Traditionally, decentralized exchanges (DEXs) fulfil orders by finding matches for buyers and sellers. However, since traders rarely find the perfect match on the other side of a trade, the process is often riddled with compromises and poor deals.
Automated market makers (AMMs) were created to overcome such shortcomings. AMMs manage orders using algorithms rather than traditional exchanges’ bid/ask systems.
One of the most popular automated market makers is Balancer AMM, an Ethereum-based portfolio manager and trading platform that’s seen a massive increase in interest due to various innovative features that set it apart from the competition.
Let’s go deeper to understand better what Balancer is and why it’s become so popular among DeFi enthusiasts.
Introducing Balancer AMM
As we mentioned earlier, Balancer is an open-source protocol built on the Ethereum blockchain that serves as an automated portfolio manager and liquidity provider.
Balancer was founded by Fernando Martinelli and Mike McDonald, who first introduced it in 2018 as an R&D product of the blockchain consulting firm, BlockScience.
The core concept of Balancer appeared groundbreaking from the start. Its team was charged with developing a technical framework for converting any cryptocurrency portfolio into a yield-farming instrument. It was created to enable users to contribute liquidity to so-called “balancer pools” in exchange for incentives measured in BAL, the platform’s native token.
In March 2020, the platform raised $3 million in a successful seed funding round led by renowned crypto-focused VC firms Accomplice, Placeholder, Inflection, and Coinfund.
That same year, Balancer released its first mainnet edition, a full-stack DeFi ecosystem that included liquidity mining tools and one of the first launchpads for initial DEX offerings (IDOs).
In February 2021, the Balancer team announced plans for the platform’s second iteration, Balancer v2. The upgrade revisited the architecture of Balancer’s automatic market-making, where it separated its AMM logic from funds management. AMM operations would henceforth be carried out via a distinct smart contract hierarchy.
In the same year, Balancer collaborated with Gnosis to create the Balancer-Gnosis Protocol (BGP), a new DEX instrument that was the first to trade Ethereum (ETH) assets safeguarded against ‘dark forest’ manipulations.
Since its inception, Balancer has been at the forefront of innovations in terms of liquidity and AMM-related technology. The protocol has more than 21K liquidity providers and currently boasts over $1.7 billion in total value locked (TVL).
How Does Balancer AMM Work?
The Balancer AMM protocol has a broad range of features. Users can trade crypto assets and generate revenue by staking BAL tokens. It’s also a liquidity provider and offers automatic portfolio management for ERC-20 tokens.
Balancer creates a flexible system for programmable liquidity. Instead of paying fees to fund managers to apply rebalancing strategies and actively manage a portfolio, the pool balances itself.
The platform doesn’t support fiat trading. In other words, you cannot deposit funds in fiat currencies or sell them for ERC-20 tokens on the platform; you’ll need a pre-existing crypto wallet.
The percentage weight of each token in it defines the value of a Balancer pool. This percentage is set when the pool is first created. Even if the prices of individual tokens within the pools change, Balancer uses customized smart contracts to guarantee that each pool retains the correct percentage of crypto assets.
For example, a pool may comprise Ether (ETH), Maker (MKR), and Chainlink (LINK) at 25%, 25%, and 50%, respectively, of its total value. If, during trading, the price of LINK doubles, the pool automatically reduces the amount of LINK so that it can still retain 50% of the pool’s overall value.
And what happens to the LINK that’s been shaved off the pool? Well, smart contracts make it available to traders seeking to purchase LINK.
It should be noted that there are no outside price oracles in Balancer pools; therefore, asset values do not shift unless someone initiates a trade.
The charge for extracting liquidity from a pool can be specified by the pool creator and can range from 0.0001% to 10%. The pool’s liquidity providers split this fee per the funds they’ve put into the pool.
Key Features and Products
We’ll now look at some features and products that make Balancer unique in the AMM and DEX spaces.
BAL Token
BAL is the utility and governance token for the Balancer ecosystem. It’s an ERC-20 coin that permits liquidity mining and yield farming. The token also allows traders and liquidity providers to participate in the Balancer governance protocols. In that case, platform users are assigned voting rights commensurate with the percentage of tokens they hold.
Liquid providers receive BAL tokens weekly based on the funds they’ve sunk into Balancer pools. The token doesn’t work very well as a speculative asset, but it’s an excellent incentive for onboarding new users to Balancer.
The supply of BAL is restricted to 100 million tokens, of which 15 million were dispersed at Balancer’s inception, and another 65 million were put aside for distribution to liquidity providers. Balancer distributes 145K tokens to its users each week, totalling 7.2 million BAL annually, meaning the coin’s total supply will be unlocked by 2028.
This method of drip-feeding ensures that BAL’s supply and demand dynamics remain stable, limiting its inflation rate. Furthermore, using BAL as a utility and governance token gives it real-world usefulness, reinforcing its supply and demand dynamic. As a result, the token can acquire and retain value.
At the time of writing, BAL was priced at $6.12, with a 24-hour trading volume of $9.2 million. The token currently has over $1.7 billion in TVL and is ranked 114th in the CoinMarketCap listing. Additionally, BAL was capitalized at about $273 million and had a circulating supply of 44.7 million, which is 46% of its maximum supply, currently standing at 96.1 million.
The Balancer Vault
The Vault is Balancer’s core feature. It’s a smart contract that manages and maintains all the tokens in each Balancer pool. It also allows users to execute joins, swaps, and exits.
Additionally, the Vault separates Balancer’s AMM functions, including token administration and accounting, from pool logic.
According to Balancer, the Vault allows them to make the smart contracts running liquidity pools much simpler and more efficient. This is because they no longer need to maintain assets actively but are only utilized to compute joins, swaps, and exits.
The Vault brings with it a plethora of uses and benefits, including the following:
- It allows for the accommodation of different pool designs.
- It enables users to create custom liquidity pools and links them to Balancer’s current liquidity.
- It eliminates the need for large fund managers to build their DEXs since anyone can design their liquidity pool, governed by their parameters, and connect them to the Balancer exchange.
- It makes batch swaps easier and more efficient since all tokens in the supported pools are readily available and easily accessible to anyone.
- It runs mechanisms that keep pools separate and permissionless, thus ensuring that if one pool is manipulated, others cannot be affected.
Balancer Pools
We’ve already touched on this feature before. To recap, Balancer pools are run by smart contracts and preserve their value using up to eight different tokens. Every token in the pool has a weight assigned to it, and users can exchange them for other tokens in the pool. The smart contracts rebalance the pool to keep the liquidity proportional and equal.
As a result, the value of each token remains proportional to the liquidity value in the entire pool. The pool’s liquidity providers are compensated for trades that occur within the pool.
The protocol supports two types of pools:
- Public Pools: As the name suggests, anyone can use these pools to provide liquidity. Their owners may set specific parameters before launching them, which cannot be changed afterwards. Public pools offer a vital conduit for small-scale investors to earn fees on their idle crypto assets.
- Private Pools: Only the pool owner can add or withdraw assets. They can also set and adjust parameters such as weightings, types of assets that can be traded, and fees to be charged. Private pools are tailor-made for asset managers with large crypto portfolios who prefer to earn fees on specific assets.
Anyone can build their pool type using Balancer thanks to its open architecture, which also gives them a variety of functional possibilities and variable pricing options.
Smart Order Router (SOR)
The Smart Order Router (SOR) is an automated process that assists users in finding the best possible trade opportunities on the Balancer platform. The price sensor scans Balancer pools for the best price and liquidity for a given output and input tokens. This can be done for simple swaps in one pool or a more complex mix of transactions over many pools.
The SOR rises in tandem with the diversification of the Balancer pools. As a result, as Balancer users establish more pools with unique setups, the SOR is expanded and improved further.
Balancer Exchange
The Balancer exchange enables users to trade at the best possible price. The protocol promotes efficient trading by aggregating crowdsourced liquidity from user portfolios while utilizing its Smart Order Routing feature to discover the best pricing for traders.
Users can leverage the Balancer exchange to trade any combination of Ethereum-compatible tokens and to access smart pricing, miner extractable value (MEV) protection, and gas subsidies and optimizations.
Balancer-Gnosis Protocol (BGP)
BGP is Balancer’s default trading interface, and it uses Gnosis Solvers and the Balancer Vault to facilitate batch trades. It also allows for gasless transactions where traders merely sign messages to swap tokens.
The Gnosis Solvers first match transactions using on-chain liquidity, allowing users to benefit from the Coincidence of Wants (CoWs). CoWs is a method of settling peer-to-peer transactions directly without an AMM, reducing fees and eliminating slippage.
BGP also leverages other DEXs to ensure that Balancer traders receive the best rates for their trades while protecting them from MEV. BGP also bundles gasless transactions to prevent fee loss from failed transactions.
Merkle Orchard Smart Contract
The Merkle Orchard is a smart contract enabling Balancer’s liquidity providers to collect weekly reward tokens. During the distribution of incentives, the smart contract examines the Merkle root of the accrued tokens. The Merkle Orchard smart contract cuts the gas fees that could have been used while obtaining liquidity mining incentives by other means. It’s currently being used to distribute BAL and other tokens to incentivize liquidity mining on the Balancer protocol.
Pros and Cons of Balancer AMM
Pros
- The platform is fully decentralized and permissionless.
- There are no limitations on the use of its liquidity pools
- Users have access to customizable AMMs
Cons
- It only supports ERC-20 tokens
- It lacks a mobile app
- Users are charged high gas fees on account of Balancer AMM being on the Ethereum network.
- The protocol isn’t user-friendly
How Does Balancer AMM Compare to Its Competitors?
Apart from having lower liquidity and thus more slippage than DEXs like Uniswap, Curve, and SushiSwap, Balancer shines in most comparisons:
- BGP allows liquidity miners to receive their rewards without paying gas fees. Failed transactions don’t incur gas fees either. This feature puts Balancer AMM ahead of Uniswap and other major DEXs.
- Balancer AMM has an advantage in terms of the variety of assets that may be added to its liquidity pools. It supports up to eight crypto assets in each pool, whereas most DEXs only support two assets locked in the same pool at 1:1.
- Balancer AMM is also more adaptable than other exchanges since its Vault and Balancer pools allow users to build unique pools and pre-calculate their values. This approach also enables users to evaluate their options when mining for liquidity.
Conclusion
Balancer AMM is a valuable protocol for cryptocurrency investors who want to swap digital assets at optimal rates or have idle portfolios they want to leverage. Besides trading ERC-20 tokens, the platform allows for creation of various customizable liquidity pools, including public, private, and smart pools.
However, the platform has several drawbacks, the biggest being lower liquidity than most major DEXs. As a result, it’s advisable to look into alternative possibilities because certain DEXs excel in one aspect but fall short in others. It’s also essential to assess how secure and reliable the exchanges are. The crypto sector is fraught with risk, so it’s best to exercise caution and research.