Bancor, one of the first DeFi trading platforms, suspended its impermanent loss protection program over the weekend due to “hostile market conditions,” prompting cries that it was decentralized in name only.
Liquidity providers on automated market makers such as Uniswap can suffer so-called impermanent loss (IL) if the value of their deposited tokens rises on the secondary market. In such a scenario, liquidity providers would earn more by simply holding their tokens instead of depositing them in the liquidity pool.
Since introducing impermanent loss protection in late 2020, Bancor has compensated liquidity providers who suffered impermanent loss with the protocol’s native token, BNT, which they could then sell to recoup their loss.
In a blog post on Sunday, Bancor said its decision to revoke impermanent loss protection would be a temporary measure and that the feature would be reactivated “as the market stabilizes.”
It blamed the decision on “the recent insolvency of two large centralized entities” and an unknown entity that “has opened a large short position on the BNT token on an external exchange.”
Citing two unnamed sources, Dirty Bubble Media claimed Celsius, the troubled crypto lender, had been withdrawing its Bancor holdings, earning BNT from IL protection payouts, and then selling the BNT. Meanwhile, Dirty Bubble claimed, Celsius was shorting Bancor on FTX.
While Bancor laid blame at the feet of outside forces, observers were quick to slam the platform, saying its decision would, at a minimum, damage trust among users who had chosen it primarily for its IL protection feature.
“Promising impermanent loss protection but then revoking coverage when it’s needed most is going to hurt a lot of people,” tweeted ChainLinkGod.
Others said that it was clear Bancor’s solution to impermanent loss was flawed from the beginning.
“Bancor’s shell game of IL hiding is collapsing,” Hasu, strategy lead at Flashbots, tweeted. “They print new BNT to compensate underwater [liquidity providers] 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.”
Need to Pause
Crypto analyst Cobie, reading Bancor’s explanation for suspending impermanent loss protection, tweeted sarcastically, “The need to pause IL protection is a result of how we designed and built IL protection.”
Still others said it was a sign Bancor wasn’t living up to the promise of decentralized finance.
“Isn’t DeFi decentralized and permissionless?” Hector Lopez, CEO at Instasize, tweeted.
CryptoDiamonds agreed, writing “The promise of decentralization in web3 is fading…”
In the blog post, Bancor said Bancor DAO “will be asked to approve the temporary IL protection pause by a ratification vote.” No such proposal could be found on the DAO’s governance forum as of Monday evening. One user, Linkmarine, had a different idea.
“I propose that [impermanent loss protection] be turned back on,” Linkmarine wrote, “because seriously what is the point of the protocol otherwise?”