Original author: Pzai, Foresight News
The core of the iteration of the crypto market lies in the innovation of the token economy, and algorithmic innovation based on smart contracts has played a key role in the iteration of the past decade. The early extension of Bitcoin-based tokenization was relatively limited, and the relative lack of technology and narrative also became a certain constraint on the issuance of tokens at the time. When the smart contract ecosystem represented by Ethereum was still in its infancy, some people began to consider how to combine smart contracts with the token issuance model. Bonding Curve, as one of the earlier algorithmic innovations on the chain, has had a profound impact on both the token economy and token engineering. Therefore, this article seeks to explore the core of Bonding Curve by tracing its roots, and deeply thinks about its significance from multiple practical cases.
From fixed supply to dynamic supply
Early token issuance was full of centralization and disorder. The process of establishing a project was even chaotic. All it took was a plain white paper and deck to appear in countless roadshows and receive countless token inflows. But what happened after the inflows? The centralized token model eventually led to the collapse of token prices, and market competition that was not effectively regulated eventually vanished.
In the reflection on these issuance models, there is a mainstream view that the issuance characteristics at that time limited the scalability of the market, including the following points:
Centralization - In addition to the centralization of issuance itself, the trading process is mostly carried out in centralized exchanges
Single asset - poor ecological connectivity, and a single chain basically only corresponds to the circulation of a single asset (except for the circulation of USDT based on the Bitcoin OMNI architecture at that time)
Liquidity restrictions: The widespread use of PoW architecture at that time led to longer block confirmation times, which restricted on-chain transfers and reduced overall liquidity.
Fixed supply issuance - For tokens with a fixed supply, the project party can only distribute them through the consensus layer or initial allocation. The fixed token economics itself is not adaptable to changes in the market environment, and the project party has a large room for manipulation, which leads to a certain exaggeration and misleading of the token value, which is also the reason why the market at that time did not ultimately achieve phased sustainability.
In his 2017 “Curation Market” concept, former Consensys social engineer Simon de la Rouviere built a “system that allows groups to coordinate around common goals (and interests) and benefit from the value they create together.” This system is built on Ethereum’s smart contract framework, adding interoperability between protocols to the underlying architecture. The core of this concept lies in “automated coordination,” that is, how to allow people to automatically create this market on the chain when they are interested in the marketization of something. In terms of mechanism design, it is necessary to build a non-intermediary participation model in which users can participate freely. As a result, the continuous token model based on Bonding Curve was born.
Simon defines several properties of a simple continuous token model:
Using tokens like ETH to mint tokens based on a price set by a hard-coded algorithm (function)
The cost of a token depends on the number of tokens in circulation (i.e. unit token price = token supply²)
The purpose of the token is to be "destroyed" for application operations/services in the network. The token supply is reduced during service usage, while the minting cost is reduced, making the use case of the token not limited to distribution.
Based on this model, we can see that compared with the previous issuance model, Bonding Curve itself provides a new issuance model for various applications with decentralized supply. Next, we will explore some of the use cases that have been implemented, explore the role of the algorithm from the perspective of token engineering, and explore the potential landing direction of Bonding Curve in the future.
Curation
As Simon originally envisioned, one of the major use cases of Bonding Curve is curation. In the previous curation process, organizational problems were often encountered, such as lack of organizational coordination and lack of information richness. Here, the author selected two projects for analysis.
Ocean Protocol
Ocean Protocol is a decentralized data sharing protocol that aims to promote the open sharing of AI data. In this process, the purpose of token economic design is to maximize the supply of relevant data and services. In traditional curation markets, the main behavior of participants is to enter and exit as a signal. Ocean combines these transaction behaviors with the actual work of providing services to build a Curated Proofs Market.
In this market, each single dataset represents a corresponding “water drop” pledge curve. On this curve, users can choose to obtain block rewards (by staking a specific dataset and granting it availability) and unstake, and the “water drop” pledge can become an indicator of user attention.
From the project narrative to the token economic model, we can see that the project needs a stable inflow in the early stage to ensure that the data set can build an equal initial consensus in the curation, and to increase the threshold for latecomers in the subsequent availability of the data set, thereby increasing the subsequent participation cost while avoiding excessive concentration of consensus on a single data set. Therefore, its Bonding Curve model is shown in the figure below. After 500 "water drops", the overall casting cost rises linearly.
In simple terms, if users discover the value of a data set early, they can buy it through the Bonding Curve and make a profit in the future, thereby achieving curation. However, this curve is still relatively rough for the curation process, because there is a certain delay between the buying and selling of these tokens and the data sets used by AI, and these data sets are not necessarily guaranteed to be available, requiring other mechanisms for further screening.
Angel Protocol
Delphi Digital, a well-known research institution, has built a token economic model based on Bonding Curve for Angel Protocol, a charity donation protocol built on Terra. There are three roles in the protocol, namely donors, charities, and charity supporters (HALO protocol token stakers, who curate in the charity market). The goal of the protocol is to combine donations with Bonding Curve to enhance the sustainability of charity.
Based on the above use cases, its token economics needs to incentivize curation, donations, and governance-related actions, and encourage stakeholders to participate over time. Therefore, Delphi proposed a token curation registry based on Bonding Curve based on the concept of The Graph (which also curates through Bonding Curve, but the project is omitted for space reasons). This model allows users to participate in staking pools and interact with the curves of specific institutions to mint charitable shares. The curve determines the exchange rate between HALO and shares. Rational curators will pursue charities that maximize their profits, and the Bonding Curve design can distribute profits between token transactions. This part of the gain shares can be distributed or destroyed.
From the perspective of value stream, the income generated from the charitable donation fund is divided into share distribution (90%) and protocol fees (10%). In terms of share distribution, 75% of the distribution goes to charities and 25% is used for reinvestment of the donation fund, thereby promoting the long-term sustainability of cash flow. The protocol fees are scored to DANO (the governance organization of the protocol) and HALO stakers.
It is not difficult to see that the intervention of Bonding Curve not only provides token stakers with diversified sources of income (natural participation, protocol income inflows and even early governance rights), but also provides a mechanism for selecting the best for charity, a fundamental use case, because curators can ensure that only charities that users need most will appear in the charity market, and build a sustainable economic source for them based on marketization.
Summarize
Through the above analysis, we can abstract the role of Bonding Curve in the field of curation:
Natural sorting based on token game: The token price index generated by the free market allows us to abstractly understand the preferences of users within the system and even the status of corresponding things.
Natural early incentives: Market-based incentives from dynamic supply can be priced in real time through the curve, giving early users an advantage in future protocol-related use cases.
Healthy Value Flow: Every purchase corresponds to real asset storage, and the organic appreciation and potential distribution of assets bring considerable positive cash flow to the protocol.
Overall, the market-based environment provided by Bonding Curve provides a great environment for curated applications and integrates into the core of the protocol growth curve.
Algorithm Control
As an innovation in the chain mechanism, Bonding Curve exists as part of the core algorithm in multiple protocols. Here, the author analyzes two examples, covering the fields of chain insurance and stablecoins.
Nexus Mutual
As one of the pioneers of on-chain insurance protocols, Nexus Mutual has pioneered a mutual insurance alternative, providing purchasing and underwriting services to members within the protocol. Members can provide funds to the mutual fund and receive NXM tokens, staking NXM to assess underwriting risks and receiving rewards.
An important parameter introduced into the protocol is the Minimum Capital Floor (MCF), which corresponds to a ratio of the existing in-protocol funds, generally referred to as MCR%. For the sustainable development of on-chain mutual insurance protocols, a corresponding relationship between an equity token (corresponding to NXM in the protocol) and the total equity of the protocol is required to achieve organic scale growth of the protocol. Originally, in the protocol, MCF was determined by governance. In November 2019, community governance decided to automate the regulation of MCF. When the MCR% value on that day is greater than 130%, MCF will increase slightly by 1%.
They modeled this change. When MCF was fixed, the overall curve grew relatively slowly. After MCF began to grow linearly, the overall growth rate increased. This is the charm of the composite Bonding Curve - the correspondence between multiple protocol indicators and tokens can directly drive token growth.
Fei
FEI was a popular algorithmic stablecoin at the time, which integrated the experience and lessons of predecessors in the mechanism innovation on the chain. When users on the chain buy and sell FEI, the algorithm anchors the token through regulation.
In order to create protocol holding value (PCV) and accept new demands, Bonding Curve has become an excellent solution, and it has mathematical fairness. Specifically, prices outside the buffer zone can be balanced by casting in the Bonding Curve, and the curve is a one-way buy curve. In addition, for the general financing and deployment of PCV, this part of the funds can be obtained through additional Bonding Curves denominated in other tokens and deployed directly to various protocols on the chain. For example, when the protocol was launched, a unique curve was established based on the Uniswap ETH-FEI liquidity pool, and the liquidity of multiple DeFi protocols was subsequently added. Each Bonding Curve corresponds to the "anchor" (liquidity) of a single protocol, and the flexible design allows PCV to be deployed in new and creative ways and integrated with potential new DeFi protocols in the future.
Unfortunately, because the use cases of its stablecoin itself are very limited, its unique mechanism also determines the fate of users falling into the "water prison". Finally, it merged with Rari Capital and suffered theft, which ended regrettably. But before that, Fei and Ondo Finance cooperated to launch Liquidity as a Service (LaaS), which can be regarded as realizing part of the above vision. Bonding Curve, as a major contributor to the construction of PCV, also added fuel to the development of DeFi that year.
in conclusion
One of the great advantages of Bonding Curve is that it allows users to directly benefit from early growth, and when the curve is integrated with other protocol indicators, a gain of 1+1>2 can be obtained. In Nexus Mutual, as the value of the pledge increases, it can correspond to the super-linear growth of the token, while in FEI, it can achieve coordinated development with other DeFi protocols while stabilizing the inflow of the protocol. In addition, the "pure on-chain governance" introduced by Bonding Curve itself is a very sustainable thing, because the contract itself will not Rug itself.
Buy to grow...?
As the subtitle says, is buying growth? Look at Friend.tech and pump.fun. They have indeed applied Bonding Curve to perfection, but what happened in the end? One applied it to social networking, and the other applied it to MEME. While they have achieved great success in their respective fields, sustainability and externalities seem to have disappeared. It seems that we are repeating the mistakes of the past.
Why? Let’s review the characteristics of these projects that use Bonding Curve as a pure token issuance tool:
Disorder of issuance: The open curve market has actually become the culprit of consensus fragmentation, because everyone wants to be the initial issuer of the curve. Just look at the launch success rate of pump.fun.
No Value Flow: For projects whose only use case is issuing tokens, any discussion about Value Flow is meaningless.
Let’s go back to a commonplace: crypto is always chasing the next billion users, but finding real use cases is always a little bumpy. The essence of putting the cart before the horse is that we are falling into the trap of the issuance model again in a different way. Ironically, the birth of token economics was originally intended to break this trap.
If we list the advantages of encryption, we can find that token economy must be the most important link, and serving real use cases is the breakthrough of token economy.
Here are a few potential use cases:
Fairer (natural) governance: Directly buying and selling governance indicators may be more intuitive than direct voting (similar to the logic of prediction markets)
Decentralized asset endorsement: For NFT or other tokens, Bonding Curve can guarantee the endorsement of its underlying assets. Decentralized distribution avoids the inaction of the project party (because there is no project party), and can also automatically distribute the generated value. If this logic is applied in RWA, a certain mortgage rate can be ensured.
Protocol Growth: What happens if you combine TVL, yield, or points with the Bonding Curve? Growth on the curve is bound to drive the flywheel of indicators.
Of course, there is more to the imagination of the token economy, and we hope to see more novel use cases emerge in the future.