Liquidity Bootstrapping Pool
What is a LBP?
A Liquidity Bootstrapping Pool is a launch mechanism that allows a fair distribution of tokens across market participants through an adjustable liquidity pool.
LBPs have a limited time duration and apply a constant downwards pressure on the token price until demand counterbalances it and market price gets discovered.
The distribution of tokens and liquidity provision are decoupled from token price changes.
How does it work under the hood?
In a LBP, the liquidity pool is launched with several parameters that define:
- How long the LBP will last
- How many tokens will be distributed
- The starting token price
- The reserve token against which the distributed token will be exchanged (e.g. UST, LUNA, etc.)
- The curve profile for price decay over time (selling pressure) during the distribution if no market participant buys the token
This is achieved by assigning initial and ending weights for both the reserve token and the distributed token in the liquidity pool.
These weights shift progressively through the duration of the LBP from more distributed asset (LSRV) at the beginning to more reserve asset (UST, LUNA) at the end. This creates a downward pressure on price over the duration of the event.
Example:
With 99 / 1 starting weights, respectively for distributed tokens and reserve tokens, used to distribute 1,000,000 tokens with a capital of 1,000 $UST, the starting price of tokens would be:
(1,000 / 1,000,000) x (99 / 1) = 0.099$
With 1 / 99 ending weights, respectively for distributed tokens and reserve tokens, at the end of the LBP, if nobody bought any token the ending price would be:
(1,000 / 1,000,000) x (1 / 99) ≈ 0.00001$
What are the benefits for the protocol?
Capital efficiency
The initial price of the token being auctioned can be magnified by up to 99 times relative to the value of the reserve asset deposited along with it. This allows a project to invest a minimum amount of capital to build substantial liquidity for the token distributed. Also projects can forgo the need to pay costly fees to market makers or exchange listings.
Price discovery
The price of the token starts high and drops based on a pre-configured price decay curve that can be resisted by buying pressure from auction participants. Anyone can buy into or sell out of the auction freely at any time, so price truly regulates itself during the event.
Open and permission-less participation
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Everybody can participate in a LBP sale with a crypto wallet. There is no minimum or maximum allocation. Auction participants control the amount of tokens they buy and the price point at which tokens are bought. It gives the token itself more integrity as the price can reach a natural floor where demand matches the decay curve.
Why is it a fair mechanism?
Many pitfalls should be avoided when a project aims at distributing a token fairly. Among others: fair price valuations, front-running bots, whales buying up supply, etc.
The high initial price and downward price pressure integrated in a LBP event give regular human participants a fair chance to take part in the price discovery and acquisition of tokens.
Bots and whales are disincentivized to either snipe liquidity at the beginning of the event as the price is deliberately set much higher than anticipated, or arbitrage during the event as demand is very hard to predict.
Given that demand and price action is highly unpredictable during such an event, whales are mostly incentivized to split their trades into smaller tranches over a period of time and based on how the sale would go.
Moreover, a LBP sale gives the project a method to find a public launch token price governed by real demand instead of arbitrarily choosing one. It ensures that the token supply is distributed across all those who wish to be involved.
In a nutshell, there are no middlemen, capital gatekeepers, or geographical constraints, no privilege favoring the interests of larger investors over smaller ones. Capital can flow freely and directly toward empowering the ideas supported by the community, while enabling investors of all sizes and backgrounds to fairly participate and capitalize on these early stage opportunities.
How is it different from other distribution mechanisms?
LBP Vs Bonding curve
With a bonding curve token distribution model, price of the distributed token follows a curve set in advance where price increases along the curve as tokens are being bought by participants.
Hence there is a strong incentive in buying early and in mass to acquire as many tokens as possible for the best price.
In the case of a LBP, tokens are distributed even if the price drops or stays constant. Participants are disincentivized from buying early and instead benefit from waiting for the price to decrease until it reaches a level they believe is fair.
LBP Vs Batch auction
In a batch auction, a set amount of tokens are divided at the end of the auction amongst participants according to the size of their contribution to the auction. On top of being prone to whales and bots placing last minute contributions and effectively diluting other participants’ allocation, participants do not know how many tokens they will get for their respective contributions, hence they do not know the final acquisition price.
LBP mechanics give full control over these parameters to the participant. It is up to the participant to choose the amount of token to buy at the price point they want.
What can be expected during a LBP?
It is important to keep in mind that the starting price of a LBP should not be seen as an evaluation of the fair price by the project distributing the token. It should rather be considered as a ceiling the project would want for the sale.
It may seem counterintuitive but a LBP uses selling pressure to distribute the token, hence the starting price would generally be set to much higher than what the fair price is believed to be (this is not the team trying to sell tokens above what it is worth!).
Setting a high starting price allows changing weights due to initial configuration of the pool to make their full impact and efficient use of initial capital invested by the project.
Weights effectively and progressively lower the price until a market equilibrium is reached.
So if the decay curve is giving too high a price, a participant can just wait for it to go down. However if participants wait too long, other participants might drive the price back up by buying the token.
Although all initial parameters are controlled by the project distributing the token, it is not possible to moderate or predict demand and price evolutions during the event.
This website shows various examples of past LBP behaviors: https://docs.alchemist.wtf/copper/fair-launch-auctions/what-is-a-fair-launch-auction
ELI5
Initial price of the auction is established above a realistic market price. The auction is set up so that there is a preconfigured downward pressure on price, causing it to drop over time until demand outweighs this.
Once people start buying, price may continue to go down if demand is not strong enough to outweigh the downward pressure, it may reach an equilibrium, or it may start to go back up if demand is high.
Anyone can join in, and buy as many tokens as they like at the available price and within the limit of the number of tokens up for sale, however once tokens are sold out the auction ends.
This setup provides a fair launch mechanism as it removes the ability of bots to front-run, it limits some of the ability of whales to manipulate price, and it gives everyone an equal opportunity to buy in if it reaches what each person considers a reasonable price.
