What happens during “Withdrawal”? - an overview of how “Surplus” and “Deficits” work within the protocol and a comparison with the traditional AMM model.
Continuing from the previous example, after the swap has occurred there is a deficit that has occurred in the Token A side.
If the LP were to remove his liquidity in the current state then the following series of steps would occur:
LP provides his bnTokenA token to the protocol (e.g. 2 bnTokenA which has an underlying value of 2 Token A)
The protocol withdraws 2 Token A tokens from the pool and burns the associated 6 BNT tokens that were paired.
The LP receives 2 Token A tokens and the protocol mints the equivalent of 1 Token A token in BNT (three in our example) to cover the difference.
Note: A keen observer will realize that there is a key difference in that all BNT that is owned by the protocol is burned at withdrawal. The LP on the other hand, is receiving newly minted BNT that just came into existence.
Previously, the process by which BNT is distributed to cover deficits has been referred to as Bancor’s “Impermanent Loss Protection mechanism”. In reality, IL is a bit of a misnomer and IL may not be the best term for it due to the fact that the BNT distribution mechanism covered more than that.
Implication of withdrawal during the pause
On June 19th, emergency actions were taken to intervene in what would have resulted in an irresponsible mass distribution of BNT tokens during a market panic. As discussed in the ratification proposal, the reason being, pending withdrawals in combination with the BNT distribution mechanism could have crashed the BNT price to essentially zero, leading to a situation in which the recovery of funds for all liquidity providers would have been in peril.
Liquidity providers in Bancor 3 who withdraw from a pool that is in deficit (see example above) will not receive BNT as part of their withdrawal to compensate for pool deficit.