DeFi Project Bancor Hit With Lawsuit Over Impermanent Loss Protection Promises

Bancor, a prominent player in the DeFi space, has found itself at the center of a class-action lawsuit filed in the U.S. District Court for the Western District of Texas.

The suit also targets its operator, BProtocol Foundation, and its founders, which claims Bancor deceived investors about its impermanent loss protection mechanism (ILP) and operated as an unregistered security.

The lawsuit comprises six charges against the defendants, including violations of the Securities Act of 1933 and the Exchange Act of 1934, breach of contract, and unjust enrichment.

The BProtocol Foundation, established in 2017 by Bancor Protocol’s founders, was a pioneer in the world of DeFi, which lets traders swap in and out of trades via liquidity pools.

These pools are smart contracts that contain crypto tokens, supplied by the platform’s users. In return for providing these tokens, users receive a share of the transaction fees generated by traders on the platform.

Liquidity pools are powered by self-executing smart contracts, which don’t require intermediaries for functionality. They rely on automated market makers (AMMs), a concept first introduced by Bancor Protocol in 2017, to maintain balance within the pools via mathematical formulas.

However, imbalances can occur, incurring losses for liquidity providers.

Impermanent loss and Bancor

When the value of a liquidity provider’s (LP) assets in a decentralized exchange (DEX) decreases due to price volatility in the liquidity pool, this can lead to what is known as an impermanent loss.

This loss can be mitigated if the relative prices of tokens in the pool return to their original state before the LP withdraws their stake.

But if the LP exits before this price realignment, the loss becomes permanent.

Critically, Bancor’s v2.1 product, unveiled in October 2020, promised investors protection against such losses. This feature played a significant role in attracting over $2.3 billion in crypto assets to the protocol. The lawsuit, however, argues that this ILP mechanism was a false promise.

It alleges that Bancor’s v2.1 operated at a deficit, of which the defendants were aware and attempted to mask by introducing a new product, v3. This new offering promised “some of the most competitive returns anywhere […] without asking users to take on any risk.”

On June 19, 2022, Bancor suspended its ILP in response to a surge in withdrawals, resulting in substantial losses for investors.

The lawsuit also challenges the degree of control the defendants maintained over the operations of the platform, contradicting the decentralized ethos of a DAO. This control allegedly extended to the organization’s capital, employees, and code, and involved manipulation and domination of Bancor DAO.

Additionally, the plaintiffs contend that the LP Program should be recognized as a binding investment contract and thus classified as a security under U.S. law. They assert that the defendants failed to adhere to the pertinent registration and disclosure requirements.

Had these requirements been met, the plaintiffs argue, they would not have invested in the LP program.

The plaintiffs claim losses nearing 50% of their LP Program investment, equating to tens of millions of dollars for U.S. retail investors. They are therefore seeking restitution, damages, and interest.

BProtocol did not immediately respond to Decrypt‘s request for comment.