Bancor, a decentralized finance (DeFi) protocol often credited as the pioneer of the DeFi space, paused its impairment loss protection (ILP) function on Sunday, citing “hostile” market conditions.
In a blog post on Monday, the DeFi protocol noted that the ILP pause is a temporary measure to protect the protocol and the users. The blog post read:
“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.”
When a user gives liquidity to a liquidity pool, the ratio of their deposited assets changes at a later moment, potentially leaving investors with more of the lower value token, this is known as impermanent loss.
Bancor’s protocol-owned liquidity was used to fund ILP: the protocol staked its native token BNT in pools and used the collected fees to reimburse users for any temporary loss. The process effectively burned excess BNT when generated trading fees are more than the cost of impermanent loss on a given stake.
The ILP function was first introduced in 2020 and was upgraded with more refinements with the launch of Bancor 3 in the second week of May this year. However, the recent market turmoil leading to a 70% decline from the top for most of the cryptocurrencies had an adverse effect on the DeFi market as well, leading to several critical changes made by DeFi protocols.
While Bancor hopes the pause in the IRL would help the protocol take a breather, many in the crypto community were unhappy with the decision. Cobie, host of crypto podcast Uponly Tv, criticized Bancor for pausing the IRL when liquidity providers need it the most.
Hasu, a research collaborator at Web3 investment-focused firm Paradigm, dug a little deeper into the impairment loss protection claims made by Bancor and how it could lead to another “spiral collapse.”
Hasu questioned the strategy behind the ILP compensations and claimed Bancor’s shell game of IL hiding is collapsing. He added:
“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.”
He went on to add that the failure of the ILP program is visible from the price action of their native token BNT over the past two weeks, where decentralized exchange (DEX) tokens such as SushiSwap (Sushi) and Uniswap (Uni) had dropped by nearly 20% while BNT has registered a 66% decline in the same time frame owing to high inflation caused by ILP compensations.