Bond, bonding, bonding curves

Bond, bonding, bonding curves. A quite abstract word, to begin with, is starting to appear more frequently in the DeFi realm.

A bond is a relationship between two parties.

In the context of DeFi, many projects have started to consider using bonding to bootstrap token liquidity and demand more sustainably.

One way of understanding this is that bonding with someone assumes you have a vested interest.

Similarly, a protocol can purchase “liquidity bonds” or “reserve bonds” in exchange for the native token that is sold at a discount to the buyer.

Liquidity bonds are liquidity provider tokens. Reserve bonds are other tokens that are not LP.

The native token purchased is said to have a discounted “bond price”, which vest over a period of time. The cool thing though is that there exists a secondary market for the bonds that can affect the discount that the protocol might offer on the subsequent bond sales.

Bond sales generate profit that can be distributed to stakers.

This is an extremely powerful idea because, with liquidity bonds, the protocol purchases liquidity which means that it owns the pools, ensuring both stability and profitability. All fees generated by trading utilizing the pool are then distributed to stakers.

If compared with liquidity mining, the bonding ensures that interests between the protocol and users are aligned. Liquidity pool tokens are not owned by the users, but they now have exposure to the native tokens that are vesting and compounding if they are also staked.

But bonding curves are also fair…

Yes, bonding curves are also about relationships and specifically between supply and demand.

Bonding curves are used by projects to raise funds, fairly and deterministically, as these are mathematical formula built into smart contracts that have mint and burn functions.

Traders interact with the bonding curve as they buy and sell.

Bonding curves are Automated Market Makers, because the counterparty of a trader is the smart contract, as opposed to another trader as it works with orderbook-based exchanges where bid and ask has to be matched by a centralized party. It’s also fair because, at any time of the process, anyone can determine the price at which the token is going to sell. When token supply is low, the price is also low. Price increases deterministically as more tokens are minted, providing the early birds a sizable return.

Despite the price automation, the curve can be customized and include fees that can then be used by the protocol to bootstrap liquidity or community initiatives.

Fees can be charged on:

  • spreads between buy and sell
  • swaps (against ETH or stablecoins)
  • transaction fees with the bonding curve