Ever since its emergence, the decentralized finance (DeFi) sector has seen a variety of innovative financial applications. The functionality of smart contracts has enabled endless possibilities for modeling ingenious financial algorithms within the crypto ecosystem.
The rapidly evolving DeFi spectrum is regularly introduced by newer decentralized projects, pushing it to another level. Decentralized exchanges (DEXs) are one of these innovations that have turned the crypto industry towards its true value and played an important role in framing the base for DeFi.
Fast forward to the current time: a number of DeFi applications are running atop decentralized exchange algorithms, and Liquidity Bootstrapping Pools, which Balancer introduced, is one of them.
Liquidity Bootstrapping Pools (LBPs)
The first thing to know before understanding LBPs is the concept of automated market makers (AMMs) and liquidity pools.
- Automated Market Makers (AMMs): AMMs are algorithmic smart contracts that handle the trading of crypto assets in a decentralized manner. It is used by DEXs to facilitate permissionless swap of assets.
- Liquidity Pools: Liquidity pools are a component of AMMs that consist of liquidity for two or more assets that enable swaps. Liquidity pools typically hold liquidity for two assets in a 50/50 ratio.
Both of these are essential elements of decentralized finance which provides an alternate way of trading crypto assets besides buying and selling on centralized exchanges.
What Is Liquidity Bootstrapping Pool (LBP) and How Does It Work?
A liquidity bootstrapping pool or LBP is an innovative liquidity pool mechanism that enables dynamic asset weightings for pooled assets rather than the following 50:50 model. Balancer first introduced this liquidity pool mechanism. A liquidity bootstrapping pool is a smart contract that manages a pool of tokens for use on a cryptocurrency exchange.
Where typical liquidity pools require 50:50 asset weightings, LBPs are customized to have any range between 1:99 and 99:1 for asset weightings. The creators of these pools can also control and adjust asset weighting over a specific timeframe. This allows efficient market-making where the price of a primary token can be dynamically managed.
These pools are usually created for selling new tokens in which a small allocation of the token supply is paired with highly liquid assets such as ETH or USDT.
Why DeFi Need Liquidity Bootstrapping Pools
As we know, DeFi is full of people always looking to extract values from live markets, and the standard design of decentralized exchanges is now facing drawbacks. The MEV bots and other such entities always keep an eye on these decentralized exchanges to benefit even from the minor price difference of an asset.
Such a scenario might not be so bad for large-cap assets, but it severely affects smaller project tokens in the initial phase. This is where the idea of the Liquidity Bootstrapping Pool comes into the picture.
As mentioned, smaller projects find it hard to sustain the token price at the starting phase or while the token sale is launched. LBPs address this shortcoming of AMM by limiting the asset pooling and enabling neutral token offerings. It essentially eliminates entry for profit-oriented whales, price-manipulative actors, or other entities for fair distribution.
The controller of LBP can kickstart token sales at a level higher than fair price while providing minimal capital for secondary assets such as USDT or ETH in the pool. This mechanism is also ideal for fair price discovery for an asset at the initial level.
Moreover, the controller can adjust the weightings of the pool and gradually lower the price to manage selling pressure or until investors find it lucrative to buy. In such cases, LBP controllers can even pause the swapping of assets to stop drastic market manipulations.
Use-case and Application for Liquidity Bootstrapping Pools
Liquidity Bootstrapping Pools are innovative and more advanced liquidity pools that fit the need of requiring constant moderation of token price for a specific period of time. The prominent applications of LBPs are as follows;
Initial Token Sale
LBPs are primarily designed to launch new tokens in the market while entering into the trillions of dollars of the crypto industry for the first time. Where a typical liquidity pool could not prevent the rush of buyers or sellers resulting in massive pumps and dumps for tokens, LBPs help project operators to attain such issues and minimize huge price fluctuations.
Fair Price Discovery
While the launch price of a new token could be hard to find, LBPs enable launching the token at a price that can be gradually lowered or increased with changing pool weightage. The price of a token launched via LBP is often far higher than, and it finds a fair market price where investors wish to buy.
Broader Token Distribution
As the token weightings and quantity can be altered in LBP, it allows unbiased distribution of tokens in the community. The restrictions over buying or selling large amounts of tokens benefit broader distribution.
Conclusion
Liquidity Bootstrapping Pools are an ideal option for new projects that are willing to launch their token in a fair manner. It keeps away the unwanted price curve that most of the toke currently suffers while being made available in the market for the first time.
LBPs enable tailored token launching and distributing mechanisms where everyone equally benefits. This method can even become a standard for fundraising while requiring minimum capital investment.
Also Read: DeFi Lending Explained: How Crypto Loans Work in Decentralized Finance
FAQs
What does LBP mean in crypto?
LBP means Liquidity Bootstrapping Pool which is a customized liquidity pool that allows any token weightings rather than adding liquidity in 50/50 ratio.
What do LBPs do in DeFi?
Liquidity Bootstrapping Pools (LBPs) are customly designed liquidity pools that enable launching new crypto assets in the market. It allows finding fair token prices and distribution among community members.
