starting to think they’re in serious trouble. Their post reminds me of the Celsius situation and their issues are likely similar/related,” she said.

The user poses two possibilities. First, Bancor may have had too many loss protections since the market began to suffer from volatility.

Therefore, Bancor would have difficulties in continuing to honor its liquidation commitments.

Second, Fully Allocated cites an excerpt from the Bancor communiqué in which they point to “the insolvency of two large centralized entities” as part of the reasons for canceling the ILP.

The text does not name names, but the user believes that they are Celsius and 3AC, which would have obtained large amounts of BNT. With the problems of these protocols, they sold the tokens on the market, hurting Bancor’s activities.

“It took a long time, but recent events have really shown me how much we need to rethink protocol design, governance, and token economics if we are to truly demonstrate the promise of cryptocurrencies,” he concluded.

Read also: Solend introduces limit on loans to try to contain liquidations

Also read: Celsius price (CEL) rises 52% despite network problems

Read also: Council approves Elon Musk’s $ 44 billion offer for Twitter, but billionaire points out pending

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