In this post, I’m going to give you some (relatively) unedited notes I took when reviewing the Bancor Network White paper.
You can read more about the Bancor Network here: https://bancor.network
The White Paper can be found here.
The Bancor Network is trying to solve a real problem, but they’re going into a crowded market in an already tiny industry: exchanges. There will be many mechanisms in this market trying to figure out the most optimal way to handle token exchanges, and there will be many more to come in the future.
Bancor Smart Tokens seem like an interesting way to solve the exchange problem, but the value proposition being proposed here could have been a bit more clear. After reading the paper, it’s clear this is competing with exchanges, but early on it wasn’t clear how this token was different. If it was more clear on this point as opposed to using the term ‘Smart Token’, I think the value of what’s being offered would be clearer.
The current exchange model for currencies/assets has a critical barrier, requiring a certain volume of trading activity to achieve market-liquidity. This inherent barrier makes it nearly impossible for small-scale currencies (such as community currencies, loyalty points or other custom tokens) to be linked (exchangeable) to other popular currencies using a market-determined exchange rate.
So it seems that the problem with smaller currencies (like reward points) is that they can’t be exchanged with other currencies easily. Is this even a problem to begin with? The market inefficiency here is tiny, because we’re talking about currencies that only a few people want to trade on the market.
So let’s say I have SCHUcoin (actual token I created on Wave) and 100 people I’m friends with start owning SCHU through local trading.
SCHUcoin can’t be traded for ETH easily (it still could, but it would take an off market transaction) on an open market because not enough people transact in this token. So they want to make this easier. But I doubt that this is a big enough problem.
There are going to be hundreds, thousands and maybe even millions of tokens in the future that are only used by a small portion or people. It’s like with blogs… there will be millions of them for all sorts of purposes, most of which won’t be interesting to 99.9999% of readers.
Now, there is something that could be said about being the ‘Google’ of tokens, namely being the focal point that brings all these currencies together, but I feel like just being the final mile for minor used tokens is not a big enough problem.
Not to mention that there seems to be a lot of different ways people could solve this problem (additional exchanges like shapeshift.io, services that allow users to create their own exchanges, blockchains that are inter-operable with other chains, etc).
A New Method for Price Discovery
Okay, so in this section, it seems like Bancor is being sold as an exchange via smart contracts. Bancor Smart Tokens hold other tokens in reserve (interesting idea), of which then a price for all of these reserve tokens in the network are calculated, getting you some aggregate pricing (as opposed to real time pricing).
So really, the token is acting as a sort of exchange with it’s own unique way of handling the exchange process and price, that that allows other currencies to be traded. They keep using the term ‘Smart Token’ to sell this idea, but that doesn’t help clarify things.
Smart tokens are unique in that they can be purchased or liquidated by a single party, using the calculated price, removing the need for two opposite wants to be simultaneously matched. This effectively means that by using the Bancor protocol, small-scale currencies with a low expected trade volume can offer continuous liquidity, thus, removing the barrier for them to be linked to the global economy.
So this is a really interesting idea, de-coupling the process of the exchange by allowing people to get value from their low-volume currencies without the need of a second party (at least initially). While I like this idea in theory, in practice, I’m not sure if the market for this is that big or that important.
Bancor’s premise here is based on the idea that the long-tail of cryptocurrencies are going to be worth much, much more than the head of the curve (BTC, ETH, etc). I have two issues with this concept:
- Some power law distributions operate this way, where the long-tail does end up being worth more than the head. However, some power law distributions do not operate this way. For example, cryptocurrencies today (BTC, ETH, XRP, etc) are worth more than the entire rest of the industry combined many times over. So even under perfect execution, there may not be a lot of revenue to be had here.
- The mechanism for facilitating this is interesting, but it’s by no means the only or even best way to solve this problem. In the short-term, companies like shapeshift.io and changelly are already opening up the industry to new cryptocurrencies and as time goes on, you can see them adding more and more. As more get on-board, there will be more reason to list these tokens or create private exchanges.
So even all things considered, there’s a lot of competitors need to be overcome before this is a viable market winner. I understand that most of the companies competing today are eventually going to be operating in competitive markets, but this market is already has a lot of viable businesses. For me, that’s the biggest concern and a major hurdle.
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