On the surface, Balancer (BAL) looks like just another decentralized exchange competing against Uniswap.
But in reality, Balancer is a DeFi powerhouse. The platform offers an entire suite of tools for automated portfolio management, yield farming, gas-efficient token trading, and building custom DEX solutions.
This guide will help you understand what Balancer is and how to take advantage of its powerful array of DeFi tools.
Balancer calls itself an automated portfolio manager, which, in our humble opinion, is slightly misleading. Before getting into why let's take a quick detour into Balancer's history.
Back in 2018, Balancer was incubated by Block Science before becoming Balancer Labs.
As Balancer Labs, the team dropped early versions of stablecoin liquidity pools and was amongst the first protocols to introduce liquidity mining.
This is where we'll loop the automated portfolio manager concept back in, so pay close attention.
In a nutshell, Balancer had built another Automated Market Maker (AMM) decentralized exchange. An AMM replaces the buyer/seller counterparties found on traditional exchanges by crowdsourcing liquidity into pools secured and operated by smart contracts.
Balancer quickly realized the standard liquidity pool format popularized by Uniswap had strict limitations. Those pools require a 50/50 deposit of two assets — a split that puts a damper on creating custom pools based on real portfolios.
Think about your portfolio. Do you hold equal weights of two tokens, or do you own several cryptocurrencies in different amounts of value?
If your portfolio is closer to the latter, don't be surprised. The index fund approach is popular for mitigating risk by diversifying into several assets.
So, Balancer's unique take on decentralized exchange enables the creation of liquidity pools with up to eight different assets.
As people create liquidity pools or deposit to existing ones, the supply side of Balancer's decentralized exchange is accounted for. Balancer's decentralized exchange is made possible by the ever-growing admixture of assets in these pools.
All of this accounts for why we think Balancer sells itself short labeling its product an automated portfolio manager. It's a decentralized exchange, a customizable DEX framework, and a robo index fund.
Next up, let's take an in-depth look at how Balancer works.
For most, Balancer is a decentralized exchange for traders to swap tokens with fewer gas costs per trade quickly.
To supply liquidity to your trade, the other side of Balancer is built for liquidity providers. Unlike Uniswap and PancakeSwap, Balancer lets LPs provide pools with up to eight weighted tokens.
Balancer's multi-asset liquidity pools introduce a third player in the ecosystem — arbitrage traders. These traders are responsible for managing the designated liquidity pool weights by buying or selling assets within them as market prices dictate.
Again, this setup is common to most AMM decentralized exchanges. Traders, liquidity providers, and arbitrageurs all play roles in keeping the protocol's liquidity balanced.
While the basic formula for how Balancer works is similar to other DEXes, the platform's key features are anything but.
Balancer private liquidity pools enable a creator to fully customize the pool, including assets, weights, and other auto-managed settings. Only allowed addresses can interact with or provide liquidity to the pool.
Anyone can contribute liquidity to Balancer public pools. These are also customizable at the outset, but their design is final and can't be modified after being created. Liquidity pool creators can set things like trading fees, AMM logic, and much more.
Balancer LBPs are by far the most popular and well-received custom liquidity pool types to date. As a type of Balancer Smart Pool, LBPs are just one of many programmable liquidity pools made possible by the platform.
In effect, an LBP replaces the ICO/IEO/IDO model with a design meant to thwart whales from accumulating all of the sale tokens.
The way a Balancer LBP works is straightforward — let's pretend you're starting a DeFi project and need to raise reserve liquidity.
To begin with, you create a Balancer pool with two tokens:
Your objective is to accumulate DAI for your reserve by exchanging your XYZ token. So, your pool balance begins heavily skewed to XYZ token. The idea is that as the LBP sale progresses, people will keep swapping DAI for XYZ so that by the sale's end, the pool is now weighted heavily toward DAI instead.
Retail investors love Balancer LBPs because they make it easy for anyone to get into a project's token sale. Moreover, if buying dries up during the LBP, the pool applies sell pressure to keep pushing the token price lower.
The possibility of getting cheaper tokens makes it unwise for deep-pocketed whales to make substantial one-time purchases. Instead, buyers are incentivized to buy several times throughout the LBP to achieve a good dollar cost average.
In March, HydraDX, a Polkadot-based DeFi protocol, successfully raised 23 million DAI, selling 87% of their HDX tokens in the process.
The vast majority of people know Balancer as a decentralized exchange. If you aren't providing liquidity to one of the pools, swapping tokens is the next best thing to do on Balancer.
Like other AMM decentralized exchanges, Balancer provides quick and easy ERC-20 token swaps using assets deposited in its liquidity pools. Unlike other DEXes, Balancer does so with better gas efficiency owing to the Smart Order Router v2.
Smart Order Routing, or SOR v2, is Balancer's way of making your trades efficient. Balancer SOR sources your trade from multiple pools to piece together the lowest possible prices when you place an order.
The SOR v2 accomplishes low-cost trades without consuming much gas, but the secret in how it does so comes down to the Balancer Vault. So, Balancer consists of tons of different pools with many assets — that much we know by now.
But piecing trades together via tons of pools creates many hops, or steps, that cost gas. To reduce the number of hops between pools and the final transaction, Balancer Vaults collect all of the assets in the pools, then dish your trade out from there.
Imagine the Vault as a master chef. They have many ingredients (assets), can organize them into different dishes (liquidity pools), and serve them up as ordered by diners (traders).
This is how Balancer routes trades across many pools while reducing transaction approvals from many to one.
Who benefits from the Balancer DEX? Traders with large orders, anyone seeking reduced slippage costs, and complicated orders requiring multiple asset swaps are prime candidates for Balancer trading.
Balancer is amongst a handful of DeFi platforms that innovated yield farming. That's because the Balancer protocol uses crowdsourced liquidity to replace intermediaries with automated markets served by smart contracts.
Clearly, Balancer's push to gain liquidity worked because the platform boasts nearly $2 billion in deposited assets of almost 9,000 liquidity providers.
In the past week alone, liquidity providers have turned a tidy $63.6 million profit. Not bad, right? But where are they getting all that money?
Balancer liquidity providers earn money from two sources:
Every time someone trades using assets in your liquidity pool, you earn fees from that trade. How much does the pool make per trade? That depends. Every liquidity pool can set its own rules on fees, but one thing is sure — the fee splits between the pool and Balancer protocol.
Asset manager fees refer to the fees paid by arbitrageurs who settle imbalances in liquidity pools. They're incentivized to balance the pools out by the profits to be made from price movement discrepancies across pools. This model works out amazingly for LPs since arbitrage is a high-frequency trading strategy that racks up fees for the pool.
We touched on the Balancer Vault in the DEX discussion above, but let's dive a bit deeper.
When you deposit tokens into a Balancer pool as a liquidity provider or trader, there are two sets of smart contracts at work.
Balancer can allow pool creators to set their own AMM rules and go fully custom by separating smart contracts into different sets. That's a big selling point for the protocol.
This also makes it possible to have a master vault contract that keeps track of ALL the tokens in ALL the pools.
Why would you want to do that? For a couple of good reasons.
First, you can route trades across many pools but source all the assets from one contract (fewer transaction approvals = lower gas costs).
Second, the vault keeps individual pool balances amongst pools separate, making the vault highly secure.
In keeping with its ethos of making liquidity pools highly customizable, Balancer v2 includes a nifty Asset Manager product.
The asset manager is a smart contract containing admin logic over the assets in the pool it’s assigned to.
Let's say you created a liquidity pool made to take assets and deploy them on lending protocols like Aave, Compound, and Curve to boost yields for LPs. The asset manager is the contract that deploys your strategies automatically using the pool's funds.
Pools with asset managers in place are very similar to index funds or ETFs. However, some people might not like the power given to asset managers since a high degree of trust must be granted to them.
Balancer is approaching the trust issue by partnering with protocols like Aave to run the first asset managers.
Balancer token, or BAL, is the governance token for the Balancer DeFi platform. The BAL token design is refreshingly straightforward. To start, let's check out BAL token metrics.
Balancer is a decentralized finance platform. Since no one party or majority interest owns Balancer, decisions are made through decentralized voting.
Who gets to vote on Balancer network decisions? Any wallet that checks off at least one of these boxes:
The main issue at stake in Balancer votes is how to spend Governable Protocol Fees. GPFs are the partial fees collected from trades and flash loans using Balancer pools.
As an aside, Balancer developed Snapshot, the off-chain voting tool used by nearly every DeFi protocol in existence.
To attract its nearly $2 billion TVL, Balancer incentivizes liquidity providers with a liquidity mining program. If you open up a Balancer pool like the popular WBTC-WETH oracle weighted pool, you'll see an APY estimate.
Hover your mouse above the sparkles emoji to see a breakdown of the rewards. In this pool, a majority of the rewards come from liquidity mining. So in the pool above, you're getting 11.42% of your APY rewarded in BAL tokens.
Balancer doesn't have any true rivals in the DeFi space, with the exception of 1inch Exchange.
1inch is a DEX aggregator, meaning it routes your order across different DeFi protocols to get you the best crypto prices. While Balancer doesn't aggregate prices and routing via other protocols, it does aggregate across its many pools filled with diversified crypto assets.
In practice, Balancer and 1inch are excellent decentralized exchanges for mitigating price slippage. But because Balancer routes all of its trades in-house using a vault that aggregates assets in all liquidity pools, gas costs tend to be cheaper than on 1inch Exchange.
However, 1inch Exchange does offer deeper liquidity since it composes of many decentralized exchanges besides its own liquidity pools.
As always, the best decentralized exchange is always the one offering trade-offs that suit your specific needs. Need the deepest liquidity? Go with 1inch. But if you're after the cheapest trade, Balancer is your best bet.
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