From Bonding Curves to Commons Market Makers

A Sensemaking Dialogue between Matthew Slater & Jeff Emmett

Crypto Commons Association
14 min readJun 8, 2022

This is the second article of the Crypto Commons Association Blog, where we mainly host contributions from the members of our community or team. To know more about our many activities, and in particular about our Hub in Austria check this link where you’ll find all is needed to get into our virtual and physical community of commoners! We are always open to collaborations, partnerships, and ideas — please connect with us.

This article is a dialog exploring shared territory between the ‘old school’ and the ‘new school’ of currency design — a fruitful (and ongoing) conversation between Matthew Slater and Jeff Emmett, two of our favorite token engineers.

Enjoy the reading, we hope it will spark valuable debates!

(Crypto Commons Association is not responsible or always completely adherent to the positions of the articles’ writers)

Matslats: Jeff Emmett is a man with a mission to tell the world about bonding curves. This sense of mission resonates with me as I have felt the same way about mutual credit accounting for many years! But Jeff’s explanations themselves don’t always resonate with me. They seem to be a mix of metaphors from electrical/mechanical engineering and biology/biomimetics, which to me don’t help explain the critical financial dynamics. So I sat down with him to try to understand for myself what all the fuss was about.

Thanks for taking this time with me Jeff. Can you explain the mechanism behind bonding curves, in their purest form?

Bonding Curves as Automated Market Makers

Jeff: Sure thing Matt! Like you, I’m also a big fan of Mutual Credit currencies, given their effectiveness as a medium of exchange, and I’m also curious how we can innovate on currencies as systems of coordination. Back to your question: normally, exchanging assets on a market requires that a buyer and a seller find each other, for example on an exchange — in contrast, the bonding curve algorithm acts as an automated counterparty that is willing to engage with any individual buyer or seller. A bonding curve, in its purest form, is just an algorithm managing the proportion of a pair (or basket) of assets held in a smart contract ‘liquidity pool’. As trade changes the proportion of assets in the pool, the algorithm adjusts its bid/offer prices to reflect the rebalance of assets. The bonding curve dynamically adjusts the prices that will be offered for the assets based on supply & demand, according to an algorithmically determined ratio.

I just want to clarify off the bat that these algorithms are not comparable to the infamous high frequency trading algorithms we sometimes hear about on Wall Street. They do not enter the markets actively seeking opportunities to make money. These algorithms trade passively, in that they only take orders from people who are looking to buy or sell that token. You can kind of think of them like a vending machine, where the amount of assets you get out depends on the amount of other assets you put in.

Matslats: So until now you’ve been calling these things ‘bonding curves’, but based on your own thinking and also the way other people are talking, you’re going to use a different term in the future?

Jeff: Right. The term ‘bonding curve’ was initially intended to describe the curve defining the ratio of two asset classes in a pool governed by a smart contract when you plot them on a graph. The term was popularized by Simon de la Rouviere when he referred to a group of people ‘bonded’ together in common purpose around the value of the issued token. I imagine this term will continue to be used among groups innovating on research, but the term can be a bit misleading as to what it does. Bonding Curves have since become more widely known as Automated Market Makers (AMMs) which I agree is a much clearer description of the mechanism. These tools solved a really big problem for crypto markets pre-2018 — that is, providing buy/sell liquidity for the exchange of tokens with low daily trading volumes — which was the case for the vast majority of tokens on the market.

Automated Counterparties & Rewarding Liquidity Provision

Matslats: I can see how an automated counterparty could be useful for an asset that is traded only infrequently. I’m old enough to remember Waves, which worked much like the centralised exchanges now, like Binance, but all done on a blockchain. I thought it was great, but apparently not many people agreed with me and the markets there were pretty quiet.

Jeff: The invention of AMMs like Bancor and Uniswap enabled even small markets to behave like deeper, more liquid ones, and played a key role in facilitating the trading of the long tail of web3 tokens. They brought together hodlers who staked their tokens in liquidity pools for a share of the trade commissions, with traders who wanted liquid markets. The combination of sudden liquidity for previously idle tokens mixed with these staking returns were likely big factors in providing the necessary network liquidity and incentives to end the last crypto bear market.

Matslats: Ah, you made me realise that ‘staking’ changed its meaning. It used to mean expressing trust in a node doing block validation, as in ‘proof of stake’ but now it is much more about lending one’s tokens to these AMMs to make small markets more liquid.

Jeff: Staking basically means temporarily ‘parking’ your tokens into some form of smart contract, which was originally to vouch for a block validator in Proof of Stake systems. Nowadays much staking is around liquidity provision (but there are several other purposes). Pretty much all the decentralised exchanges are based on some variation of AMMs now. These AMM-type decentralised exchanges with liquidity pools differ from centralised exchanges because:

  • There is no order book, and no ‘limit’ orders (except in some futuristic AMMs), only market orders at the price offered by the algorithm.
  • That means the exchange doesn’t have custody of (trader) funds, and so doesn’t need to know their legal identity.
  • All transactions happen instantaneously in the next block.

Matslats: Great, but all of this is pretty well known. What you’re excited about is some special use-case for this tech, right?

Differentiating Primary & Secondary AMMs (PAMMs & SAMMs)

Jeff: Yes, but first I need to make another distinction. So far we’ve been talking about the vast majority of AMMs like Uniswap, Bancor, Sushiswap, Balancer, 1Inch, etc, but that’s not all AMMs can do. The team at Gyroscope has come up with helpful terms to define two different types of AMM. Most of the examples we’ve discussed so far are classified as secondary market AMMs (SAMMs), since they serve the purpose of exchanging assets that are issued elsewhere.

A short animation describing the agents & resources involved in a SAMM like Uniswap. The primary purpose of this SAMM is to provide liquidity for traders between ETH & BTC, for example. (Note: this would actually be wBTC instead of BTC — wrapped BTC is ERC-20 compliant and compatible with tools like Uniswap.)

In comparison, a primary market AMM (PAMM) has the purpose of issuing (or minting) native assets as it sells them and burning those same native assets as it buys them back.

A short animation of the agents & resources involved in a PAMM like Nexus Mutual or TrueBit. The primary purpose of this PAMM is to provide dynamic issuance for a native asset of interest.

Rather than have a primary issuance event, a project can now issue its tokens continuously through a PAMM, which controls the token supply according to the demand for it, along with other parameters. This invites a whole new set of applications because:

  1. The token price can be algorithmically determined, which puts control theoretic ‘guardrails’ on the price to make it more value stable and less manipulable by speculators.
  2. Controlling the market for one’s own tokens enables you to do things like imposing trading fees to generate income (which further deters speculators), simultaneously redirecting those funds to deliver continuous funding to a community that can provide #RealValue.
  3. With token price being deterministically correlated to the amount of tokens in supply, PAMMs open up the possibility of computationally modeling the impacts of supply and demand on token price, enabling agent-based behavioral modeling and much more.

A token issued through a PAMM might also be traded on secondary markets which might have lower transaction fees. The PAMM itself is best placed to benefit from the arbitrage opportunities, which can provide another source of continuous income to the project or community that is issuing tokens.

PAMMs as Volatility Damping Continuous Token Issuance Mechanisms

Matslats: This could really have helped Faircoin in 2018, when the exchange rate was set by an open participation process: it followed bitcoin’s sudden rise, but the group didn’t want to lower the price when Bitcoin crashed, so huge gap opened up between the high official Faircoin price and the low free market price. People stopped buying at the high official price and eventually the cash reserve dwindled as users gradually cashed out.

Jeff: Definitely. A PAMM can be thought of as an interface between the tokens internal to an organisation and the external, harder currency which the organisation uses to trade with the outside world. It manages the rates at which people buy into and sell out of the organisation. When DAO treasuries contain only their own tokens (as opposed to harder assets like stablecoins), volatile pricing can render the amount of money under management very unpredictable. PAMMs are just scripts, and can be designed to restrict access to the market according to certain criteria, say for members only, or to take a cut on each transaction.

Matslats: The basic idea is pretty simple — I’m trying to think of the nearest real-world examples of organisations using the fact that they issue an asset to control the market in it.

I’m reminded of how sometimes countries will use reserves of their own currency and of harder currencies to manipulate the rate of their own currency on global markets. Similarly these last years we’ve been hearing about cash rich companies buying back their own shares because pumping the price this way is the best use of excess cash. And conversely companies issue new shares all the time as bonuses to staff.

Jeff: Right — there are many parallels to how these kinds of ‘economic leverage’ can occur, but the difference is that now blockchains enable purpose-driven communities to do this algorithmically, transparently and equitably, with any fungible blockchain asset.

And it goes way beyond equity and corporate shares. These tools could support new revenue and business models for emergent open source projects, nonprofits, and other public goods producing endeavors. Millennials are maturing and their values are starting to influence finance, and they need a livable planet before they need ever-increasing financial returns. If they could park their savings directly in planting trees or cleaning up trash in order to see and measure ‘returns’ in ecosystem health, rather than speculating in blue-chip ‘business-as-usual’ stocks, they just might! As a society facing the existential crisis of climate change, we need to be able to put our money where our mouths are — and fast. I believe these tools could help us do just that.

Matslats: I think few people, even in blockchain, understand the degree to which we must reimagine wealth and finance — even money must be redefined in order for society to respond to climate change and mass extinction in a way that minimizes suffering and death. At a time when humanity should be ‘all hands on deck’ most of us are either working bullshit jobs to make the rich richer, or are unemployed because money is continuously syphoned out of the real economy. When you talk about Millennials ‘investing’ in planting trees and cleaning up trash, and seeking non-financial, ecological returns; that’s radical, but I find it hard to grasp.

What I can imagine is nonprofit organisations doing the equivalent of issuing bonds in a less onerous and more experimental way than is possible for them in mainstream finance. I could imagine buying <MyNGO> tokens, and the NGO investing the money to generate a return which goes, some to me, and some to their own activities. Then when I need the money out, I could hopefully sell the tokens at face value.

Introducing the Commons Market Maker

Jeff: Agreed! There are multiple ways these tools could be deployed to rethink funding flows for non-profits. That brings us to the last concept I want to introduce, as a particular type of PAMM that is geared towards continuous funding for public goods — sorry but it’s yet another acronym. Projects like the Commons Stack are setting up PAMMs with an additional spending account which they call the ‘Common Pool’ (because it’s a Common Pool Resource that is collectively allocated towards community goals). This configuration is being called a Commons Market Maker (CMM). According to David Bollier, a “commons” is the combination of three things: a community, its shared resources, and the rules by which those resources can be used.

The CMM can be considered a new tool which accumulates and manages the hard asset (money) in the Common Pool. It also defines the community (which is the token holders) that can access the money and defines the rules about how the money can be spent (via continuous voting enabled by smart contract logic).

A short animation of the agents & resource pools involved in a Commons Market Maker. The primary purpose of the CMM is to provide continuous funding for a community treasury and the dynamic issuance for their native asset.

So how would this work in practice? A community of individuals come together and decide to mutually invest in their commons. They place their money into a pool and a Commons Market Maker issues them tokens. The CMM then allocates a certain proportion of those funds into a reserve fund (essentially a fractional reserve system), with the remainder of those funds being used to initialize the Common Pool for discretionary spending by the community. The tokens that commoners now hold are used for voting over how the Common Pool funds are spent.

The CMM continuously funds the Common Pool by imposing entry fees for issuing tokens and/or exit fees for redeeming tokens. This has the added benefit of deterring speculators with extra transaction fees, and ensures that the community benefits from any speculation that does happen.

The design space for these kinds of commons-friendly market makers is vast and unexplored. For example, CMM designers can reward specific verifiable actions, or limit redemption of tokens only to those with that verified action recorded on chain.

Can CMMs Really Provide Continuous Funding?

Matslats: I’m dubious about this ‘continuous funding’ which relies on continuous trade of the tokens. You seem to be saying that if an organisation’s reserves are depleted due to members exiting, the fall in token price stimulates demand for tokens increases and the reserve is replenished — that as long as business continues as usual, the token price is self stabilising. I’m reminded of the infamous price-specie-flow mechanism (PSFM) — the idea that monetary systems balance themselves, basically because supply/demand and prices and reserves are all connected with the market mechanism. The theory is very elegant but numerous economists have shown that it does not describe at all what happens in real world systems.

Jeff: Ah I certainly see the parallel, and I recognise the flaws in the price-specie flow mechanism, but I think in the token ecosystem context we are discussing, those problems are not a deal breaker. The PSFM applies when the purpose of the monetary system is trade, and the longevity and justice of a trade system depends very much on maintaining a balance of trade, which we agree, the PSFM rarely manages to do. But the tokens we are discussing here are less about trade and exchange, and more about collective funding using PAMMs to bootstrap and capitalise organisations. In this case balance of trade is not the objective, so the inadequacy of PSFM to balance trade and exchange rates between currencies is not really a concern.

Matslats: That sounds reasonable, but I’d be interested to hear from other economists if they agree. Another thing that concerns me is that you seem to think ordinary people (rather than speculators) would trade continually in the tokens of a non-profit organisation. Could this be an assumption that comes from being in a field which has been growing for many years? Or is it merely a prediction about the philanthropic habits of Millennials? In other words, will these new AMMs really translate out of the optimistic, upward surging, young wealthy generous crypto bubble to fund nonprofits in other environments?

A Maturing Toolkit

Jeff: Although it could look like a fad due to the hype cycles around crypto, I think these tools are truly verging on new ways of collectively putting our money where our values are. It’s also doing that alongside new granularity and subsidiarity in decision making, and I think that’s fundamentally important. In a future world your regular choice of investments could include a <climateDAO> that funded emergent climate solutions, or <hungerDAO> that fed the hungry, or even <neighbourDAO> that supported your community. If you are bullish on Tesla stocks, wait ’til you see the latent demand for investments that directly support emergent regenerative practices on a global scale! (Of course, we are a ways off from that yet.)

I think this is less about speculation than it is a new way of collaborating at scale. Contributing to a DAO is simultaneously a novel investment as well as compensation model, which could (once the hype wears off) actually be effective tools for local cooperatives or purpose-driven neighbourhood groups. Although CMM tokens can be purchased (since every organization requires some form of upfront capital), they are not merely financial instruments. CMM tokens could be combined with subscriptions for access to tiered membership benefits, be issued to incentivize certain actions (say, planting a tree), or used to surface information from members regarding their preferences, such as organisational direction or how communal funds should be spent. People may buy some tokens here to support this local community group, and sell other tokens that they’ve earned in another. Tokens could even be given out evenly to all members in a group, if it were desirable for everyone to have equal voice.

With trends suggesting further growth of these kinds of digital cooperative organizations, I don’t think we need to question whether there will be more investment capital flowing through these tools. The true test will be in whether the early organizations who use them can successfully work through their challenges to deliver #RealValue. If so, more experiments will come. If not, more will probably come anyway — we are likely to see a lot of failures along the path of progress too, and that shouldn’t stop us from continuing to iterate these tools until they’re useful.

Closing Out — Responsible Monetary Policy for Tokens?

Matslats: I started this process trying to unpack a lot of your language and translated it into universal financial concepts and I think we’ve made some progress with this. I still have many concerns that new and repurposed language is being used to cover up for poorly designed financial mechanics and merely give the impression of innovation without real value underneath. Given the growth of the crypto field in the last decade, it must be very tempting for people to overestimate their cleverness, and to mistake financial engineering for wealth creation. I certainly see potential in the new tools in giving power to nonprofits and reclaimed commons, but until the language and mechanisms are more comprehensible, I have trouble seeing this take off.

Jeff: I couldn’t agree with you more. Although interspersed with some novel innovations, most of the crypto space today is working with poor tools and often poorer understanding of monetary innovation. Being able to mint unlimited amounts of essentially ‘fiat tokens’ with no value backing them, treating your own native token supply like your treasury, these are all unsustainable ways to create and manage currencies that lead to huge amounts of market instability and failed experiments. New tools like Commons Market Makers could help to disintermediate some of these monetary and fiscal policy decisions with replicable templates for responsible management of an asset-backed token supply, which could help create more stable and reliable commons-based economies. In fact, the conservation laws applied by a bonding curve in a token economy can actually emulate a mutual credit ecosystem! So perhaps we are on the same mission after all.

I think it’s important to be realistic about where we’re at with this technology. The visions I’ve presented above are selling a ‘vehicle’ that can get us from point A to B in funding public goods — but that vehicle doesn’t actually exist yet. In reality, we’re still working on the engineering design for the combustion engine — the Commons Market Maker that can power the economic engine of these new vehicles. If it seems that the terminology is overly technical, and the math is overly complex, that’s because it is — these tools need to be tested in multiple contexts, simplified in UX and explanation, and then applied in ways that can actually deliver #RealValue to the world. We are just too early to have seen that full cycle yet. The good news is, we can all be a part of it. IMHO, the best parts of history are yet to be written!

- FIN -