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 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.
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?
There are key advantages to using a protocol token like BNT in a network of liquidity pools.
Here are a few:
1) Network Effects:
Staking on Bancor directly increases demand for BNT. Since every pool in the network holds some part of its liquidity in BNT, as more liquidity is locked up in Bancor pools, each pool on the network becomes more liquid.
As liquidity providers (LPs) join the network, existing LPs benefit not only because the liquidity of the protocol increases but also because the value of their ownership increases.
In systems based on ETH, adding liquidity to a pool does not have a direct effect on other pools on the network, since demand for ETH is tied to its usage in many networks.
2) Staking Rewards:
Pending a community vote, Bancor Protocol may activate BNT Staking Rewards. Users who stake their BNT in Bancor pools will receive BNT staking rewards via newly minted BNT (i.e., BNT inflation). These rewards will increase the profitability of staking inside Bancor pools, and create a strong incentive for users holding BNT to become liquidity providers on the network.
Following the launch of the BancorDAO, BNT will be used to vote on key attributes of the Bancor Protocol.
4) Cross-Chain Conversions:
Using BNT in Bancor pools allows Bancor to efficiently process token trades across blockchains. BNT mints and destroys itself across chains to process these cross-chain trades (currently live on the Ethereum and EOS blockchains).