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How Liquid Tokens Work

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  • How Liquid Tokens Work

    [IMG]https://cdn-images-1.medium.com/max/1024/1*geYGFBL4GM4TqI0WcuxRWw.jpeg[/IMG]How Do Liquid Tokens*Work?

    A Liquid Token is a smart contract which acts as an automated market maker by regulating the buying and selling of a token along a predetermined price curve, with a single pool of collateral to back it*up.
    You’re essentially adding collateral when buying the Liquid Token, and reducing collateral when selling the Liquid*Token.
    Consider an example of a Liquid Token, called*A:
    • Token A can be bought at any time according to a price set by its smart contract, by depositing its collateral token into the smart contract.
    • When collateral is deposited into A’s smart contract, new units of A are issued to the buyer, increasing both the collateral of token A, and its*supply.
    • The price of A increases as its supply grows (according to the Bancor Formula).
    • The tokens used to buy A are kept in the token’s reserve pool (as collateral).
    • At any point in time, A can be sold back to the contract in exchange for A’s collateral token, and the smart contract will burn the sold A token(s).
    Liquid Tokens continuously recalculate their price in relation to their collateral token by maintaining a fixed ratio between the Liquid Token’s total value and the value of its reserve pool. This ratio, known as the “reserve ratio” (RR), can be used to maintain the price stabilityof a Liquid*Token.
    The higher a Liquid Token’s reserve ratio, the greater its price stability. For instance, a Liquid Token with a 50% reserve ratio has greater price stability than a Liquid Token with a 10% RR, while one with 100% RR is essentially “pegged” to the value of its collateral.
    [IMG]https://cdn-images-1.medium.com/max/1024/1*QP4VcCTNZVavg6BmhFzRtQ.png[/IMG]The price curve of a Liquid Token with a 10% Reserve Ratio (left), and the price curve of a Liquid Token with a 50% Reserve Ratio. The red area represents the amount of collateral stored in the Liquid Token’s smart contract at each point along the price curve. As a Liquid Token is bought, collateral is added and the Liquid Token’s price rises; as the Liquid Token is sold, collateral is withdrawn and the Liquid Token’s price falls, all according to predetermined and foreseeable terms. The greater a Liquid Token’s Reserve Ratio, the more collateral required to move its price. (See more Liquid Token implementations in Section A of the Appendix.)In general, when a user buys or sells a Liquid Token, three variables affect the price they*receive:
    1. The amount of tokens in the Liquid Token’s reserve*pool
    2. The Liquid Token’s reserve*ratio
    3. The amount of Liquid Tokens being bought or*sold
    With these variables, users can calculate how much of a Liquid Token (or collateral token) they’ll receive for any given conversion with far greater accuracy compared to liquidity mechanisms based on order-matching. This is one notable benefit of peer-to-contract vs. peer-to-peer conversions.
    See example Liquid Token price calculations in the Appendix.
    Liquid Tokens are also, by definition, tokens with a dynamic supply, meaning their supply changes each time they are bought or sold. They still follow the laws of supply and demand — that is, when they are being bought more than being sold, their price is rising, and vice*versa.
    Today, the vast majority of tokens on the Bancor Network are connected to the network through a different implementation of the Bancor Protocol called Relays. Relaysare used primarily to provide automated liquidity to existing tokens, having processed billions in non-custodial conversions since 2017, in tokens like ETH, EOS, DAI, BNB, IQ &*more.
    Comparing Relays to Liquid*Tokens:

    1. A Relay is designed primarily to provide liquidity to existing tokens. It determines prices by balancing two token reserves in its smart contract and typically maintains a fixed 50% reserve ratio between the two token reserves. (Learn more about Bancor*Relays.)
    2. A Liquid Token, on the other hand, is a mechanism for creating new, instantly liquid tokens with dynamic supply. A Liquid Token determines its price by measuring its total value against one reserve (its collateral), and can be configured to maintain any reserve*ratio.
    The ability to set any fixed (and in the future, dynamic) reserve ratio for a Liquid Token allows for flexibility in terms of experimenting with various liquidity models. Liquid Tokens can be designed to favor certain market behaviors or promote certain economic incentives. For instance, a user may create a Liquid Token that mimics the price stability of a Top-100 traded token, despite it having significantly less volume and a relatively small amount of tokens in its reserve*pool.
    Launched in June 2017, BNT (Bancor’s Network Token) was the first and is today the largest example of a live Liquid Token. It holds ETH as its collateral, with a 10% reserve ratio. That means the ETH held in its reserve pool always makes up 10% of the total market cap of BNT — which, as of this writing, is roughly $44*million.
    Theoretically, any token (ETH or DAI, etc.) can be used as a Liquid Token’s collateral. When Liquid Tokens (or any type of Smart Token) hold the same token in one of their reserves, they become convertible for one another through transference (A to B, and C to B, so A to C). For example, Relays and Liquid Tokens which hold BNT in their reserve are convertible to hundreds of other tokens on the Bancor Network, including across different blockchains.
    Up until now, users could launch their own token directly on a blockchain or through various token creation platforms. But, in order for tokens to become liquid and easily convertible for other popular tokens, creators have had to pay hefty listing fees to for-profit exchanges. Even then, most tokens struggle to gain adoption because the volatility of their token is dependent on the volume of buyers or sellers on an exchange, or — if the token is integrated with an automated liquidity protocol — on the capital deposited in the token’s reserve*pool.
    With Liquid Tokens, you can easily launch a new token that is liquid from day one. New or niche tokens with low trade volume or small reserve pools need no longer suffer from low liquidity and high volatility — which creates expensive slippage costs for users and discourages adoption. While both Relays and Liquid Tokens disconnect a token’s liquidity from its trade volume, Liquid Tokens go a step further by giving new tokens — which aren’t yet able to fund deep reserve pools — the power to offer seamless conversions to their users and predictable price movements.
    This new form of automated liquidity has the potential to transform the way users tokenize digital items, communities, ecosystems and more. One could imagine a social network where any user or group of users can create their own Liquid Token which rises in value as other users purchase it, and is instantly interchangeable for other tokens in the network and beyond. A real-world use-case for Liquid Tokens is currently being piloted in Kenya, where marginalized communities are creating their own Liquid Tokens to close cash gaps and facilitate trade across villages, while ensuring that a community cannot issue new tokens without adding collateral to the smart contract.
    https://medium.com/media/5b7c5f57e10...6d207da12/hrefThanks to a recent wave of evolving liquidity innovations, including Bancor Liquid Tokens, Token Bonding Curves & other reserve-based solutions, the world of programmable value is unfolding before us as tokens move beyond speculation and into everyday consumer applications — enabling new use-cases beyond the*horizon.
    Thanks to Tomer Bariach for helping with the Liquid Token examples & the*math.
    About The Bancor*Protocol

    Bancor is a liquidity protocol revolutionizing the way people create and share value by enabling constant convertibility between tokens. Conversions via Bancor Protocol are executed against on-chain liquidity pools using automated market makers to price and process transactions without order books or counterparties, allowing for faster, cheaper and more predictable conversions across 9700+ ERC20 and EOS token pairs, including non-custodial conversions between blockchains.
    How to get involved with*Bancor

    Appendix

    Section A

    The graphs below show Liquid Tokens with varying Reserve Ratios (RR). The blue area represents the total market cap of each Liquid Token at its current price, while the red area represents the amount of collateral stored. (See additional details in the Bancor White*Paper.)
    [IMG]https://cdn-images-1.medium.com/max/1024/1*8ILZTXOfRuoWoFXFLK-Dyg.gif[/IMG][IMG]https://cdn-images-1.medium.com/max/1024/1*zLEsU3K9ckUWAcP9RMI36g.gif[/IMG]Section B

    Liquid Token & Relay Price Calculator
    Formula for calculating a Liquid Token’s Market*Cap:
    Reserve/Reserve Ratio = Price * Supply = Market*Cap
    When a user buys or sells a Liquid Token, three variables affect the price they receive. Each of these variables can be used to pre-calculate the effect on a Liquid Token’s price prior to a user submitting a conversion:
    1. The amount of tokens in the Liquid Token’s reserve*pool
    2. The Liquid Token’s reserve*ratio
    3. The amount of Liquid Tokens being bought or*sold
    The table below shows how different Reserve Pool Sizes, Reserve Ratios & Conversion Amounts affect the price of a Liquid Token token, the amount received by the user and the price slippage.
    [IMG]https://cdn-images-1.medium.com/max/1024/1*njhFL_9zt7_X1wdsDsuOxg.png[/IMG]Reserve Ratio

    Liquid Tokens A, B, C show the effect of adjusting Reserve Ratio. While Reserve Pool Size and Conversion Amount remain constant, in the case of A & B, a Reserve Ratio adjustment from 50% to 10% results in a jump in price elasticity, nearly twice the Slippage and a user receiving fewer tokens. Further reducing the Reserve Ratio to 2% (in the case of Liquid Token C) leads to additional increases in price elasticity and Slippage. Note that in both instances, reducing the Reserve Ratio by 5X increases the Liquid Token’s Market Cap by*5X.
    Conversion Amount

    By comparing Liquid Tokens C & D, one can see the effect that Conversion Amount has on the token’s price elasticity, the Amount Received by the user and Slippage. With D, since the Conversion Amount is extremely high relative to the Reserve Pool Size, we see a dramatic increase in Final Price, far fewer tokens received and a large jump in Slippage.
    Reserve Pool*Size

    One can see similarities comparing the outcome of conversions against Liquid Tokens D and E. The Final Price and Slippage are identical, reflecting the constant Reserve Ratio, as well as the Conversion Amount relative to the Reserve Pool Size. Comparing F to E shows that a large increase in Reserve Ratio will increase the Amount Received, while reducing the price elasticity and Slippage.

    How Liquid Tokens Work was originally published in Bancor on Medium, where people are continuing the conversation by highlighting and responding to this story.


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