The crypto ecosystem has brought countless innovations and disruptions to antiquated business models. The decentralized nature of blockchain has allowed new market participants to compete against incumbents in previously unexplored ways.
This has been achieved through innovative funding methods that have only become possible through advances in blockchain and the cryptocurrency space. One of the more recent and significant advancements in the blockchain space has taken shape in the automated pricing methodology of Bonding Curves.
Bonding Curves Offerings, or BCOs, allow projects to efficiently, fairly, and reliably distribute tokens to project adopters, who fund and speculate on new business ventures in a transparent way.
Bonding curves are built upon one of the most fundamental concepts in economics: price being a function of supply and demand. This tried and tested economic law is the complex study of a more familiar adage: an asset is only worth what someone is willing to pay for it.
Every seller needs a counterparty to buy, and every buyer needs to be matched with someone willing to sell. As more participants look to purchase an asset, sellers want to be compensated at a higher rate for this asset that now has a greater demand from the market.
The inverse is also true regarding selling an asset. As more assets become available for sale, there will be a price decrease that reflects the lower demand seen in the market. At any point in time, the price of an asset is a reflection of the equilibrium that has been reached between market participants, those willing to sell and those willing to buy the asset.
Traditionally, the process is overseen by a centralized entity; someone who oversees incoming buy and sell orders while matching market participants and ensuring liquidity.
Bonding Curves offer an innovative solution because they do not require the oversight of a centralized entity to create, oversee, and enforce the market’s pursuit of this equilibrium. Instead of relying on a third-party entity to create the market and mediate the transaction, Bonding Curves rely on a mathematical function packaged within a Smart Contract called an Automatic Market Maker.
Ok… well what is an Automated Market Maker?
The traditional exchange of assets relies on an order book to maintain a record of what market participants are willing to pay or receive for an asset they would like to buy or sell. An order book offers a clear record of the market’s liquidity and allows the exchange to provide a close match (spread) between the price buyers are willing to bid and sellers are willing to ask.
Automated Market Makers differ in that the buyer or seller does not need to rely on a counterparty in order to execute the transactions maintained in an order book. In essence, the network participant on the other side of their transaction order is the contract itself.
The contract mints or creates new tokens to place into circulation for a buy order while burning or destroying tokens that have been sold, eliminating them from circulation.
The mathematical formula that has been deployed to create markets, manage liquidity and execute orders is at the heart of a Bonding Curve. This fundamental reliance on the transparency of an auditable mathematical formula has created new market opportunities that were previously unrealized.
The Bonding Curve ensures that each newly minted token (which is sold to a buyer in the market), is more expensive than the previous token. Because the price of each token is defined by the curve / formula itself, every market participant knows exactly how much each token will cost at any given time. As tokens have the lowest price at the lowest part of the curve, there is a price advantage for early adopters.
Early buyers have a considerable upside potential when compared with later entrants to market, as prices are lowest when supply is low as well.
The most fundamental advantage of Bonding Curves over traditional asset pricing mechanisms is that the pricing of assets is transparent, defined, and immutable at all stages. The market is able to reach the equilibrium of consensus through clearly defined rules, without third-party intervention.
Additionally, this fundraising method addresses many of the inefficiencies that have led to fraud and misappropriation within the Initial Coin Offering (ICO) model. Starting offer prices are not set arbitrarily by the project's founders. All tokens are accounted for at all times. The token’s distribution is automatic and configurable.
More significant still, most Bonding Curves support a Decentralized Autonomous Organization that ensures participants have a voice and influence within the governance and strategic direction of the project. Beyond early participants earning gains on their investment through wider market adoption of the project use case, they are able to take an active role within a community that builds the solutions the market needs.
Ultimately, Bonding Curves are able to finance a project by taking a small percentage of the collateral funds that have been contributed to the market. Different projects adopt different mechanisms to commercialize these investments.
Some projects take a difference between the buy and ask price that is normally found in a traditional order book. This amount is defined within the contract at the launch and is auditable by all network participants.
Other projects take a fee for switching between the token and another asset like ETH or a stablecoin. Another popular method in the market today is the project taking a small percentage fee on each transaction with the Bonding Curve.
Regardless of the approach the formula takes, most BCOs will require some level of initial liquidity to be injected into the contract. This initial jump start will support later participants by creating a preliminary level of liquidity within the contract for traders to utilize.
Projects often launch via a mechanism called Initial Bonding Curve Offering (IBCO), during which liquidity is pooled together from early investors and injected in the contract at once to mint the first tokens out, often at a discount. But due to the programmable nature of the mathematical formula, the launching possibilities are vast and are typically tailored to meet the needs and objectives of each unique project.
Bonding Curve Offerings present a viable funding raising structure that addresses many of the inefficiencies of traditional methods. With greater transparency and constant liquidity, the project team and their investors are able to more efficiently price and fund their ventures.