Understand Bancor — The Truth About BNT Supply And Why BNT Market Cap And Other Valuation Metrics Are Overstated
Market capitalization is by all means the most frequently used valuation metric in the crypto world. It tells investors how the market currently values a given asset and allows for a simple comparison with other assets. Although market cap is considered as an objective measure, it’s actually heavily dependent on the definition of circulating supply. The unique mechanics of the BNT token make BNT supply a nontrivial issue. This paper aims to clarify the complexity of the BNT supply and its impact on publicly quoted valuation metrics for the BNT token.
- Fixed BNT supply was a big limitation to the growth of Bancor. That’s why it was replaced with the elastic BNT supply, which has enabled the most important features of Bancor protocol: single-sided liquidity and impermanent loss protection.
- Not all BNT is equal. BNT contract supply consists of protocol-owned and investor-owned BNT — they behave in a different way and must be approached separately.
- Protocol-owned BNT is locked in Bancor — it can exit the pools only temporarily when it’s bought from the protocol. Only investor-owned BNT should be considered as circulating supply.
- The best approximation of BNT circulating supply (adjusted circulating supply) subtracts both protocol-owned BNT and protocol-owned non-BNT tokens from the contract supply.
- Market cap for BNT reported currently on popular data analytics websites is overstated by 60% due to incorrect use of BNT contract supply as circulating supply.
Fixed supply is overrated
Fixed supply is a deep-seated concept in the crypto world. It’s popularity can be attributed to the Bitcoin narrative, which began as a decentralized payments system, and came to rest as a store of value fuelled by the token’s scarcity. There is a fixed supply of 21M BTC and there will never be more than that. Scarcity is a desired feature for store of value assets — holders are guaranteed the value of their possessions won’t get diluted with new supply. This is a similar value proposition to collecting antiques or works of art; however the world of finance is dependent on more sophisticated mechanisms to maintain itself. BNT does not discover its value through scarcity, but through utility.
BNT is a utility token which serves an important role in the Bancor ecosystem; it is a liquidity bridge between all tokens on the network (let’s call them TKN). Each pool on Bancor contains equal value of BNT and TKN, therefore, the Total Value Locked (TVL) of the protocol can be approximately twice as much as BNT market cap (assuming that 100% of BNT supply is used to provide liquidity on Bancor). In other words, BNT market cap restricts the maximum size of the network which, in turn, determines the attractiveness of the DEX for traders. If TVL is high, liquidity pools are deep and allow for the execution of buys and sell orders with low price impact (the difference between market price and execution price). High TVL means more trading activity and more revenue for the protocol.
Fixed BNT supply was a big limitation to the growth of Bancor. That’s why it was replaced with the elastic BNT supply in Bancor V2.1.
The bull case for elastic supply
Elastic supply means the protocol can mint and burn BNT to support the functioning of the system. It enables the most important features of Bancor protocol: single-sided liquidity and impermanent loss protection.
Convenient single-sided exposure for liquidity providers
Unlike in other AMMs, in Bancor liquidity providers are allowed to provide liquidity in a single asset only. This is possible because the addition of TKN to a liquidity pool triggers a protocol minting event. The protocol creates an equal value of BNT to match the TKN deposit and keep the pool in balance. This protocol-owned BNT increases the TVL of the network — if liquidity providers were forced to provide liquidity for both sides, they would need to sell half of their TKN into BNT (effectively providing half the TVL). It could discourage some TKN holders from providing liquidity and they wouldn’t do it at all. Bancor, therefore, appeals to a liquidity provider demographic that is intent on maintaining exposure to selected tokens at the exclusion of others.
Single-sided exposure is also supported for BNT — when a BNT holder stakes BNT in Bancor, the protocol burns the corresponding amount of protocol-owned BNT. In a sense, the protocol’s BNT serves as a kind of place-holder for BNT liquidity providers, who can choose which pools they wish to participate in. Protocol-owned BNT is also burned when TKN liquidity providers withdraw their liquidity from Bancor. By minting and burning, the protocol makes sure that all pools have an equal value of BNT and TKN.
Impermanent loss protection for liquidity providers
Protocol-owned BNT earns trading fees which are used as impermanent loss protection for liquidity providers. If fees are not sufficient at the time of withdrawal, the protocol mints extra BNT to provide full compensation.
The elastic nature of BNT supply allows Bancor to offer the most attractive conditions for liquidity providers. Not only does it enable single-asset exposure and impermanent loss protection but also helps increase TVL of the network due to protocol-owned BNT. Elastic BNT supply removes unnecessary limits to the growth of the protocol implied by fixed supply.
Not all BNT is equal — protocol-owned vs investor-owned BNT
Having discussed the mechanics of elastic BNT supply, one can definitely notice that not all BNT behaves in the same way. BNT added to the pool by a BNT holder can be withdrawn and sold. This can’t be done with protocol-owned BNT. Therefore, it makes sense to distinguish two types of BNT depending on the owner: investor-owned BNT and protocol-owned BNT.
BNT owned by individuals is like all other tokens. Holders decide what they want to do with it. They can hold, sell, use it in other protocols or add it into liquidity pools on Bancor. Investor-owned BNT dictates the price of BNT — if there are more buyers than sellers, BNT price goes up; more sellers than buyers, price goes down. Simple market dynamics.
BNT owned by the protocol is minted directly into the pool to match TKN deposit and gets burned when TKN is withdrawn or investor-owned BNT replaces protocol-owned BNT in the pool. While protocol-owned BNT is not issued directly into the price-setting external market, it can be moved there temporarily when the BNT price goes up or down in relation to TKN.
To simplify the illustration of how the BNT price fluctuations impact the BNT token flows, the following assumptions are made:
- Bancor contains only one pool: TKN-BNT and 100% of BNT in the pool is protocol-owned.
- BNT price movements are always relative to TKN. BNT price increase means that BNT outperforms TKN.
- BNT price is always set first on the external market — in this case arbitrageurs arb the difference between the BNT price on Bancor and the BNT price on the external market until they are equal.
BNT outperforms TKN (BNT price increases)
If BNT price on the market goes up, arbitrageurs buy cheap BNT from the TKN-BNT pool and sell it on the market for profit until prices are equal. To buy BNT from the TKN-BNT pool, arbitrageurs have to sell TKN into the pool which means the TKN reserve increases and the BNT reserve decreases. As a result, the amount of BNT in the pool is lower than originally minted BNT. Some protocol-owned BNT has been extracted from Bancor and sold to investors on the external market. There has been a transfer from protocol-owned BNT into investor-owned BNT.
By selling BNT into the market, the protocol accumulates TKN. TKN reserves in the pool are higher than the total amount initially deposited by liquidity providers. Even if all of them wanted to withdraw their TKN, some TKN would be left in the pool. It’s owned by the protocol, therefore, we can call it protocol-owned TKN.
TKN outperforms BNT (BNT price decreases)
If BNT price on the market goes down, arbitrageurs buy cheap BNT from the market and sell into the TKN-BNT pool on Bancor for profit until prices are equal. Selling BNT into the TKN-BNT pool equals buying TKN from the pool — it means that the TKN reserve decreases and the BNT reserve increases. As a result, the amount of BNT in the pool is higher than originally minted BNT. Some investor-owned BNT has been bought from the market and captured in the pool on Bancor. There has been a transfer from investor-owned BNT into protocol-owned BNT.
Above processes can be easily summarised in the below table:
Protocol-owned BNT reduces BNT volatility
The existence of protocol-owned BNT creates interesting market dynamics. When BNT price increases in relation to TKN, the protocol accumulates TKN by selling BNT from the pools. Protocol-minted BNT ends up on the market but this is just a temporary inflationary event. Acquired TKNs become protocol-owned assets and will be used to fight selling pressure on BNT when TKN appreciates in relation to BNT. By selling protocol-owned TKN, the protocol buys back its lost BNT, removing previously injected supply from the market.
Selling BNT into a rising market and buying BNT from a falling market reduces BNT volatility. On the one hand it suppresses erratic pumps in BNT price but on the other hand it counteracts panic selling during swings to the downside. Such a design makes BNT less prone to pure token speculation and links BNT price with organic growth of the protocol.
There is a clear difference between protocol-owned BNT and investor-owned BNT. Although in certain conditions BNT can change the owner from protocol to investor and vice versa, this change is reverted when BNT price comes back to its original state. One can ask a question: if not all BNT is equal, should all BNT supply be considered as circulating supply?
The mystery of circulating supply
Look at the long explanation of methodology to calculate circulating supply used by CoinMarketCap team: link. The definition starts with “Circulating Supply is the best approximation of the number of assets that are circulating…”. The best approximation — that’s the key phrase to understand it. There is often a big number of assets that have to be excluded from circulating supply to make it a reliable metric: private sale, ecosystem, marketing, operations, team, foundation, treasury, etc. All assets which are currently not available on the market and, therefore, can’t be sold should be excluded. It’s a joint manual effort of data aggregator’s and project’s teams to determine what portion of the supply is freely circulating in the market.
Circulating Supply is not an easily available number, it’s a consensus on what it should be.
Let’s try to reach a consensus on BNT circulating supply.
Different types of BNT supply
Different types of BNT (protocol-owned and investor-owned) imply different types of BNT supply. It’s easy to distinguish at least two: contract supply and circulating supply, however, circulating supply may also be approached in two different ways.
Contract supply is the total number of BNT tokens currently in existence: it’s a sum of all protocol-owned and investor-owned BNT. This number can be checked on the BNT ERC20 contract on Etherscan (link).
At the moment, contract supply is what data aggregators like Coingecko, Coinmarketcap and Token Terminal report as Circulating Supply / Total Supply. The real circulating supply is, however, substantially lower than the contract supply.
Circulating supply refers to tokens which are available on the open market and, therefore, can be sold. Investor-owned BNT definitely falls into this category. Regardless of where investors hold their tokens: inside or outside Bancor pools, they can always sell them on the market, putting downward pressure on BNT price.
What about protocol-owned BNT? Is it available on the open market? No. It’s locked in Bancor pools and can’t be withdrawn by anyone. As explained earlier, the only way protocol-owned BNT can exit the pools and enter the open market is when investors buy BNT from the protocol — the BNT price increases and protocol-owned BNT becomes investor-owned BNT.
Protocol-owned BNT is not in circulation. Only investor-owned BNT should be considered as circulating supply. Circulating supply can, therefore, be calculated by subtracting protocol-owned BNT from the contract supply.
Circulating Supply = Contract Supply — Protocol-Owned BNT
Adjusted circulating supply
Even if contract supply is fixed (and it isn’t), circulating supply changes with BNT price. If the BNT price increases, circulating supply goes up. If the BNT price decreases, circulating supply goes down. It’s the outcome of the aforementioned transfer between protocol-owned BNT and investor-owned BNT. However, this approach completely ignores the existence of protocol-owned TKN which fluctuates in the opposite direction to protocol-owned BNT.
If BNT price is high in relation to TKN, BNT circulating supply is inflated because some BNT has been transferred from the protocol to investors (see: Figure 1). At the same time, the protocol-owned reserve of TKN has increased. BNT that entered circulation can be considered as borrowed from the protocol in exchange for TKN collateral. When TKN price catches up with BNT price, “borrowed” BNT is paid back to the protocol and TKN collateral returns to the external market (see: Figure 2). It happens because protocol-owned TKN buys back BNT from the external market; it’s firepower to fight selling pressure on BNT.
The value of protocol-owned TKN (expressed in BNT) represents part of the BNT circulating supply which is “borrowed” from the protocol — it has entered the circulation only temporarily in exchange for TKN collateral.
This approach leads to the concept of adjusted circulating supply which can be calculated by subtracting protocol-owned TKN from the circulating supply.
Adjusted Circulating Supply = Circulating Supply — Protocol-Owned TKN (in BNT)
Protocol-owned TKN can also be a negative number. When BNT price decreases in relation to TKN, BNT reserve in Bancor goes up and TKN reserve goes down (see: Figure 2). When TKN reserve is lower than the total amount of TKN deposited, Bancor effectively owes TKN to liquidity providers. Negative protocol-owned TKN can be considered as protocol’s debt, a TKN “loan” given to the market in exchange for BNT collateral temporarily removed from the circulation. Market pays back this “loan” when BNT price catches up with TKN price but its existence should be accounted for in supply data and this is exactly what Adjusted Circulating Supply does.
Adjusted Circulating Supply can be written down as:
Adjusted Circulating Supply = Contract Supply — (Protocol-Owned BNT + Protocol-Owned TKN)
Adjusted circulating supply subtracts both protocol-owned BNT and protocol-owned TKN from the contract supply. Although it’s a “virtual” number, as protocol-owned TKN must be converted to BNT, this is the best approximation of real circulating supply which takes into account the complex mechanics of Bancor network.
Figure 4: Different types of BNT supply over time
Why does correct BNT supply matter?
All the above discussions about different types of BNT and different types of BNT supply may sound a bit academic but they are extremely important for BNT investors. Because common data-reporting channels (Coingecko, Coinmarketcap, Token Terminal) quote BNT contract supply as circulating supply, all popular valuation metrics: Market Cap, Fully-Diluted Market Cap, Price to Sales are overstated.
Investors and analysts compare valuation metrics for different assets and form their opinions if one asset is under- or overvalued in relation to other ones. Such comparisons are heavily skewed for BNT if contract supply is used instead of circulating supply.
For example, market cap for BNT reported currently on Coingecko and Coinmarketcap is 60% higher than “real” market cap calculated on adjusted circulating supply and almost 90% higher if simple circulating supply is used.
Another popular data analytics website, Token Terminal, takes BNT contract supply to calculate fully-diluted market cap and other valuation metrics like Price to Sales ratio. Fully-diluted market cap tries to predict the final state of future supply assuming that all tokens have already entered the circulation. Contract supply is not a good approximation of this state — it only represents currently existing tokens (and a lot of them are not in circulation). The future state of BNT supply is dependent on Bancor DAO (e.g. the rate of liquidity mining rewards) and protocol’s health (e.g. ability to cover impermanent loss compensation from trading fees, rate of BNT burn in Vortex). It can’t be easily predicted, therefore, the best available approximation of fully-diluted market cap is adjusted circulating supply. It suggests that the Price to Sales ratio for BNT reported by Token Terminal is overstated by approximately 60% (actual percentage is dependent on the nondeterministic rate of future inflation dependent on Bancor DAO and protocol’s health).
Summing up, if market participants are not aware of the $BNT supply nuances and consider publicly available overstated figures as fair value for BNT, it may indicate a strong case for substantial BNT’s under-valuation.
Appendix: How to interpret BNT price?
Although investors often denominate asset prices in fiat currencies, mostly USD, it’s not how BNT price should be considered when it comes to analysis of Bancor protocol.
In the simple model with only one pool on Bancor: TKN-BNT, BNT price is denominated in TKN. BNT price increase means that it goes up in relation to TKN, i.e. BNT outperforms TKN. It doesn’t mean that BNT price in USD or any other fiat currency goes up too. It’s possible that both BNT and TKN prices go down in USD but BNT declines at a slower rate. In this case BNT outperforms TKN, i.e. BNT price goes up in relation to TKN.
In real life there are many pools on Bancor and TKN is just a general term for the basket of different assets in these pools. Each time this article mentions BNT price, it refers to the price denominated in TKN, i.e. relative to the whole basket of assets available on Bancor.