CASE FILE — Jun 22, 2022

Bancor Suspends Its Impermanent-Loss Shield as BNT Rewards Spiral

DR By Diego Ramos Jun 22, 2022 3 min read

Bancor has paused the impermanent-loss (IL) protection built into its v3 protocol — the feature it had promoted as its core selling point for liquidity providers — after the mechanism proved unable to withstand a sharp market downturn.

The protocol announced the suspension on Monday, citing "hostile market conditions." Bancor had positioned IL protection as an answer to the kind of losses that hit the majority of Uniswap V3 liquidity providers, a problem this outlet covered back in November 2021, with Bancor promising its own design would hold up better. That promise is now being tested, and by the protocol's own account, it isn't holding. Users can still withdraw funds during the pause, but doing so forfeits the IL protection that drew many of them to the platform in the first place.

The protection worked by pairing deposits against a shared reserve of BNT rather than requiring a conventional 50/50 two-token pool; swaps route through BNT to reach other assets, and any impermanent loss on a position gets offset with freshly issued BNT paid out at withdrawal. Funding came from two sources: fees generated by Bancor's own protocol-owned BNT liquidity, and a share of protocol fees used to buy back and burn vBNT. Marketed under the tagline "Deposit one token, stay exposed to one token," the model held up in calmer conditions but depended on a funding drip that couldn't keep pace with the recent volatility.

Bancor itself acknowledged the underlying design flaw in its announcement, describing a double cost built into BNT emissions: issuing BNT rewards depreciates BNT's own value, which itself constitutes impermanent loss at the network level — and that loss then gets compensated with still more BNT emissions, compounding the depreciation further. As the broader market fell, large volumes of BNT rewards were sold off, triggering this feedback loop and rendering the IL protection unsustainable. Bancor pinned much of the selling on two large centralized entities — described as long-standing farmers on the protocol who dumped rewards to cover other liabilities — combined with a sizeable short position recently opened against BNT, without naming the parties involved.

The pause leaves existing LPs with an uncomfortable choice: exit now and absorb losses they were originally promised protection against, or hold on and hope conditions improve. Bancor's messaging struck an optimistic note, stating that on-chain data suggested the worst of the BNT reward dumping was already behind it, and that pausing IL protection would give the protocol room to stabilize and let BNT recover. In practice, BNT's price bottomed on June 19 — the day the pause took effect — but has shown only a marginal rebound since, and no recovery at all when measured against ETH.

Even if Bancor avoids a broader run on the protocol, once IL protection is switched back on, many LPs are likely to withdraw and sell their BNT immediately — potentially restarting the same cycle of reward dumping and depreciation that caused the problem in the first place.

Beyond the mechanics, the decision has drawn criticism over process: Bancor suspended IL protection without putting the change to a DAO vote. Other protocols have faced comparable governance controversies recently — Solend attempted to seize control of a large user's position over concerns it threatened the protocol's solvency, and Tribe DAO reversed course on whether to refund victims of April's roughly $80 million Fei-Rari exploit. In Bancor's case, however, the authority to suspend IL protection wasn't a new decision made on the fly — it was embedded in the fine print of an earlier, security-focused governance proposal. Under a policy passed in April, BIP21, Bancor's multisig signers can act on certain changes under what the proposal calls "retroactive community approval." Point 7 of BIP21 states that the DAO cannot intervene in fund withdrawals, "save for the adjustments to the protection mechanism." That framework was originally meant to let the protocol respond quickly to hacks, exploits, or coordinated rug pulls involving a vetted token, empowering intervention in the affected pools immediately after a token becomes compromised. The IL protection pause, however, involves no exploit or rug pull of any whitelisted token — meaning Bancor applied emergency powers granted for security incidents to instead prop up a reward mechanism straining under ordinary market stress, at the direct expense of the LPs it was meant to protect.

Beyond the mechanics, the decision has drawn criticism over process: Bancor suspended IL protection without putting the change to a DAO vote. Other protocols have faced comparable governance controversies recently — Solend attempted to seize control of a large user's position over concerns it threatened the protocol's solvency, and Tribe DAO reversed course on whether to refund victims of April's roughly $80 million Fei-Rari exploit. In Bancor's case, however, the authority to suspend IL protection wasn't a new decision made on the fly — it was embedded in the fine print of an earlier, security-focused governance proposal. Under a policy passed in April, BIP21, Bancor's multisig signers can act on certain changes under what the proposal calls "retroactive community approval." Point 7 of BIP21 states that the DAO cannot intervene in fund withdrawals, "save for the adjustments to the protection mechanism." That framework was originally meant to let the protocol respond quickly to hacks, exploits, or coordinated rug pulls involving a vetted token, empowering intervention in the affected pools immediately after a token becomes compromised. The IL protection pause, however, involves no exploit or rug pull of any whitelisted token — meaning Bancor applied emergency powers granted for security incidents to instead prop up a reward mechanism straining under ordinary market stress, at the direct expense of the LPs it was meant to protect.

Bancor