DeFi 101: What Is Balancer?

Balancer is an automated market maker (AMM) that works like a decentralised index fund. Users can create liquidity pools with up to eight different tokens in any ratio. The Balancer crypto protocol then rebalances the pools, with fees going to liquidity providers.

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Last week, we wrote about Curve Finance. 

Curve Finance is one of the most successful automated market makers (AMMs) in decentralised finance (DeFi).

Automated market maker is just another way of saying decentralised exchange (DEx), which is an app that lets users trade digital assets without relying on a centralised order book. 

Instead, users exchange tokens via crowd-sourced liquidity pools, with different AMMs serving different purposes. Uniswap, one of the most popular DEx’s, offers pools in a 50:50 ratio to allow users to trade pretty much any token.

Curve Finance has a similar model but only supports stablecoins and other similarly behaving assets, allowing it to offer ultra-low fees and minimal slippage. Then there’s Balancer: one of the most customisable AMMs.

Users have near-limitless options to customise token groupings and liquidity pool weightings on Balancer, opening the door to all manner of innovation.

We’ll get to that soon, but let’s start with some background.

Balancer crypto protocol: background

Like Aave, Compound, and Curve, Balancer is one of the original DeFi apps. 

Work began on the protocol in 2018 when Block Science, an engineering and research firm, incubated the project.

The team spun it out as a standalone company, Balancer Labs, in 2020. And the protocol started providing liquidity across multiple assets using custom weightings, the same approach used by traditional exchange-traded funds (ETFs).

Balancer started amassing liquidity on March 24th 2020, hitting $770 million in Total Value Locked (TVL) by late September that same year. As DeFi summer cooled, so did Balancer, but it took off again in early 2021.

The AMM had nearly $4 billion in liquidity locked into its pools at its peak. And while there was a sharp drop-off following the 2022 market correction, its TVL steadied around $1.1bn before rising once more.

Users stick with Balancer because it enables several novel use cases for DeFi, several of which we’ll cover in detail now.

What is Balancer used for?

Balancer plays several roles in decentralised finance.

DeFi Index Fund

It’s perhaps best-known as a non-custodial index fund. Put another way, it works something like an automated exchange-traded fund (ETF).

In essence, Balancer liquidity pools are ‘weighted DeFi indices,’ with portfolios of up to eight ERC-20 tokens. But instead of someone manually rebalancing each one, the Balancer crypto protocol automatically rebalances them on every trade.

That means thousands of rebalances a day, ensuring a highly active DeFi ecosystem that benefits liquidity providers and traders alike; what’s more, where traditional investors typically pay fees to buy and hold an ETF.

Balancer pays fees to its liquidity providers, unlocking a compelling way for investors to generate reliable APY.

Decentralised Exchange (DEx)

Alongside acting as an ETF lookalike, Balancer also acts as a decentralised exchange, with traders using its liquidity pools to swap tokens. 

This allows Balancer to effectively combine the services of an asset manager like Fidelity with an exchange like the Nasdaq, redistributing trading fees to asset holders and boosting their potential returns.

Token Launchpad

Balancer’s setup allows it to play a third interesting role. 

The platform offers something called liquidity bootstrapping, a way for new projects to launch their tokens.

The concept behind liquidity bootstrapping is that it creates deeper liquidity and more diversified token distribution for protocols at launch. An example might be a pool that launches with 80% in its native token and 20% in ETH at the start.

The pool can then rebalance over time, ultimately hoping to invert to 80% in ETH and 20% in the native token, delivering deeper liquidity and less slippage.

Balancer vs Uniswap: How Balancer works

As mentioned at the start, AMMs optimise their smart contracts for different aspects.

Uniswap designed its smart contracts with flexibility in mind but limits its users to depositing into liquidity pools with a maximum of two assets.

Curve Finance focuses on maintaining ultra-low fees and slippage, limiting its liquidity pools to similarly behaving assets, like stablecoins. On the other hand, Balancer lets users add up to eight different tokens to liquidity pools.

The protocol then uses its algorithms to enable interactions between liquidity providers, liquidity pools, and traders with a focus on two objectives: 

1. Rebalancing pools 
2. Finding the best price across pools

The above process works as follows: suppose a pool wants to maintain a balance of 80% BTC and 20% ETH.

If a trader wants to trade ETH for BTC on Balancer, the protocol will check all its other liquidity pools to find the best BTC price. The protocol’s design means that the other pools looking to rebalance will offer the best BTC price.

Which ultimately allows the trading platform and liquidity pools to work in lockstep.

Two faces of Balancer

Balancer is a platform of two halves.

On the one side, you have the exchange and its loyal base of traders. On the other, liquidity providers pour money into DeFi index funds.

Liquidity providers store funds with Balancer because they believe the weighted funds, with their promise of trading fees, offer a better return than other options. And more often than not, they’re right.

Balancer offers some of the most stable returns in DeFi. That’s why Elitium uses the platform to generate APY for clients. And given that it’s been in operation since 2020, it’s also one of the most reliable DeFi platforms.

Reliability and security are two critical facets of any platform with which Elitium interacts. Balancer passes on both fronts with flying colours.