What is Balancer: An Automated Portfolio Manager and AMM
Launched in February 2020, Balancer is an automated portfolio manager and market maker built on the Ethereum network. With its Version 2 released in May 2021 and a recent Polygon partnership, Balancer continues to innovate in the decentralized finance (DeFi) space. The protocol is powered by its native governance token, BAL, which currently trades at $24.49. BAL is sitting significantly below its $74.45 all-time high from two months ago.
What is Balancer?
While it offers services as an exchange and a liquidity provider, Balancer’s outstanding feature remains its flexibility and efficiency as a portfolio manager. Whereas a traditional portfolio manager would charge you for rebalancing your portfolio every six months or so, Balancer rebalances continuously. Not only that, it actually pays you a share of the platform’s trading fees while it manages your assets. Balancer Labs describes this as “similar to combining Fidelity asset management and NASDAQ’s exchange, then distributing NASDAQ’s trading profits to Fidelity’s asset holders.”
How does Balancer work?
When it functions as an exchange, Balancer resembles DeFi’s most popular automated market maker (AMM), Uniswap, even down to the minimalist user interface. Just connect a Web 3.0 wallet (such as Metamask or Trust Wallet) and you have access.
As a decentralized exchange (DEX), Balancer is permissionless and non-custodial, meaning anyone who uses the protocol can retain the keys to their crypto. Balancer’s Smart Order Routing (SOR) routes the trade through multiple pools to find the best prices. It can also create trading pairs that aren’t usually available. There is some backend magic to combat slippage and impermanent loss, which is an improvement upon other DEXs. All of this is fine, but what’s really interesting to the investor is Balancer’s liquidity pools and the BAL tokens mined from them.
What is a Liquidity Pool?
Firstly, a liquidity pool is a pool of tokens locked by smart contracts. These pools provide the liquidity necessary for trading on exchanges. The AMMs use the pools to minimize price fluctuations, which is especially useful for tokens with a small user base and low liquidity. The individuals or groups who provide liquidity (liquidity providers, or LPs) into the pools can be rewarded in a number of ways. In Balancer’s case, LPs receive a portion of the trading fees and also get a share of weekly BAL distributions.
What is the BAL token?
The BAL token is mined by providing liquidity to Balancer’s liquidity pools, called Balancer Pools. BAL has a fixed total supply limit of 100 million BAL, of which 43 million have already been mined, and 145,000 more are shared out among the LPs every week. At the current rate, all BAL tokens will have been mined by 2028.
The amount of BAL each LP gets depends on the pool and the amount of liquidity provided. BAL is a governance token that grants voting rights, which allows users to guide the direction of this decentralized protocol. The past year has seen big gains for BAL token holders. Between November 2020 and May 2021, it rose from $10 to nearly $75 before the recent crypto-wide crash. Despite the drop, it has still more than doubled its value since its launch in June 2020.
If you have an idle portfolio of ERC-20 assets, Balancer’s service is a clever way for you to put your crypto to work while retaining custody. The service’s customizability gives it an edge over its peers and is comparable to an index fund put into practice. The Balancer Pools have flexible parameters, which allows users and pool creators to decide the following:
- Which tokens can be added
- Each token’s weighting
- Swap fees
- When to start or stop trading
- Whether to limit the value LPs can deposit
- Whether to whitelist addresses
Balancer vs. Popular DEXes
While Uniswap only allows pools with two tokens, and the Curve DEX only accepts wrapped Bitcoin and stablecoins, Balancer allows for two to eight ERC-20 assets per pool. So, for example, a pool might contain 20% BAL, 40% DAI, and 40% ETH. Regardless of how much each token appreciates or depreciates on the open market, Balancer Pools maintain an equilibrium. The pool will remain 20% BAL, 40% DAI, 40% ETH.
There are thousands of Balancer Pools, all with different token allocations and parameters. (Source: https://medium.com/balancer-protocol)
How Does Balancer’s Portfolio Rebalancing Work?
In the Balancer model, it is arbitrage traders who really rebalance your portfolio. Whenever market prices differ from those offered by a Balancer Pool, arbitrageurs enter that pool and buy the appreciating tokens in order to sell them on the external market. They will do this until the asset prices are the same inside and outside the pool. At that point, the arbitrage opportunity has been canceled out, and in the meantime, the process has maintained the weightings of the tokens in the liquidity pool. These arbitrageurs pay transaction fees and, as an LP to the pool, you will receive a share of those fees. Fees can range from 0.0001% to 10% depending on the parameters of the pool.
Because of the incentives for arbitrage, Balancer is continuously rebalancing to keep each pool’s assets in their desired weights. In traditional finance, rebalancing is periodic and costly. DeFi is all about making exclusive financial products universally accessible. The Balancer protocol provides a superior service as a portfolio manager, and it’s for everyone.
Additional Use Cases of Balancer
There are various types of pools on the platform. Private Balancer Pools offer the most customization, allowing anyone to choose the parameters and change them at will. In these private pools, only the creator themselves can provide liquidity. For public pools, once the parameters have been set, they are permanently fixed. An investor can choose from thousands of public pools with different permutations.
The platform also has Smart Pools, which are controlled by smart contracts that might regularly adjust the weightings, the fees, or even the tokens. It is a dynamic system. Smart contracts also control Liquidity Bootstrapping Pools (LBPs), which are another innovation from the team at Balancer Labs.
These LBPs have been successfully used this year for the initial distribution of tokens. Using mechanisms for up and downward pressures on the pool tokens, the LBPs have been able to ensure fair distribution of new tokens. Using a somewhat Dutch Auction style, in LBPs the investors are incentivized to wait until they think a reasonable price has been reached. This stands in contrast to the typical FOMO-based models used by other platforms.
What About Gas Fees?
With the high gas fees on the Ethereum network, all DeFi projects are looking for ways to reduce costs, and the Balancer team has a couple of fixes. A new feature of the V2 upgrade is the single vault into which all the tokens from the pools are now stored. This significantly reduces the number of transactions and thus reduces fees. It also benefits arbitrageurs who may be doing multiple intra-exchange transactions and now only experience one settlement when they leave the exchange.
Balancer’s new Single Vault Protocol contains the tokens of all of Balancer’s Liquidity Pools for more efficient trading. (Source: https://medium.com/balancer-protocol)
Another way Balancer is reducing fees is by partnering with Polygon, whose off-chain layer-2 solution is serving many DeFi projects. This may be a useful stop-gap while gas fees are high and ETH 2.0 remains a way off. Nevertheless, V2 and the Polygon partnership, along with increased adoption, caused BAL’s price to rise impressively throughout early 2021.
Who are using Balancer?
- Investors who want to make ERC-20 assets in their wallets work for them
- Portfolio managers looking for exposure to varied assets without expensive and time-consuming rebalancing
- Arbitrageurs following opportunities created by the pricing discrepancies between exchanges and liquidity pools
- Traders exchanging tokens looking for low slippage and generally favorable rates
- Ethereum smart contracts trading on behalf of users or seeking liquidity to liquidate positions on other protocols
- Project teams looking for capital throughinitial token launches
DeFi project rankings for July 2021 (Source: defipulse.com)
How Is Balancer Doing?
Balancer’s 80BAL-20WETH public pool is in the top ten liquidity pools in DeFi, with only Curve and Uniswap having more popular pools. The total value of liquidity locked in Balancer is currently around $700 million, with 8,700 liquidity providers who have earned around $60 million in fees. These are not huge numbers, but Balancer was only launched in February 2020. This space is always changing, and the crypto-wide price drop has naturally affected Balancer.
In terms of security, there is always a risk that the developers have missed something. In February 2020, four months after Balancer’s launch, an attacker exploited a bug involving a flash loan from the dYdX DEX, which took nearly half a million US dollars in WETH tokens. It was thought that the hacker had detailed knowledge of DeFi programming, and the funds were never recovered. The Balancer team acknowledged the hack and made good on their promise to refund users’ losses in August 2020. There have been no incidents since then.
BAL Token Price History
The BAL token’s current price is $24.49. The major drop since its May high of 74$ was also experienced by the entire crypto space. As DeFi begins to recover, BAL has the potential for considerable upside growth. The market cap of BAL is $239 million, which puts it at #165 on the market cap ranking. This is behind the likes of comparable AMMs like Curve, Uniswap, and Bancor. Thus, it may appeal to investors looking for significant returns on investments from mid-to small-cap crypto projects.
BAL’s price chart from launch to July 2021 (Source: TradingView)
Balancer is a great solution for DeFi users who want to maintain a balanced portfolio and earn passive income on Ethereum assets. The new V2 features reflect a highly active team looking to grow. They recently raised over $24 million from investors in a token sale that brought new investments from the likes of Alameda Capital, Pantera Capital, and Blockchain Capital. With a strong performance from its native BAL token after a year on the market and a roadmap including a Version 3, Balancer will continue evolving and making even better more universally accessible financial products.