Earlier this week, I wrote about the influence that Initial Coin Offerings(ICOs) are playing in Ethereum’s increasing market share in the digital currency space. Now, a new company has closed a record ICO to bring some stability to the crypto-currency space. Insert your ironic comment here… ;)
In June 13, blockchain startup Bancor raised $150 million in an ICO with the objective to legitimize the exchange rates f digital currencies. Bancor is trying to adapt some well-established techniques from financial services to the smart token/digital currency worlds. Regardless of whether you agree with the Bancor’s approach( I have some concerns about the fundamentals), we should all welcome that type of financial rigor and innovation in the crypto-coin space. So how does exactly Bancor works?
Bancor is attempting to provide a foundational platform to make smart tokens( the ones you use in an ICO) widely acceptable. Bancor envisions a world in which almost every company can issue its own digital currency with guarantee liquidity. As crazy as that might sound considering the current digital currency market, Bancor’s model is incredibly viable. Let’s explain it using an example:
Let’s assume that your favorite company( FC) decides to issue a new smart token(FCT) that customers can use to conduct business with FC or some of its partners that accept the new currency. In that scenario, Bancor will allow FC to establish a constant exchange rate between FCT and a proprietary token called Bancor Network Exchange Token(BNT). The rate is enforced using Ethereum’s smart contracts and, more importantly, is backed by a pool of Ethereum. In order to make this work, Bancor needs to hold Ethereum reserves to guarantee liquidity.
The magic behind Bancor relies on the well-known Constant Reserve Rates(CRR) model which builds liquidity into the BNT itself. Bancor’s BNTs will be used to back a large number of the relevant cryptocurrencies in the market. To make this model more viable, Bancor introduces a protocol that guarantees the exchange of BNTs to other crypto-assets including Ethereum’s Ether.
If you are into finance, you might already be comparing Bancor’s relationship to digital currencies to the role that central bank policies such as Capital Adequacy Ratios play on banks. The main difference, of course, is that central banks’ cash instruments are globally accepted and are rarely exposed to the levels of volatility of cryptocurrencies.
We Need More Ideas Like Bancor
Bancor’s vision is as ambitious as it is risky. Concerns ranging from the viability (or the lack thereof) of most ICO smart-tokens to the dependencies on currencies built on top of Bancor itself are some of the challenges that the blockchain startup is likely to face. Regardless, ideas like Bancor targeted to bring stability to cryptocurrencies are fundamental to the long term viability of digital currencies.
In my opinion, there are over a dozen well-established mechanisms in financial markets that can be adapters to the digital currencies market in order to improve its stability. Option contracts, collateral models, derivative contracts, risk management models are just some of the ideas that be modeled as smart contracts in order to improve stable exchange rates in digital currencies.