What is a Bonding Curve?
A bonding curve is a mathematical formula that describes the relationship between the supply and demand of a token in a decentralized finance (DeFi) ecosystem. It is used to create a new token and control its supply, price, and distribution mechanism.
A bonding curve can be seen as a financial instrument that enables automatic market-making by allocating tokens to investors based on the current supply and demand dynamics. It is also used as a method to fund decentralized autonomous organizations (DAOs) and incentivize users to participate in the network.
The bonding curve is typically expressed as a mathematical formula that maps the total supply of tokens to a price. As more tokens are minted, the price of the token increases, and vice versa. This creates a continuous feedback loop that ensures that the price of the token remains stable and proportional to the demand for it.
The bonding curve is also designed to be transparent, predictable, and auditable, ensuring that all participants have access to the same information and can make informed decisions. This makes it a popular tool for decentralized projects looking to raise funds and grow their communities in a trustless and decentralized way.
Popular Examples of a Bonding Curve
Bancor Protocol: The Bancor Protocol is a blockchain-based platform that uses bonding curves to ensure that tokens are always liquid and easily tradable. It allows for the creation of Smart Tokens, which are ERC20-compliant tokens that hold one or more other tokens in reserve, as well as BNT, the Bancor Network Token, which is used as a reserve currency.
Curve.fi: Curve.fi is a decentralized exchange and liquidity pool that uses bonding curves to provide low-slippage trades and to keep liquidity stable. It uses an automated market maker (AMM) model that allows users to trade stablecoins with minimal price impact and low fees.
Augur: Augur is a decentralized prediction market platform that uses a bonding curve to determine the value of its native token, REP. REP holders can stake their tokens in the platform to earn fees, and the bonding curve ensures that the token's value remains stable even as more REP is staked.
The bonding curve can be understood as a virtual water tank. Imagine that you own a water tank and people can buy water from you at different prices, depending on how much water is already in the tank. When the water tank is empty, you can sell a small amount of water for a high price, but as more and more water is added to the tank, the price decreases. This is because the more water there is in the tank, the more likely it is that there will be enough water to meet the needs of the people who want to buy it. Similarly, the bonding curve sets the price of a cryptocurrency or token based on the amount of it that is currently in circulation. The more of the currency or token that is circulating, the lower the price becomes, just like with the water tank.