The Bancor Protocol is made up of a network of smart contracts (called “liquidity pools”) designed to perform algorithmic token trades and pooling of on-chain liquidity.
What sets Bancor apart from most decentralized and centralized exchanges is liquidity on Bancor is provided by thousands of unaffiliated users who each receive a share of Bancor’s trading fees, instead of liquidity coming from a small handful of professional market-makers.
This is because adding liquidity on Bancor is permissionless (no central party can block or control the process) and easy for everyday users (add liquidity and earn fees in a couple clicks).
Every liquidity pool on Bancor holds BNT (Bancor’s Network Token) in its reserves or USDB, a stablecoin backed by BNT, as well as the “base token” receiving liquidity. BNT serves as the intermediary token connecting pools in the network and across blockchains. For example, a trade from DAI to BAT has the following conversion path: DAI > BNT > BAT.
Users who trade on Bancor do not need to hold BNT; however, users creating a liquidity pool on Bancor or providing liquidity to an existing pool must hold BNT (or its stable derivative, USDB).
When creating or staking in a Bancor pool, users do so in equal values of ERC20 token + BNT, or EOS token + BNT. For example, users provide liquidity to the DAI/BNT pool in equal parts DAI + BNT:
Why use BNT instead of a blockchain asset?
There are key advantages to using a protocol token like BNT, instead of a blockchain asset like ETH, in liquidity pools.
Here are a few:
1) Cross-Chain Conversions:
Using BNT or USDB in Bancor pools allows Bancor to efficiently process token trades across blockchains. All ERC-20 and EOS token on Bancor are convertible cross-chain, via BNT. BNT mints and destroys itself across chains to process these cross-chain trades.
2) Network Effects:
Since users are required to hold BNT in order to stake liquidity into the system, staking on Bancor directly influences the demand for and price of BNT.
This means that as more liquidity is added to a pool, every pool on the Bancor network becomes more liquid.
In systems based on ETH, adding new liquidity to one pool does not have a direct effect on other pools on the network.
3) BNT Staking Rewards (Coming soon)
In Q2 2020, Bancor plans to release BNT staking rewards. Users who are staking tokens in Bancor pools will receive BNT staking rewards via newly minted BNT (i.e., BNT inflation). These rewards will increase the ROI of staking inside Bancor pools, and create a strong incentive for users holding BNT to become liquidity providers to the network.