We are in the midst of an exciting era for DeFi. We witnessed the frenzy of the DeFi summer of 2020 and its renewed boom in the winter just past. It has proven that just keeping up with the pace of development in this field requires our full attention.
Every week a new project is officially announced, claiming to be the latest and greatest creation in its target field. With this increased attention comes a rise in risk. Therefore, you must be extra cautious when deciding which projects in the DeFi space to put your hard-earned savings into.
In this article, I’ll explain why I think Balancer, and Balancer 2.0 in particular, will likely be the next big thing in DeFi with its innovative and essential features.
A Balancer Primer
Before we dive in, let’s give a brief overview of Balancer.
Balancer is an automated market maker (AMM) protocol built on Ether. It has its own governance token – BAL.
Balancer’s trading pairs (referred to as pools in this paper) can consist of multiple tokens (number between 2-8), each with its own share in the pool (specifically ranging from 2% to 98%). This is different from a 50/50 AMM (e.g. Uniswap) that relies on the x*y=k equation, since Balancer has different, situation-dependent impermanent loss schemes as well as capital efficiency.
To steer trades, it uses a system that intelligently takes liquidity from multiple pools so that it can automatically find the best price available within the available pool. This system is called Smart Order Routing (SOR).
Balancer pools are highly customizable, allowing anyone to create a pool with a custom fee (ranging from 0.00001% to 10%).
This fee for will be allocated to those who provide liquidity to the pool, i.e. liquidity providers (LPs).
In addition, one of Balancer’s advantages over competitors (such as SushiSwap) is that it can be virtually zero-fee, as the lowest fees within competing AMMs can be a stumbling block to high-frequency trading.
This allows Balancer to offer a self-balancing index fund – the exact opposite of an ETF. In traditional financial institutions, asset managers are hired to balance ETFs because they themselves consist of assets whose prices are bound to change, whereas in the case of an inverse ETF, you, as the liquidity provider, get paid when the ETF is balanced again.
This works because market participants are incentivized to rebalance their portfolios to take advantage of arbitrage opportunities. Their fees are paid to fund investors like you.
The reward is returned in the form of a Balancer Pool Token (BPT) because this particular pool is combinable – you can create Balancer pools of Balancer pools. This can meet the need for products that aggregate many different products together – imagine a project that tokenizes real estate, with each city having a separate Balancer pool – a combined version of these pools can represent an entire state/country.
A Balancer pool has the following variables.
- Variable tokens – increase or decrease the tokens in the pool (2-8)
- Variable weight – change the weight of any token in the pool (2% – 98%)
- Change Fee (0.00001% to 10%)
- LP black and white list – restrict the specific addresses that can be LPs within the pool
- Max Depositable Limit – Limit the maximum value that LPs can store
- Start/Stop Trading – suspend trading in the pool
And Balancer pools can be divided into three types.
- Public pools (also called shared pools) – anyone can increase liquidity (and receive the corresponding Balancer pool tokens), but all pool parameters are fixed and unchanging. (de-trusted, finalized)
- Private pools – all parameters are flexible and variable – only the owner can change the parameters and only the owner can increase liquidity (trust-required, variable)
- Smart pool – anyone can increase liquidity, parameters can be fixed or dynamically controlled by a smart contract. (de-trusted, flexible)
The above scalability opens up a wide range of use cases that go beyond simple transactions.
Liquidity Bootstrap Pools
Another use case worth discussing is the launch of a brand new token with liquidity, where Balancer provides a new paradigm for optimal token allocation.
Unfortunately, Uniswap’s 50/50 token pricing scheme means that even small totals can cause huge price volatility, leading to irrational price discovery and becoming a poor token allocation mechanism where bots can take the lead instead of the community, making them victims of market manipulation.
In addition, this model requires the founding team to deploy a large amount of capital (after all, the other 50% needs to be placed in a mature token like ETH).
To solve this problem, Balancer offers so-called Liquidity Boot Pools (LBPs) – short-term smart pools that dynamically change the weight of internal tokens. For example, from ETH 2%, TOKEN 98% to ETH 98%, TOKEN 2%. This scheme allows founders to create a liquidity bootstrap pool with little or no capital investment of their own. The result is that token prices experience constant downward pressure throughout the sale process. When this is combined with moderate buying demand, the price can remain stable throughout the sale because the giant whale accounts/bots do not have an incentive to buy all the tokens at once.
There have been many successful LBPs to date, with the most recent examples including Radicle (blog post coming soon), HydraDX, and Perpetual Protocol.
Balancer provides value to all parts of the liquidity ecosystem – a self-balancing portfolio for investors, a deep source of liquidity for traders, and an efficient bootstrapping tool for issuers.
Because Balancer has successfully provided a stable, highly configurable building block for the DeFi ecosystem, we are certain that more use cases will emerge as people experiment with it.
At the time of writing, Balancer was in the top 10 of DeFi protocols in terms of total locked-in value, recording a TVL of $1.62 billion.
With the upgraded version 2.0 landing in April, there is reason to believe that Balancer will be able to take the top five spots. Not only that, it also clearly has the potential to become a major source of liquidity for DeFi.
Advantages of Version 2.0
Here’s why I think Balancer 2.0 and its continued development will give it a chance to be the top DEX in the space by 2021
Track Record & Support
Before we dive into the technical details, it’s important to reflect and realize that the team driving the project is perhaps the most important piece of the puzzle necessary for success.
It is clear that any team that does not aim for long-term growth is incompetent, and teams that do not listen to the community are ultimately doomed to failure. There’s a reason why venture capital firms make founders a top priority in whether or not to invest in a project.
Predicting which projects will succeed is hard, but anticipating that the right team will eventually be able to identify and seize the opportunity to succeed is simple.
The team behind Balancer (Balancer Labs) has been in the DeFi space for some time, and they launched Balancer as a research project in early 2018.
They have demonstrated that they can successfully develop and maintain a DeFi product based on decentralized governance. The team has shown that they respect and care about the ethos of the industry. This collaborative mindset has led them to build snapshot.page, an open source tool for implementing Gas-free voting, which has become the de facto standard for decentralized governance voting. At the time of writing, there are 600 projects using it.
Keeping an eye on the money flow
It seems I’m not the only one who feels this way about Balancer Labs, as they have never lacked for financial support. They’ve already reaped significant funding from the big names in the space-Balancer received $3 million in March 2020 from Accomplice and Placeholder, and in February 2021 from giants Three Arrows Capital, DeFiance Capital, Alameda Research and Pantera Capital invested a total of $12 million in Series A funding.
How can a 2021 DeFi article ignore an issue that cannot be ignored – Gas fees!
High Gas is plaguing the entire DeFi ecosystem.
In the case of Balancer, high Gas fees are crippling SOR (Smart Order Routing) because the Gas fees incurred for acquiring liquidity from multiple pools are already more than the money that should be saved through slippage due to the Gas fees incurred for acquiring liquidity from each pool.
To address this issue, Balancer 2.0 groups the assets of each pool into a single vault (referred to in this paper as the Protocol Vault) that holds the assets of all Balancer pools.
The benefit of this is that what used to be multiple trades, each incurring a Gas fee, is now one trade. This will ultimately allow Balancer to take full advantage of its multi-pool transaction routing, thus providing the greatest possible liquidity and the lowest possible slippage.
This is achieved by decoupling the pool’s AMM logic from token management and auditing.
As far as I know, when trading with more than one liquidity pool for additional liquidity, all other AMMs choose the old Gas fee inefficient model. This means Balancer should be the best in the industry, providing low slippage for the same liquidity.
Net Token Transfer
Storing each token in a vault provides another huge advantage, where transactions within the exchange can be managed more efficiently, requiring only one settlement when leaving the exchange.
In Balancer’s new protocol vault, only the final net token amount is transferred out of and into the vault (via ERC20 transactions). This makes arbitrage trading very easy. First, it allows you to successfully execute arbitrage trades in the Balancer pool without any tokens.
For example, if you find a price asymmetry, you can execute the following trades.
- DAI -> MKR (pool 1)
- MKR -> BAL (pool 2)
- BAL -> DAI (pool 3)
- profit in the form of DAI
Internal Token Balance
In addition, Balancer 2.0 allows users to hold internal token balances within a vault. For example, if you trade DAI with ETH but know you will swap the DAI back to ETH in a few hours, you can keep both tokens in the vault and use them for the next transaction without the need for a meaningless ERC20 transaction in between.
Internal token balances are very useful for high frequency trading and are a very beneficial DeFi building block, allowing DEX aggregators to leverage Balancer internal balances to help traders offer the lowest Gas costs to their users.
Balancer recently announced a partnership with Gauntlet that will introduce dynamic fees.
At the moment, choosing an appropriate exchange fee when creating a liquidity pool is nearly impossible. Essentially, the optimal transaction fee for a pair of tokens will constantly change over the lifetime of the two tokens and throughout the market cycle.
For example, a fixed fee may result in diminishing returns after a change in circumstances, such as a liquidity shift to another pool. Another example is the potential for liquidity providers to suffer greater impermanent losses during times of dramatic price volatility.
Just as bike-sharing apps have adaptive pricing (surge pricing) during peak times, Gauntlet can similarly provide appropriate fee optimization for pools based on actual conditions.
Because the fees themselves change dynamically as conditions continue to change, you can rest assured that the fees calculated through Gauntlet’s time-tested algorithms are always optimal.
This has to be the feature I look forward to most as a retail investor!
Traditional AMMs are not an efficient use of capital, as a large portion of a pair’s assets remain unused (no trades get down to the last ounce of liquidity).
To fully exploit the potential of these assets, Balancer 2.0 introduces a new and revolutionary concept, the Asset Manager.
The Asset Manager-an external smart contract nominated by the liquidity pool-has full rights to the tokens in the pool.
As a result, the asset manager can lend unused tokens to the lending agreement. By putting the capital to work when it is not being used in exchange for liquidity, the return on the pool is increased.
Most excitingly, Balancer has partnered with Aave to create the first Asset Manager!
The Asset Manager is an innovative AMM feature that shows the power of DeFi’s composability.
The details of how this works are abstract to the end user – but if you’re curious, this blog post does a great job of explaining it.
With these aforementioned freshly minted features, Balancer LPs can earn through three channels.
- BAL through liquidity mining
- Dynamically optimized exchange fees
- Asset Manager
They always say that you have to learn from your mistakes! Balancer used to have quite a few UX hiccups after launch, and even after the launch of a new, simplified UI in December 2020, there are still imperfections. For example, it’s easy to not take into account the default slippage settings when executing a trade – the worst case scenario is a failed trade and a wasted Gas .
In version 2.0, Balancer has invested in a full-time UI team to redesign the user experience from the ground up. the GUI is expected to be completely different, incorporating best practices from blue-chip DApps.
It is because the team recognizes the importance of the issues that additional attention to user education will be added in the new release.
The new UI will be greatly simplified, transparent and user-friendly, making users less likely to make mistakes while using it and providing clearer guidance information in case of errors.
Flexible Price Predictor
On-chain price feedback is a key part of many DeFi applications (prediction markets, lending, margin trading, etc.). Currently, it is not a good idea to use the Balancer pool as a price prognosticator by deriving exchange rates from the proportion of tokens in the pool, as this is vulnerable to sandwich attacks. Nevertheless, perhaps due to lack of education, some teams have inadvertently used it.
Using the accumulator used by Uniswap 2.0 Lead, Balancer 2.0 will make the protocol more resilient and user-friendly by introducing a price prophecy machine that can resist such sandwich attacks.
There are two types of prophecy machines that can be used to query low Gas costs.
- Instant – more real-time prices, but inelastic in the face of manipulation
- Elastic – less real time, but more elastic in the face of manipulation
The existence of two price types allows projects to use the price that best suits their situation – lending agreements may use elastic prices, while prediction markets, for example, may prefer immediate prices.
As Balancer continues its transition to a community-driven protocol, version 2.0 will implement three new protocol-level fees to add to the reserve pool, with funding fully controlled by BAL token holders
- Transaction Fee – a small percentage of the transaction fee paid by the trader to the pool LP
- Withdrawal fee – a fraction of any tokens raised from the protocol vault Note that trading and transferring liquidity between pools are not withdrawals.
- Lightning Lending Fee – A small percentage of the assets used to obtain Lightning Lending from the Protocol Vault.
At inception, the first two (transaction and withdrawal) fees will be closed. Lightning loan fees will start with a smaller value to ensure that there is always some capital cost for creating a lightning loan on Balancer.
Initially, all agreement fees will be kept in the agreement library, setting the stage for the community management to decide if/how to use them.
Full of dry goods!
So let’s summarize the whole article.
In this article, we covered the reasons why Balancer can be considered a one-stop shop for all AMMs. We reviewed the basics of the first version of the protocol , and saw how it works in multiple use cases outside of traditional trading, most commonly in self-balancing funds and liquidity boot pools, also known as LBP.
Balancer enables these use cases through its unique blend of high customizability, multiple token pools, and different types of pools (public, private, smart).
With version 2.0, Balancer is one step closer to realizing its ambitious vision of becoming the primary source of DeFi liquidity by introducing a new set of innovative features that will completely differentiate it from the competition.
The additional Gas efficiency gained through the new protocol vault and internal token balance not only helps Balancer to equal the Gas usage of other popular protocols, but also unlocks additional use cases (e.g. DEX aggregators) that are unparalleled in terms of low Gas usage across the industry.
Efficient Gas utilization translates into efficient capital utilization. Since there is no additional cost associated with accessing liquidity from multiple pools, Balancer can leverage its extensive pool of capital to provide more liquidity compared to other decentralized exchanges.
As if that wasn’t enough, Balancer 2.0 also introduces novel asset manager and dynamic fee features, both of which will generate additional revenue for LPs at no additional cost, simply by intelligently utilizing the idle liquidity in the pool and continuously optimizing the fees of the liquidity pool.
To ensure the usability of all of the above, version 2.0 will also introduce a new UI design with a stronger focus on user experience and user education.
Further improvements, such as the flexible price predictor and control over fee governance, are not as awesome as other new features, but they are very important building blocks in their own right and will help polish the protocol in the long run.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/how-balancer-2-0-meets-all-your-expectations-for-amm/
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