How Nibbl’s bonding curve solves liquidity challenges of fractional NFT tokens
Fractional NFT token ownership is supposed to eventually transition from a single owner to decentralized communities. To achieve this, tokens need to get distributed from the original NFT owner to the community over time, and there needs to be high liquidity for people to buy and sell their tokens. But that’s not usually the case.
Leaving some very popular NFTs, most fractional NFTs have very low liquidity. There are a number of reasons why fractional tokens currently have low liquidity.
- Lack of incentives: If you believe the value of the token will increase over time, you wouldn’t want to add liquidity on an AMM to avoid high impermanent loss, given that most fractional tokens are low market cap assets and their value can increase sharply in very little time. If there is low liquidity in a pool, not many people will buy a fractional token due to the high impermanent loss involved in a trade.
- Loss of token utility: If you want to use the token for utility or to access token-gated features in the fractional NFT community, you wouldn’t want to add liquidity on an AMM.
- High gas cost: The gas cost of creating a liquidity pool on Uni-V3 usually ranges from 0.3ETH–1ETH. The gas fee of adding liquidity to an existing pool also usually ranges from 0.03–0.1ETH. Add to it the complexity a non-technical user has to face while starting a new pool.
- Reliance on fractionalizer to distribute tokens: Fractional NFTs are supposed to transition from being owned by one person to being owned by the community. Current systems rely too heavily on the original NFT fractionalizer to add token liquidity on a Uniswap-like AMM and then sell their tokens in low liquidity pools, in order to dilute ownership of the tokens to the community over time.
Introducing Nibbl’s Bonding Curve Design
Here’s where Nibbl comes in. We aim to solve both, liquidity as well as token distribution challenges associated with fractional tokens by using continuous tokens issued on a single-sided bonding curve. Nibbl’s protocol ensures liquidity at the protocol level.
Quick Primer on Bonding curve
A bonding curve is a mathematical curve that defines a relationship between price and token supply. Here’s an example of a bonding curve, where
currentPrice = tokenSupply²
When a person purchases a token, each subsequent buyer will have to pay a slightly higher price for each token, generating a potential profit for early investors. As more people find out about the project and buying continues, the value of each token gradually increases along the bonding curve. Early investors can sell their tokens at a higher price, earning themselves a neat profit.
While giving demos for Nibbl’s beta, the trickiest part for me is explaining how both price and supply can increase over time. This might be because it is counter-intuitive to think that. A good analogy to understand this is startup fundraising — where existing investors get diluted in each round but the value of their shares continues to increase.
Also, note that the curve can expand or contract based on buying and selling of the tokens i.e. if the curve is at point A and someone put in 100 ETH to buy 100 tokens, then on selling 100 tokens, the person will get 100 ETH back and the bonding curve will come back to point A.
The Reserve Ratio of the bonding curve determines the shape of the bonding curve.
The price curve grew more aggressively with increasing supply in the bottom-left curve with a 10% Reserve Ratio. A Reserve Ratio higher than 10% would flatten towards the linear top-right shape as it approaches 50%.
Nibbl’s 2 curve model
We innovated with a 2-bonding curve model so that the original NFT owner can decide how much liquidity they need to add to kickstart the trading.
Let’s say you have a Bored Ape worth 100 ETH that you’d like to fractionalize. In order for you to support the bonding curve from 0 to 100 ETH, you’d need to add liquidity. On Nibbl, we allow you to deposit any amount of liquidity from 0 to the initial point (A in this case) and we calculate the reserve ratio of the curve (referred to as the secondary curve) according to the amount of liquidity deposited.
The minimum reserve ratio for the secondary curve you can choose is 5%, and the maximum is 30%.
For example, if you add liquidity worth 10 ETH for an initial valuation of 100 ETH, the reserve ratio of the secondary curve becomes 10%. This also ensures that fractional token owners are always guaranteed liquidity on Nibbl till point 0. Whenever there is trading on the primary curve, we use the fees accrued to increase the reserve ratio of the secondary curve. As a result, the reserve ratio of the secondary curve approaches that of the primary curve over time.
The reserve ratio of the primary curve for all fractional NFTs is set to 30%.
Benefits of this design
- ADD LIQUIDITY DIRECTLY FROM THE PLATFORM
The original owner can add liquidity straight from the platform and liquidate their tokens over time to get back ETH. They don’t need to undertake complicated calculations about impermanent loss, how many tokens he should add in the LP pool etc. when adding liquidity on an AMM.
- GUARANTEED LIQUIDITY
Token owners can always find sufficient liquidity to buy tokens to get into the fractional token community without high slippage as is the case with most fractional tokens. They don’t need to rely on anyone else to add liquidity on an AMM. Also, they are guaranteed to find liquidity if they want to sell their tokens.
- BOOST COMMUNITY OWNERSHIP
The inflation introduced in the system whenever someone mints new tokens via the bonding curve allows for the NFT to become more community-owned over time and the bonding curve ensures that people who buy early are rewarded well.
- NO LOCKING-UP OF TOKENS
Since this is a single-sided curve i.e. when you put in ETH, you get tokens and if you sell tokens, you get ETH; None of the tokens are locked up to provide liquidity in a Uniswap-like AMM so they can be used to participate in the fractional token community or in buyouts. Note: These tokens are essentially ERC20 tokens and token owners can decide to liquidate on a DEX if they wish to.
- INFINITE ROYALTIES
Royalties are integrated directly into the platform. Whenever there is trading on the bonding curve, a percentage of the trading fees goes to the original NFT owner. This is dependent on the initial liquidity the original owner adds.
- A VALUATION-BASED BUYOUT MECHANISM
This bonding curve design also allowed us to build a valuation-based buyout system that is much more efficient than all-or-nothing voting-based buyouts. More on this in the next article.
I hope you enjoyed this piece!
At Nibbl, we aim to open up NFT ownership to every single investor and collector through fractionalization, and make fractionalization more efficient through innovative mechanisms. Our next article will be about how buyouts work differently on Nibbl.
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