LP Bonding Compared To Yield Farming
In my update recent update on Bomb Money I mentioned their move to LP bonding now that $BSHARE emissions ended. In this article I want to go into more detail about LP Bonding and compare it to yield farming. The main idea is to highlight why a protocol does it and how the investor can participate.
LP Bonding is where a DeFi protocol offers their native token in exchange for LP tokens created by the investor. The native token is offered at a discount to the current market price to incentivise the investor to swap the LP. There is a vesting period to ensure the investor doesn’t hand over the LP and then immediately dump the native token. Vesting periods typically last from 3 to 14 days. Examples of protocols that offer LP Bonding include Bomb Money, DEX Finance, Grape Finance, and Momentum. In some cases you don’t even need to create the LP, the protocol does it for you by handing over a token (e.g. Momentum allows you to simply deposit BUSD).
The Basic Problem With Yield Farming For Protocols
Yield farming incentivises investors to stake an LP by paying enhanced rewards for staking the LP. This is also known as renting liquidity because the protocol is regularly paying a small amount of the native token in exchange for the investor continuing to provide liquidity. The problem for the protocol is that the investor can decide to remove liquidity at any time. This gives the protocol an unstable pool of liquidity.
LP Bonding is a solution to the rented liquidity problem because the protocol ends up owning the liquidity. Another difference is that the protocol needs to make a larger upfront payment of the native token. No one outside the protocol itself can remove the liquidity unless there is a security compromise. The investor also receives a reward but the nature of the reward is just a little bit different. You are effectively receiving a discount for making a time commitment to invest in the native token.
Benefits For Investors
The two main weaknesses of yield farming for investors are impermanent loss and a potentially undesirable reallocation of tokens within the LP. With LP Bonding, you are not exposed to impermanent loss because you hand it over immediately. Another benefit is that you fully participate in the gains of your desired token. If you hold an LP for yield farming, an LP automatically rebalances the amount of each token in the LP because buyers are effectively taking the outperforming token out of the basket and leaving more of the underperforming token in there. As an example, if $BOMB outperforms $BTCB and I hold the $BOMB/$BTCB LP, I will have less $BOMB and more $BTCB in my LP than when I initially created it. You may be ok with this but it’s important to understand this about LPs.
If LP Bonding has a comparative return to yield farming then it could be advantageous to take part in it. If the discount is low or becomes a premium there will be no interest in them. The contracts will respond to a lack of demand to make them more appealing to investors if they are not taken up.
Potential Problems For Protocols
The biggest issue for LP Bonding is that it can create sell pressure on the token being paid to the bond holder. When the vesting period ends, they can dump a greater quantity of the token on the market. The other problem is that the protocol needs to have the native token available and done in a way that mitigates sell pressure and doesn’t make it become inflationary.
Final Thoughts
LP Bonding does not immediately give value to a protocol or guarantee success. It is simply a tool that can help maintain the health of the protocol. Investors can also make wise use of it while having some advantages over yield farming. It will not replace yield farming completely but should be considered as a viable option by a protocol’s Treasury. There is also a good opportunity for investors to get in early on these deals or if there is bullish momentum in a token. It can also be a method of following a Dollar Cost averaging strategy to accumulate the token. I may write a future article about strategies you can adopt to participate in LP Bonding.
Disclaimer: None of what is written in this article constitutes financial advice. Investing in cryptocurrencies, and in particular decentralised finance, is high risk. What I write is not a recommendation to invest in the projects I discuss. I am not aware of your personal circumstances. Only invest what you can afford to lose. Make sure to do your own research rather than relying solely on my content.
Links
About LP Bonding: https://bondprotocol.finance/
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