What Is a Bonding Curve and How Does It Affect Token Price?

It may sound a bit complicated, but it’s nice for crypto finances. Bonding curves are a mathematical tool whose use is increasing in the world of Decentralized Finance (DeFi). They can solve several problems haunting the crypto space and hindering trading. And that’s good news!

The bonding curves exemplify how crypto technology can adapt concepts from traditional mathematics to create fair, decentralized, and autonomous solutions. This article will explore the basics about how they work, and why they are an important tool in the Obyte ecosystem.

What are Bonding Curves?

A bonding curve is a mathematical function that connects the supply of a digital asset with its value. By implementing a bonding curve formula, the price of a newly issued token changes in response to changes in the token’s supply (as it is bought or sold). So, for example, the formula could work so that each subsequent buyer will have to pay slightly more for the issued token.

The general idea behind bonding curves in cryptocurrencies is to allow an automated and fair valuation of an asset. To make it possible, in the beginning, a new token is minted in exchange for a reserve asset provided by investors. This minting occurs strictly according to the mathematical formula connecting the total supply of the issued token and the total reserve amount deposited to back its value. The opposite operation, the token exchange for the reserve currency, obeys the same rules.

The issuance and redemption of the token, as well as the storage of the deposited reserve, is handled by an Autonomous Agent (AA) in Obyte —which functions similarly to an Ethereum smart contract (which is not a contract). So, the process is fully decentralized.

Unlike traditional exchanges, the AA functioning as an Automated Market Maker (AMM) ensures that the buyer or seller doesn’t rely on a third party to execute transactions. This eliminates the need for an order book.

Advantages of bonding curves

This system unlocks a never-before-seen potential for the DeFi ecosystem. With it, developers can build the foundation for a fairer and more efficient market. The principle of bonding curves allows tokens to be issued in a market independent of exchanges, centralized control, or order books. They can create a market that adjusts automatically in response to trader activity.

Bonding curves also promote liquidity. Thus, tokens can be bought or sold instantly and anytime, as the AA automates the entire process. In addition, liquidity providers can earn some nice rewards for their liquidity.

This kind of design also offers a solution for project financing. By implementing this algorithm, investors can benefit by acquiring tokens early and seeing their value subsequently increase. That allows projects to get fair funding, and the founders cannot arbitrarily manipulate the supply.

Sustained organic growth can be reached this way too. Instead of an initial token dump that opens the door to dizzying rises at launch or sudden steep falls, the bonding curve tokens serve as an incentive for the project to achieve its goals.

Bonding curves in Obyte

In stablecoins

Bonding curves can be a practical and decentralized solution for issuing capital-efficient stablecoins. Even in the event of an abrupt depreciation of the reserve currency, they wouldn’t require users to overcollateralize (the stablecoin would lose the peg though until it’s restored by traders). As a nice extra feature, they may come with a complimentary token that’s an interest-bearing investment instrument.

Obyte has taken the concept of bonding curves further to build a multi-dimensional bonding curve that issues multiple tokens (T1 and T2) against a single reserve. This system can keep one of the prices constant while keeping its supply flexible. This is a new untested area, and thanks to experimentation and experience, we have two models of bonded stablecoins.

1. Bonded Stablecoins v1

The v1 is a system of multi-dimensional bonding curves that offers incentives and disincentives for those transactions that change the price in the desired or undesired direction. Thus, a fee is charged for all transactions that push the price of any token out of parity.

All these collected fees are accumulated in a capacitor. This is a buffer for the reserve currency stored in the same AA, but it’s separate from the reserve. Every time someone moves the token’s price back to parity, they get a reward, which is paid from the capacitor fund.

Assuming that the price of one of the tokens issued, e.g., T2, targets USD price and the reserve currency is GBYTE, then the target price of the token T2 can fluctuate even when there are no transactions on the curve, just because the reserve asset itself is volatile.

To resolve this, the capacitor is divided into two parts: slow and fast. All collected fees are distributed between the slow and fast capacitors in some proportions. But the rewards are paid from the fast capacitor only, while the slow one stays intact. After some timeout, a share of the slow capacitor can be moved to the fast capacitor, thus refilling it.

After another timeout, another percentage of the remaining slow capacity can be moved, and so on. With this procedure, the accumulated capacity will be used over longer periods of time and provide incentives for corrective movements.

2. Bonded Stablecoins v2

V2 Bonded Stablecoins also use an issuance curve to stabilize the price of the tokens. However, v1 required a specific behavior from T1 token holders to keep the price anchored, which is not always met. In v2, a stability fund is the sole owner of all T1 tokens issued, and investors who want exposure to the T1 price need to buy shares in the fund.

The Decision Engine (DE) is an AA that buys or sells T1 or T2 tokens to maintain the price anchor and increase the fund’s value. This way, instead of waiting indefinitely for traders to correct the price, the DE would automatically fix it (if it has sufficient funds) or give the traders limited time to correct it by buying low and having an opportunity to sell higher as soon as the price gets closer to the target. This is ensured by choosing such a bonding curve that the token’s price goes up when bought, and down when sold.

If you want to delve into how we build multi-dimensional bonding curves for stablecoins, you can visit our previous Bonded Stablecoins articles v1 and v2. We illustrate there how they work, with all the necessary graphs and formulas.

In Prediction Markets

Prophet is a prediction market platform on Obyte that uses bonding curves to create liquid and always-available trading markets for sports, politics, economic events, etc. It allows anyone to bet on future events, or provide liquidity to those bets in exchange for trading fees.

There are two tokens for markets (bets) with two possible outcomes: a YES token and a NO token. For markets with three outcomes, there is also a DRAW token. Bettors buy the token of the result they think will be the winner. The more bought a token is, the more value it gets (due to the bonding curve). As soon as the result of the event becomes known, all losing tokens lose their value, while the winning tokens gain it.

For those who are not into betting, there’s also another way to make profits with Prophet. Users can provide liquidity to the markets too. To achieve this, they need to buy a proportion of all the possible types of outcome tokens of a market. In the end, they’ll keep the bettors’ fees, independent of the market’s results.

Unlike others, Prophet takes a different approach and uses bonding curves to price its tokens. These link the total supply of tokens issued to the total reserve committed to issuing them. The algorithm makes buying or selling tokens through the AA possible, and token prices change automatically in response to demand. This way, it is always possible to trade tokens, regardless of the number of buyers or sellers.

In governance tokens

Bonding curves are also used in the OSWAP token, the governance token of the largest DEX in Obyte (Oswap.io). This algorithm incentivizes the provision of liquidity and allows traders to bet on the long-term success of the DEX.

The OSWAP token is issued on a bonding curve that provides always-available liquidity. The price of the OSWAP token on the bonding curve gradually increases at a rate that depends on the Total Value Locked (TVL) of all Oswap pools. A higher TVL yields a faster appreciation rate.

There are continuous emissions of new OSWAP tokens. Half of its emissions go to liquidity providers, and the other half goes to stakeholders participating in governance. Governance participants decide which Oswap pools are incentivized and in what proportions. They can update a few parameters such as the exchange rate, issuance rate, target revaluation rate, oracles, etc.

Currently, this governance token has a price of 175.9 GBYTEs, a yearly appreciation rate of 4.55%, and a supply of over 966.5 units. The bonding curve was created thanks to the initial investors in the presale, who bought the reserve in GBYTEs. This article lets you delve deeper into the topic.

Finally, we can say that bonding curves offer a structure that addresses many of the issues of traditional methods. As a result, DeFi solutions can have more automated and effective economics. In this regard, Obyte is leading efforts to achieve true decentralization with greater transparency and consistent liquidity.