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Key Takeaways
By linking supply and demand, bonding curves provide a mathematical framework to the crypto industry and can be used to automate pricing and liquidity.
Projects can customize token price and distribution by applying different curves, including linear, exponential, logarithmic, and step-function curves.
While full self-sustainability is not guaranteed due to token volatility and risks, platforms like pump.fun show how bonding curves enable predictable token issuance and early market participation.
Introduction
Supply and demand are age-old economic principles that have shaped markets for centuries. They drive everything from the price of rare jewels to the value of everyday goods like milk and eggs. But how can these fundamental concepts be applied to the crypto industry, where assets solely exist in digital form?
The crypto landscape includes many mathematical concepts. One such concept is bonding curves, which define the relationship between the price and supply of a particular asset.
As more tokens are purchased, the price tends to increase, and as tokens are sold or removed from circulation, the price typically decreases. This is a traditional bonding curve model and a mechanism that tends to benefit early market participants and traders.
Bonding curves form an essential mathematical framework in tokenomics. Popular platforms like pump.fun rely on the bonding curves mechanism for their success in automating pricing, liquidity, and token distribution.
Given the significance of bonding curves, let's explore their function, the different types of curves, and their importance in the crypto industry.
What Are Bonding Curves?
Bonding curves are mathematical models that aim to create a direct correlation between the supply of crypto assets and their price. They are governed by an algorithm, meaning that a predefined formula automatically adjusts an asset's price based on its supply.
This is no different from how resources have been treated throughout history. When demand for a resource grows while its availability remains limited, its price tends to rise. Bonding curves try to apply the same principle in the crypto market, adjusting the price of tokens based on supply.
The pricing mechanism of bonding curves is managed by smart contracts, ensuring that their execution on blockchain networks is automatic, transparent, and decentralized.
How Do Bonding Curves Work?
The fundamental principle behind bonding curves is quite simple: the more tokens are bought, the more supply there is in circulation, which typically results in an increase in price. Conversely, the more tokens are sold, the less supply there is in circulation, decreasing the price.
To illustrate this point, imagine a new project that launches tokens using a bonding curve. Due to the low initial supply, those who buy the tokens first will most likely purchase them at a low price.
However, if the token gains popularity and more traders begin to purchase it, the supply in circulation will increase, and new tokens may be minted according to the bonding curve, causing the price to climb.
The automated nature of the bonding curve ensures liquidity as tokens continue to be bought or sold. Projects can customize bonding curve tokenomics by using mathematical models to define their own unique curves. There is no actual limit to the types of curves that can be used, but the most common ones take the form of linear, exponential, and logarithmic curves.
Linear bonding curves
The most simple mathematical model for this mechanism is a linear bonding curve. In this model, the price of a token increases in direct proportion to the number of tokens sold, adding to the total supply of tokens in circulation. The price will increase by a predetermined, fixed amount for every new token minted or sold.
Below is a simple representation of a linear bonding curve, which is the simplest form of a bonding curve.
Exponential bonding curves
In an exponential bonding curve, the price of a token at any given time depends exponentially on the supply in circulation. If tokens are purchased at double the rate, the price will more than double, meaning they can become much more expensive much faster.
Exponential curves typically reward early buyers the most, who can sell their tokens later when demand increases. Thus, projects that want to encourage early participation may employ this curve. While early buyers may take significant risks, they may also profit the most if the project is successful.
Below is a simple representation of an exponential bonding curve. As you can see, the increase in price accelerates as the number of tokens in circulation increases.
Logarithmic bonding curves
A logarithmic curve causes the price of tokens to rise quickly as more tokens are minted. However, as the supply continues to expand, the price begins to slow down. Typically, this model tends to benefit early traders the most since the initial spike eventually levels off.
A logarithmic curve can provide liquidity to a project via these first buyers who may be looking to make a quick, early profit. Below is a simple representation of a logarithmic bonding curve.
While linear, exponential, and logarithmic curves are common, there are also other types used in DeFi projects. These include step-function bonding curves for mile-stone-dependent price increases and S-curves for phased growth and stabilization. There are even inverse bonding curves, where the price of initial tokens might be higher, but as the supply grows, the price becomes cheaper for future buyers.
Practical Use of Bonding Curves
Having discussed the theory behind bonding curves, let's look at the practical usage of these mechanisms on the platform pump.fun. Built on the Solana blockchain, pump.fun is a decentralized token launch and exchange platform. Using smart contracts, it automates pricing, liquidity, and distribution.
Pump.fun allows users to create and distribute their own tokens, most commonly meme coins. These community-driven coins don’t have intrinsic value but can increase in price due to popularity. At the core of this platform are bonding curves, which determine how tokens are created, valued, and sold within the ecosystem.
Unlike many traditional cryptocurrencies and meme coins, which rely on speculative trading and hype, pump.fun employs a smooth bonding curve to promote price stability and transparency. This allows for clarity and predictability as the token price gradually increases or decreases using a predefined mathematical function as more tokens are bought or sold.
Let's imagine that a new token has just been launched. The bonding curve has predetermined that the price will start at 0.1 SOL for the first token and gradually increase as more tokens are sold.
For example, after the first 500 tokens are sold, the price could increase to 0.2 SOL, and after 1000 tokens, it might rise to 0.4 SOL. As the number of tokens sold continues to grow, the price will continue to increase smoothly, with the price increments becoming larger as the supply in circulation increases.
On pump.fun you can get a visual representation of the bonding curve progress. This percentage bar can increase or decrease depending on the tokens being bought or sold. Also, when a token reaches a specific market cap, it is crowned ‘king of the hill,’ a competition on pump.fun that increases the winning token's visibility until it is dethroned by another token.
Once the token reaches a specific market cap and the bonding curve progress bar nears 100%, it automatically transitions to Raydium for further trading. Essentially, pump.fun pairs a portion of the SOL raised through the bonding curve with the tokens to create a trading pool on Raydium. Below is a step-by-step process, as you’ll find on pump.fun.
This structure incentivizes early buyers with lower prices, while later buyers pay higher prices as more tokens are purchased. It also showcases how bonding curves can effectively be applied to DeFi, demonstrating its ability to potentially create somewhat self-sustaining markets driven purely by supply and demand dynamics.
Closing Thoughts
The age-old principle of supply and demand has shaped markets, and mathematical models try to provide a similar framework for managing digital assets in the crypto industry. As we have explored, bonding curves can provide liquidity and, at times, stability by applying the long-standing concepts of resource pricing to DeFi.
Platforms like pump.fun demonstrate the practical applications of bonding curves, emphasizing their ability to promote early participation and manage liquidity. As the principle of supply and demand has remained relevant in traditional markets for centuries, mathematical models like bonding curves may also follow a similar path of relevancy in the crypto industry.
Further Reading
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