DeFi Protocol Bancor Pauses Impermanent Loss Protection Feature Amid Liquidity Crisis

Prominent DeFi protocol Bancor suspended its Impermanent Loss Protection program, citing “hostile market conditions” and “manipulative behavior” as the main causes behind the action. Assuring users and investors that it’s only a temporary measure, Bancor noted that all funds on the protocol are secure, and trading remains active on all liquidity pools.

Impermanent Loss

As the months-long selloffs have shown no signs of reversal, many DeFi protocols have fallen deep into the crisis mode due to liquidity strains as investors withdraw funds from liquidity pools.

Following that crypto lender Celsius froze users’ accounts last week, decentralized automated market maker (AMM) – Bancor – announced, on Monday, halting its Impermanent Loss (IL) Protection feature designed to offset the impact of IL by distributing its native token BNT to those affected.

IL occurs in DeFi when the value of the staked assets changes relative to their initial value during the deposit time due to external market conditions. When launching its Bancor Version 3 earlier this year, the protocol refined the protection mechanism, positioning it as a special feature distinguishable from other DeFi competitors.

According to the official blog post, the bold measure aiming to “protect the protocol and its users from potentially manipulative actors” will be lifted once the market stabilizes again. However, the protocol did not unveil a specific timeline for such an extreme measure.

The decentralized exchange calmed its users that they could continue receiving yields for their staked assets during the turbulent period and withdraw funds with IL protection once the feature is reactivated. The statement reads:

“Withdrawals performed during this unstable period will not be eligible for IL protection. Users who remain in the protocol will continue earning yields and be entitled to withdraw their fully-protected value when IL protection is reactivated…

Deposits are currently not accepted to prevent confusion via direct contract interaction where the information on paused protection is not visible.”

Selling Pressure

The abrupt change of policies came as a response to the rewarded BNT getting consistently dumped in the past 18 months, leading the asset’s price to slump. At present, BNT is trading at $0.53, around 95% down from its 2021 peak.

The team paused the feature to prevent BNT from continually plunging. This has to do with IL compensations in BNT to users, increasing the supply of such an asset and thus facilitating the token’s price decline. In addition, the team cited “the recent insolvency of two large centralized entities who were key beneficiaries of BNT liquidity mining rewards” as partly responsible for exacerbating the situation:

“To cover their liabilities, these entities have rapidly liquidated their BNT positions and withdrawn large sums of liquidity from the system, while an unknown entity has opened a large short position on the BNT token on an external exchange.”

Liquidity Crisis

Prior to Bancor’s latest move safeguarding its native token, Babel Finance had already joined Celsius in pausing withdrawals due to liquidity pressure. As the crypto industry is witnessing the worst selloffs in years, some firms are in deep trouble financing their loans, and a flood of liquidations has occurred to famed digital asset hedge funds like Three Arrow Capital (3AC).

In Bancor’s case, the protocol said it had identified “anomalies” through its on-chain data, suggesting that more than one major participant has been actively shorting the token.