Will Inflation Tokens Compensation for Impermanent Loss Like Algorithmic Stablecoins Have a Death Spiral?

We discussed in depth the mechanism of the death spiral of the luna stablecoin UST yesterday, and now let’s analyze whether the inflationary token will also have a death spiral to solve impermanent loss? First, let’s take a look at the working process of inflation tokens to compensate for the impermanent loss. Here we take ETH-BNT as an example. When you provide x0 ETH for single-sided liquidity, the system will mint an equivalent amount of BNT and then deposit both tokens into the ETH-BNT pool together. When the price of ETH rises, the amount of ETH in the pool will decrease. If removing liquidity, you will receive the remaining ETH in the pool and receive the impermanent loss compensation by BNT, the value of those remaining ETH plus the compensated BNT is equal to x0 ETH when you initially provide liquidity. In this case, there are two sources of BNT for compensation, one is the trading fee and the other is the additional minting of BNT. When the price of ETH falls, the amount of ETH in the pool will increase. If you withdraw the liquidity, you will receive x0 ETH when you provide liquidity. Although BNT does not need to compensate your impermanent loss at this time, the BNT in the pool becomes less than initially minted. In other words it is equivalent to mint additional BNT in disguised form when you deposit. As a result , BNT will be additionally issued no matter the price up or down. The more volatile the more BNT issued, the more BNT will be issued. Let’s take an extreme example next. If you are an ETH whale, raise ETH first 10x, then remove the liquidity, and would get much BNTs compensation for impermanent loss. Subsequently you add huge ETHs again, and sell the much BNTs to move the ETH price back to first time providing liquidity. The system issued BNT twice during the rise and fall, but the price of ETH remained unchanged. If the process is profitable, it will be attracting more people to come in to operate, resulting in a massive increase in BNT similar to luna, and finally triggering the collapse of BNT.