Balancer Vault and Liquidity Pools
In this article, we will explain the Balancer Vault and Liquidity Pools, which is a liquidity provider, portfolio manager, and an AMM that runs on Ethereum.
Balancer is a liquidity provider, portfolio manager and AMM on the Ethereum Blockchain. It stores all its assets in a single smart contract called the Balancer Vault. The protocol keeps an accounting ledger of all the tokens which are stored in the Vault which make up Balancer’s Pools. This novel system of keeping all assets stored on the same smart contract was introduced in Balancer V2, which was released on May 11, 2021.
The major advantage of keeping all assets on the same smart contract is thait allows the protocol’s accounting to be kept separate from the Pool logic. When token swaps are made, the protocol can simply change the balances of the pools in their internal accounting without having to spend gas for each and every swap. A swap of Token A > B > C can be made in this way with minimal gas fees. Arbitrage and even flash loans will be possible without holding any of the underlying assets, just by paying for the gas to make the trade.
Coincidence of Wants Solvers
Balancer swaps are executed using Coincidence of Wants solvers for gas optimized trades in partnership with Cowswap (check out the Codex article on Cowswap if you’d like to learn more).
Balancer’s native token is called BAL and the governance token is veBAL. This is similar to CRV/veCRV with a couple of differences. The max time lock for veBAL is 1 year but in order to receive veBAL, instead of simply locking BAL, users have to lock an LP token consisting of BAL/ETH in an 80:20 ratio.
Aura is the Convex to Balancer’s Curve, with their own governance token auraBAL (similar to cvxCRV). Check out our previous post about Curve/Convex and Defi Infrastructure if you'd like to read more about this model. The Aura Finance protocol allows Balancer users to stake their 80:20 BAL/ETH LP tokens in Aura to receive auraBAL. Aura then locks the LP token for the maximum period and pays out yield to the user.
The simplification that Balancer is offering through their Pools is that anyone can build a new trading strategy based on an existing Balancer pool. And similar to the way the Vault keeps track of the balances for the Pools, it can also do the same for individual users internal balances. This further reduces gas fees for Balancer users.
Balancer’s weighted pools may contain between 2 and 8 tokens in varying ratios. This is a departure from the traditional pool design of other AMMs (like Uniswap or Sushiswap) of 2 tokens with a 50/50 weighting. In weighted pools certain tokens can have a higher ratio compared to others, up to 80/20. One advantage of a higher weighting for one token compared to another is it reduces the risk of impermanent loss. If you want to provide liquidity to a ETH/BTC pool, and you are especially bullish on the price of ETH, you can weigh the pool more heavily toward ETH which will reduce the impact of impermanent loss if ETH experiences bigger gains compared to BTC.
Stable pools are just that, stable. They are for assets that are expected to consistently trade at or near the same valuation like FRAX/DAI.
This is an extension of Stable Pools for assets with highly correlated, but not necessarily pegged prices like Lido’s wstETH-WETH.
Liquidity Bootstrapping Pools
Liquidity bootstrapping pools (LBP’s) are often used when a protocol wants to launch liquidity for their token or to determine a fair market price for a token that is undervalued. These pools can change their token weights dynamically to find a price equilibrium by using weighted math. Initially, the owner can set the liquidity depth and token weights, and swaps can be paused at any time.
These can be used to deposit tokens from a wide range of the DeFi landscape. They allow fund managers to deposit up to 50 tokens in various weights and implement a variety of advanced portfolio strategies. This allows more precise control to be exercised.
Balancer offers very efficient token swaps with a novel Vault design. It also has very flexible pool structures which protocols will certainly find many uses for in the future. We'll be watching this one.