How It Works is a Series that analyzes the Operational Model of Protocol/DApps, updates the basic understanding of a Token, thereby providing you with the most intuitive views about the Token of that project. You can refer to it for more investment perspectives.
Overview of Balancer (BAL)
Balancer is an AMM where users can trade (Swap), provide liquidity (add liquidity) with two or more tokens and at different rates.
Balancer comes in two versions;
- V1 will be released in Q2/2020
- V2 just released on 11/5/2021
The design of V2 has many unique and different points from V1, in this article, I will focus on analyzing and understanding the strengths of V2 and how it captures value for BAL, the Balancer’s native token.
You can learn about Balancer V2 in advance here.
Advantages and limitations of Balancer V1
I will focus on presenting the main points that v1 does well and its limitations.
At the time of Q2/2020, DeFi started to explode, users began to interact with AMM and related products, they began to realize many advantages of AMM, but its limitations also began to show. – the problem of Impermanent Loss (IL) and the monotony of AMMs at that time.
The balancer came in at this stage, providing an AMM with many options for a variety of use cases, while also providing a temporary solution to the IL problem.
- Liquidity Pools with more rates and tokens to choose from for different use cases (Pool 50% – 50%, Pool 80% – 20%, Pool 90% – 6% – 2% – 2%,…).
- 3 different types of pools:
- Shared Pool: Anyone can add liquidity.
- Private Pool: Only Pool owner can add liquidity and change rate, add tokens, change swap fee….
- Smart Pool: An advanced form of Private Pool, the owner of the Pool is a Smart Contract, it allows the pool design to adjust parameters based on any type of Tokens.
Despite providing such a promising product, in terms of TVL and Volume, the Balancer was not very successful. (Uniswap’s TVL and Volume are 6-8 times higher than Balancer’s TVL and Volume at the end of 2020).
In my personal opinion, the failure of the Balancer is due to:
- Balancer Can’t attract Users, Initial bootstrap doesn’t stand out leading to Initial network effect not bringing high efficiency while their direct competitor at that time was too good for this part – Retroactive thousands of dollars for users.
- Product with many features, requires quite high knowledge of AMM products toeffective use.
- Besides, V1’s interface is also a bit confusing and complicated with new users.
Overview of Balancer V2
V2 is an upgraded version of V1, V2’s highlights compared to V1:
- Protocol Vault – One vault for All.
- Improve gas efficiency.
- Flash loans & Flash Swaps (arbitrage trading between Pools).
- Custom AMM Formula.
- Increase capital efficiency through Asset Managers.
The main architectural change between V1 and V2 is that V2 uses only a single Vault to contain and manage all Balancer pools assets.
Balancer V2 separates AMM logic from token management and accounting. Token management/accounting is done by Vault while AMM logic is done individually for each Pool.
Custom AMM Formula
In V1, there are 3 types of pools: public pools, private pools, and smart pools.
In V2, there will be more types, will initially run 2 main types of Pool;
- Weighted pools: Permissionless, Pool 8 tokens like public pools in V1 but save gas and can be expanded to 16 tokens later.
- Two-token weighted oracle pools: Pool 50% – 50% like Pairs on Uniswap.
There are 3 types of pools being developed and tested:
- Stable pools: Pools for stablecoins.
- Liquidity Bootstrapping Pool: Application for Launchpad, IDO of the new token.
- Smart versions of Weighted Pools and Stable pools.
In V1, trading with two or more pools will be inefficient because users have to send and receive ERC20 tokens from pools.
With V2, even though transactions are batched against multiple pools, only the net amount of tokens is eventually moved to the Vault, saving a significant amount of gas in the process.
In most AMMs, most assets are not actually being used at any point in time => capital efficiency is low.
Balancer v2 introduces Asset Managers to solve this problem. Asset Managers are external smart contracts nominated by pools that have full rights to the underlying tokens that Pool has deposited into the vault.
The application of Asset Managers is to help some of the Balancer’s Pools earn more yield by bringing some of the unused capital in the Balancer Pools to the Lending Protocol (like Aave) to increase the profit for the Pools.
This solution is not new, Curve pioneered this solution with the introduction of Compound pool and Y pool but the problem with Curve is the cost is too high.
Eg, a simple swap from TUSD to USDC on Curve consumes more than 800,000 gas while a normal swap on Uniswap only costs around 100,000 – 120,000 gas.
Balancer v2’s Asset Managers promise to solve this and the problems around it. You can read more articles about the project here.
Balancer v2 . progress
Although there are many improvements compared to v1, but V2 also just Launched a few features mentioned above such as:
- The interface of balancer v2 has been reworked, it is simpler and more beautiful when compared to v1 (live).
- Protocol Vault (live), Balancer is migrating liquidity from v1 to v2 but progressing quite slowly and carefully, TVL of both Balancer is more than $2.3B but TVL in Vaults v2 Only around $130M.
- There are only 2 types of Pool live on v2: Weighted pools and Two-token weighted oracle pools, they are temporarily not permissionless, users can only Trade and Add liquidity to existing Pools.
- Asset Managers (not live yet).
Currently, Balancer is still continuing to build and perfect v2 so the components of Balancer in the future may be different from now;
Basically, v2 will have 3 main components:
- Liquidity Provider: This is the party that supplies, provides assets to create liquidity for the market.
- Swapper: Users can trade any token in the Vault, in return they have to pay 0.01 – 10% fee per transaction (depending on the fee set by that Pool).
- Asset Managers: bring out a part of the unused capital in the Balancer Pools to increase profits for those Pools.
The process is similar to Uniswap LPs, the LP will provide the tokens of the Pool proportionally, receive LP fees and can farming (only one pool is supported).
Balancer v2 has 2 other points as follows:
- There are more types of pools
- Dynamic LP fee, which can be changed by governance and is currently set up by Gauntlet.
When trading on Balancer v2, Swapper will send a salary of A token, plus a part of LP fee (maybe a little more protocol fee later) to receive a number of tokens B.
Balancer has a difference in transaction fees that users need to pay attention to is that LP fee is not fixed at 0.3% like Uniswap but depends on each pool, so when using Balancer, you should pay attention to the fee of each pool. from 0.01% – 10%).
The abstract concept is to bring a part of the unused capital in the Balancer Pools contained in the Vaults to the outside to earn more profits for those Pools.
The first Asset Managers on Balancer has been confirmed as Aave, Aave will bring some of the unused capital in Balancer Pools to Aave’s Lending Protocol to get additional yield for Balancer pools.
Currently, Asset Managers is still under construction, you can read more articles this For more details.
How does Balancer Capture Value for BAL Token?
At the moment, BAL only function is Balancer Governance Token (voting).
But according to my experience, in the future, when the features of the Launch protocol and stable operation will be, there will be Proposals to activate a number of Incentives that BAL holders can enjoy, instead of just a single Incentive like now.
In my opinion, the idea of v2 will follow this process in turn:
- Focus on creating good products.
- Attract more TVL, generate volume & other revenue streams.
- Charge Protocol fee (part of the swap fee).
- Protocol fee & other revenue stream (yield from lending protocol) is included in Treasury.
- Distribute some or all of the funds from the treasury to the BAL staker (or BAL holder).
Currently, the protocol fee is set to 0 by default, and the ways to use Funds in the Treasury are as diverse as;
- Fund Gitcoin Grants to improve the protocol.
- Fund advertising campaigns.
- Fund grants to attract strategic partnerships.
- Buy insurance for Balancer to prevent bad cases happening.
- Lending on Lending protocols.
- Distribute back to the BAL Staker (or BAL holder).
In addition, the way to distribute to BAL holders (or BAL staker) can be one of the following 3 ways:
- Buyback from market & burn.
- Distribute for BAL Staker the same way Sushi is doing.
- Distribute for BAL staker but add time weights variable like Curve model and oSUSHI model.
Although Balancer offers many innovations in its design, at the moment, the above outstanding features are not live yet => Temporarily consider it an idea because we do not know how and when in reality they work. will debut?
Besides, their direct competitors Uniswap v3 and Sushiswap multi-chain have launched and have very good figures, will after launching Innovation features of v2, Balancer will regain market share from Uniswap v3 and other prominent AMMs?
In addition, the issue of scaling to layer 2 or other EVM-compatible chains is also very important, while the AMM pie in Ethereum is very cramped and temporarily shows no sign of further expansion, new markets in outside (layer 2,…) had a greater opportunity to expand.
Will the Balancer make any move? Will Balancer continue to work hard to develop and perfect the remaining features of Balancer v2 on the Ethereum mainnet? Or will there be other plans?
In short, Balancer is in a rather sensitive period and needs to observe more about the project’s moves on the progress of V2 and how to expand Balancer’s ecosystem to make more accurate investment decisions.
Summarizing the operation model of the Balancer, we can draw some main ideas as follows:
- V1 is good but can’t attract Users, Poor Initial bootstrap leads to bad Initial network effect, no snowball.
- V2 has a lot of innovation but has not yet live all the features described => potential but needs more observation.
- How to capture the value of the Balancer for BAL tokens: Focus on creating good products => Attract a lot of TVL, generate volume & other revenue streams => Charge Protocol fee (part of the swap fee that users have to bear) => Protocol fee & other revenue stream (yield from lending protocol) is put into Treasury => Distribute part or all of money from treasury to BAL staker (or BAL holder).