9 Sep 2021
5 min read
Launched in 2020, Balancer is a broad DeFi ecosystem. It acts as an automated market maker (AMM), decentralised exchange, and liquidity platform. The protocol has had a rapid user base growth due to its innovative infrastructure and simple-to-use features. Let’s take a look at what Balancer is and why it has become such a popular protocol for DeFi enthusiasts.
Balancer has various use cases. Instead of relying on order books as centralised exchanges do, Balancer takes an innovative approach to the AMM system. An AMM is an underlying system that powers decentralised exchanges. Unlike traditional order books, AMMs relies on a mathematical formula to provide liquidity to the exchange it operates in through automated trading, allowing digital assets to be traded permissionless.
The platform uses the AMM system to self-balance its pools. Instead of paying fees to portfolio managers to rebalance users’ portfolios —as in traditional index funds— they collect fees from traders who rebalance their portfolios by following arbitrage opportunities. This works as an incentive for most users as well. Balancer uses smart contracts to set the proportion for each pool, making sure they retain a correct proportion of assets even if the price of several coins vary. These pools are called “Balancer Pools,” which hold between two to eight cryptocurrencies.
As an example, let’s say we have a pool with 25% BTC, 25% DAI, 50% ADA. If a user starts a trade with ADA, the pool is rebalanced —the tokens are deducted and the pool’s asset ratios are rebalanced to set a proportional value to the rest of the pool. The protocol will automatically look for the best available price from other Balancer pools using a system called Smart Order Routing (SOR) —an off-chain linear optimization of routing orders across pools for best price execution. This system will take into account the amount traded, fees, and gas costs to achieve the highest yield possible.
If the price of ADA doubles, the protocol automatically deducts the number of ADA coins it holds so it can retain the previous 50%. The deducted ADA coins are made available to traders looking to buy ADA as prices go up. Liquidity providers earn fees while their funds are being rebalanced, unlike traditional stock market index funds don’t.
Balancer allows users to swap ERC-20 tokens with similar infrastructure to those of its competitors, like Sushiswap or Uniswap but providing pool owners with more control of their pools. As an AMM, Balancer users don’t have the need for a third party to swap their assets. Balancer automatically routes trades through various liquidity pools in order to find the best rate for traders. Deposits might be direct or might need to go through other coins to be exchanged later to BAL. For instance, a user deposits ETH and it’s automatically swapped to BAL, or it first goes through USDT and then BAL.
Balancer Pools are divided into three different types to meet investors’ appetite for risk.
Public Pools allow traders to add liquidity or withdraw assets. Public pool’s parameters are already set by the protocol and cannot be changed. These pools are useful for traders with smaller portfolios that seek to earn fees from the most liquid pools.
Private Pools are for traders with bigger holdings seeking to rip profits from specific assets. Parameters can be changed, such as fees, weightings, and the types of assets it accepts. Only the pool creator can add or withdraw assets.
Smart Pools are private pools as well, the difference is that they’re owned by smart contracts.
A new feature on the Balancer network is Balancer MetaStable Pools —a different kind of pool that will boost liquidity by allowing users to trade highly correlated tokens but not hard-pegged in prices, making it a better option for traders looking for pegged tokens that gradually accumulate fees. Balancer partnered with Ethereum staking solution Lido.
Hard-pegged tokens are different from highly-correlated tokens as they can be exchanged 1:1, and they’re mainly stablecoins. Stablecoins are usually tied to fiat currencies to keep their 1:1 ratio, yet some others are tied to commodities, such as the case of hard-pegged tokens like USDT (Tether) and USDC (USDCoin).
The MetaStable Pools will offer further benefits to traders and liquidity providers by introducing “Nesting” which basically nests other pools by holding their Balancer pool Tokens (BPTs ) —facilitating cheap swaps between their constituent tokens and those of
“MetaStable Pools work well for tokens that gradually diverge in value. In the above example, StaBAL3-USD is highly correlated with the price of a US dollar, but the pool token grows in value as trade fees accumulate. Similarly, a MetaStable Pool with DAI and cDAI would work well, since the cDAI slowly grows in value as the underlying DAI is lent on Compound.”
Balancer Lab is the parent company of Balancer, founded by Fernando Martinelli and Mike McDonald. Its members have a deep understanding of blockchain technology and the decentralised space, many of them have previously worked for the crypto industry for several years.
Fernando Martinelli: co-founder and CEO of Balancer, member of the Maker community.
Mike McDonald: co-founder and current Chief Technology Officer, security engineer and the creator of mkr.tools.
Kristen Stone: Current Chief Operating Officer, previously a product manager at Coinbase with five years of experience in the crypto industry.
Timur Badretdinov: frontend developer who has worked on several crypto projects before Balancer. He was the founder of “Longcaller,” a platform for educational and insightful pieces on cryptocurrencies and blockchain.
BAL is Balancer’s utility and governance token. It’s an ERC-20 token that allows yield farming and liquidity mining. BAL is one of the most valuable tokens in the market, priced at $28.55 per coin at press time. It can be bought in almost any crypto exchange or DEXs like Sushiswap, Binance, Kraken, or Coinbase.
Liquidity mining is supported thanks to the Liquidity Mining committee, which has the control of token distribution and decides which pool will be used to allocate tokens. The committee has its own Discord channel where they discuss the liquidity program each weekend.
Balancer v2 is underway —a soon-to-be-released enhanced version of the Balancer protocol. While the protocol has been fully audited by different security and analytics firms —Certora, OpenZeppelin, and Trail of Bits, to name a few— the team has a bug bounty program for the V2 release, with a reward depending on the severity of the vulnerability. Critical vulnerabilities like liquidity pool draining or permanently locking significant funds in it could be rewarded with up to 1,000 ETH, or around $2 million.
Balancer is one of the most innovative DeFi platforms in the community, even praised by other protocols like open-source protocol Aave. While the protocol is fairly new, it has grown to become one of the most valuable projects in the market. The Balancer V2 release will see an improvement in gas efficiency, lower trading costs, and the introduction of asset managers to increase capital efficiency of Balancer liquidity. With so much work underway, we can expect a bright future for the Balancer team and its community.
Fintech and finance writer, with keen interest in blockchain and crypto.
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