DeFi (Decentralized Finance) has been growing at a rapid pace lately. It’s still in its infancy, but with every new project that comes out it feels more and more inevitable that the DeFi space will eventually hit its goal: To replace the entire traditional financial system without the need for middlemen, third parties, or centralized control.
Balancer is a particularly noteworthy project in the DeFi space.
Balancer takes the idea of a traditional index fund and flips it on its head. Doing this also enables Balancer to be a traditional market maker that - so far - also works in harmony as an “index fund” without the need for any human managers.
Let’s dive in and get a closer look at this project!
Balancer is a decentralized, automated system that replaces the traditional market maker.
Market makers have always been a staple of traditional financial markets. They're a third party, they make a lot of money, and they’re present in almost every kind of market -- equity, stocks, currency, metals and oil trades…
So if I wanted to sell some HongKong dollars and buy US dollars, there has to be somebody on the other side of that trade in order to make it work. That’s what a market maker does -- and they make a little money on that trade by providing and fronting up that US dollar for me when I want to trade.
With balancer they’re doing the same thing -- only it’s completely decentralized.
On one side of the transaction, Balancer has many different liquidity pools that act as “crypto index funds” for people who are providing liquidity into the pool.
On the other side of the transaction, Balancer is a Dex — a Decentralized Exchange — that allows users to trade their coins for other coins from the liquidity pools at market rates, plus a small fee.
That fee then goes back into the liquidity pool and becomes the profit of those investing in the “crypto index funds”.
But there’s a lot more than just that. Balancer is also an automated crypto asset management platform, liquidity provider, and price sensor.
It has quite a few functions in one, and it's also providing some features for passive income that we don’t see anywhere else in DeFi.
Balancer software runs on Ethereum, and uses a combination of cryptocurrency assets in smart contracts to provide its service. This enables both trading and investing in liquidity pool “index funds” without any third party financial intermediary.
The central premise of Balancer is this:
Instead of paying fees to portfolio managers to rebalance your portfolio, you get paid fees automatically from traders who help rebalance your portfolio automatically by following arbitrage opportunities.
Balancer Lab was founded by Fernando Martinelli and Mike McDonald, but it began as a research program at a software firm called BlockScience in 2018, which is a firm that does research and development on complex systems.
Fernando Matinelli, Balancer’s CEO, is a control and automation electronics engineer, with a master’s in robotics and image processing. He also has an MBA from Sorbonne University in Paris. After college he briefly worked for Bain company as a strategy consultant in Germany.
He started very young as an entrepreneur. When he was 14 he started a cyber cafe for gamers who played the game Counter Strike and it was very successful.
After he worked for Bain, he started a company that allows people to prepare for job interviews called Prep Lounge which was also successful. Then he created an energy drink company -- which there doesn’t seem to be a lot of information on.
In late 2012 Martinelli was introduced to cryptocurrency by a friend. He says initially he dismissed it. But the second time he looked at it in early 2013, it struck him how revolutionary the space was. He kept paying close attention and when Ethereum came out, it really caught his attention. He knew Bitcoin was great as a store of value, but Ethereum’s flexibility with smart contracts allows you to create a financial system instead of a coin.
Martinelli was excited about stablecoins as well. Those were something he was particularly interested in creating solutions to get mass adoption for, and Ethereum allowed that to happen. This is all what led him to decide to participate in the early days of the MakerDao community.
He got involved with MakerDao in early 2016, and he worked with that project for a while on control theory. That’s when he went deeper into the crypto space and started meeting a lot more people at the cusp of DeFi.
After collaborating for a bit with MakerDao doing research on the control mechanisms, it led him to his own research with BlockScience which is where he eventually created Balancer.
BlockScience is an engineering research and development analytics firm where Martinelli started Balancer as a small research project. Initially, it was just him alone collaborating with BlockScience building the project.
The reason Balancer started in the first place is because, in his words, Martinelli wanted to research “the idea of: how can I keep a cryptocurrency portfolio stable in terms of percentage of value distributed, in an automated and decentralized way?”
He wanted to create something where you can position your assets without actively going to buy and sell tokens just because one of them went up by a lot. You want to have the peace of mind of passively investing in a basket -- and having it automatically rebalanced for you. Much like an index fund.
That was the idea he started out with, and that’s how Balancer was born.
Balancer began as a small project at BlockScience in 2018. But pretty soon, Martinelli realized the idea behind Balancer worked extremely well and had a very big potential. He and the initial team spun the project off of BlockScience and created Balancer as its own company.
Nickoli from MakerDao was excited about the project because he had also been looking for a solution where he could invest his crypto into a “safer” and more diversified basket. So he joined the project as a tech advisor and wrote much of the initial code for the project.
Mike McDonald also joined as the co-founder at that time:
Mike McDonald is the co-founder and CTO at Balancer. Prior to jumping on board with Balancer, he was trained as a security engineer and created a project called mkr.tools, which is a data analytics site made to track historical trades on another Decentralized Exchange called OasisDex. It has evolved to track all sorts of CDP and general system statistics needed by the crypto community.
A couple other members of Balancer’s team include:
Kristen Stone, the COO at Balancer. She has worked in the crypto industry for over five years, was product manager at Coinbase and built teams in product and engineering.
Timur Badretdinov is the front-end developer. He’s worked on several projects prior to Balancer, including founding a company called “long caller," a platform focused on providing cryptocurrency reviews and educational blockchain content.
How Balancer Works:
One way to think of Balancer, is that balancer takes two different parts of the traditional financial supply chain, and it merges them into one.
So on one side you have the asset management supply chain. This is the same as when you are putting your money into Fidelity, then having them manage your investment in an index fund for you. Fidelity has trillions of dollars of assets on its balance sheet, full of money it is holding for people in index funds.
On the other side, you have the market makers. Traditional market makers are operating on the different exchanges like the NYSE, NASDAQ, or S&P 500. They’re the people who have assets and are always willing to quote prices on the assets for people who want to buy them.
So for example, market makers have US dollars and British pounds. And they are always willing to provide an exchange rate between them for anyone who wants to exchange.
The nature of a traditional market maker is that they need access to assets so that they can “make the market,” and the nature of an asset manager is that they manage lots of assets for people investing into indexes.
Normally, asset managers and market makers exist in silos. These two functions of finance have always been done by completely different entities.
So one of these entities has assets. And the other one needs assets. But the two never meet in traditional finance.
That’s where Balancer changes things. Balancer plays the part of both of them. And it does that while completely eliminating the middleman.
Balancer is basically a program where both of these parts of the supply chain exist inside one smart contract on the blockchain.
So you have users on one end that want to invest into an index of diversified cryptocurrencies. They are supplying their assets to the index so they can benefit from diversified growth of that index.
The assets those users supply are now in a pool, and can then be used to “make a market” (i.e., be used for Decentralized Exchange) on the market maker side of things. And the market maker is the smart contract itself.
So in a nutshell, Balancer is compressing down the entire financial supply chain into a set of smart contracts, and allowing for a new kind of efficiency to emerge from that compression that we’ve never seen before.
So does it work?
So far, Balancer has had no problems combining those two sides of the market. No one in traditional finance has thought of doing it before this, but it works very well.
As of this writing, Balancer has $1.8B in total liquidity from 8,700 liquidity providers investing into liquidity pools. In the past seven days, they’ve done $263M in trading volume, which has earned liquidity providers a total of $63.6M in fees.
Balancer uses Ethereum smart contracts to do all of this. It just eliminates the fees that, in traditional finance, are going to fidelity, to NASDAQ, to NYSE -- to all those regulated entities that have to spend a lot of money being regulated and paying lots of wealthy banker salaries.
This is why you have to pay an index fund manager for them to manage your funds. The beauty of Ethereum and smart contracts is that you no longer need anyone for that.
Smart contracts automate all of it, and it’s totally trustless and permissionless. No one is getting in the middle anymore.
This is not only cheaper for everyone. It’s more efficient, faster, and gives users control and ownership over their crypto assets.
Let’s dive a little deeper into…
When I talk about a Balancer pool, or an index fund, or a liquidity pool -- those all essentially mean the same thing.
Just as an index fund can be composed of different stocks, Balancer pools are composed of up to eight different cryptocurrencies so you have exposure to diversification.
A balancer pool’s value is determined by the percentages of each token within it - a weight chosen during the pool’s creation.
Balancer uses smart contracts to ensure each pool retains the correct proportion of assets, even as the prices of individual coins in the pools might vary.
For example, a Balancer pool might start off with 25% ETH, 25% DAI and 50% AAVE. If at some point, the price of AAVE doubles, the pool automatically reduces the amount of AAVE it holds so that it can retain 50% of the pool’s value.
And where does the extra AAVE go?
Balancer’s smart contracts make it available to traders looking to buy AAVE as prices go up. In return, the people who contributed AAVE to the pool (the liquidity providers) make money from those trading fees.
It’s unique that liquidity providers earn fees while their index funds get rebalanced. Compare that to traditional index funds from Fidelity where investors pay fees for the rebalancing of services.
You can create your own “crypto index funds” on Balancer based on the cryptocurrencies in your portfolio, or join someone else’s pool to benefit from the way they have already diversified.
You make money from providing liquidity to these funds in three different ways:
This makes Balancer a solution for DeFi users who want to earn passive income on Ethereum-based assets while retaining exposure to the underlying asset.
Types Of Balancer Pools
The Balancer protocol has several broad types of pools you can use to make money:
Private Pools - these give the owner governance over the pool and make the person who owns the pool the sole contributor of liquidity to the pool. Also the parameters of the pool are liable to change by the owner. Basically, this means you can create your own pool according to your own specifications, where you are the sole contributor. Private pools are useful to asset managers with large portfolios seeking to earn fees on their specific assets.
Shared Pools - These are for people who want to become liquidity providers. Anyone can contribute to them and receive the benefits. Liquidity providers are rewarded with the Balancer Pool Tokens (BPTs).
Smart Pools - These are similar to private pools, but are controlled by a smart contract. They also reward using BPTs and allow anyone to contribute liquidity to the pool. This feature allows pools to be programmed to perform additional functions, such as changing weights, or creating an index fund that tracks a property portfolio.
If you want to narrow down which pool you’d like to contribute to, you can filter for your desired asset. You can supply liquidity for an almost endless option of pools. There is support for a long list of different Ethereum-based tokens.
To choose which pool you’d like to start earning on, simply browse the website and examine the pool for key aspects - like balance, volume, and fees.
Pools weighted differently with different cyptos end up producing different kinds of yields, and are visualized like this:
But Balancer can get very sophisticated, providing thousands of configuration options with custom price curves that enable infinite strategies, so even the most advanced investor can get what they want:
And unlike pools for other DEXs like Uniswap, with Balancer you can choose the trading fee that you want your pool to charge if you are the creator of the pool. This is important if you’d like to use Balancer pools to trade (see below).
After you invest into a pool, you’ll notice that the pool will keep that allocation and you will have full exposure to the underlying asset while earning those returns.
Balancer pools are continuously self-rebalanced by the protocol. It typically happens almost instantaneously - a lot faster than traditional rebalancing of an index fund.
Trading Strategies For Liquidity Providers & Pool Creators
When you do traditional portfolio management, you usually want to rebalance occasionally so you can take profit. So let’s say in your traditional portfolio you have 80% bonds, 20% stocks. And suddenly the stocks go up 2x or 3x. And now you have way more stocks than 20% of your total portfolio.
So at some point you rebalance - you sell some stocks to equal out. And you keep the profit.
So in traditional portfolio management, the profit works well because it works at longer intervals where you let the stocks rise for a week or two, and then you rebalance.
But with Balancer, the rebalancing of assets happens automatically. It’s a continuous rebalancing, which sometimes doesn’t give you time to realize profits from your cryptos rising.
But there actually IS a way to simulate traditional portfolio management using Balancer.
You can tell the protocol to wait for a certain amount of profit for one of the tokens in the protocol to go up by a given amount before it automatically sells it.
In fact, Martinelli wrote an article that details quite a few ways you can use Balancer pools for swing trading. But here’s the basic way you’d address the above situation:
When you can set the fee for your protocol - say 10 percent - your pool is only going to sell at that fee. Which means you are also controlling how often your pool gets rebalanced.
For example, let’s say ETH is at $2000 dollars. Your pool with a 10% fee means it will be automatically selling at $2200 and buying at around $1800. What will happen is, the price will be stuck there until someone trades. And if the external market price goes from 2000 all the way to 2201, that’s when someone’s going to buy from you.
So you’re going to be selling at 2200, and if the price goes down -- whenever it’s between that bandwidth of 1800 and 2200 -- you’re not selling or buying. Because it makes no sense for rational actors to pay more or less than the current market price.
If it falls to 1800 then the pool protocol will actually start buying ETH for you. The fact that you can customize these fees allows you to choose what strategy you want.
If you want to be rebalancing very often, you’d want to set a lower fee. And if you want to rebalance very sporadically when prices have huge variations, you set a higher fee. You can control when you want the protocol to automatically rebalance for you with the fee.
We’re used to the 0.3% on Uniswap which is fixed, which is why prior to Balancer people never thought about doing this.
Balancer’s DEX Function:
On the “other side” of the liquidity pools, users use the DEX function for trading and arbitrage opportunities.
You simply select the asset you'd like to swap, and the resulting token you’d like to receive.
Once that’s done, you’ll be shown the exchange rate and the projected price slippage. You can define the maximum price slippage you’re comfortable with for the trade.
Balancer can route your order through multiple protocols. They call this Smart Order Routing.
So if you want to trade BAT in exchange for COMP, it might actually trade BAT first to DAI, then to ETH, then to COMP in order to give you the best deal in your trade.
This is taking advantage of all the different liquidity pools on the other end of the platform that have set different trading fees.
Prior to your swap, Balancer will show you how your order has been optimized using balancer pools. Smart Order Routing finds the cheapest exchange options between these different pools.
Once you’re comfortable with your order parameters, you can swap and exchange tokens.
The intermediate trades through multiple protocols are not only advantageous for the person trading or swapping, but also for liquidity providers. That’s one of the things that makes Balancer such a win-win for everybody.
Balancer has its own governance tokens - BAL - which they’ve been distributing as a reward for providing liquidity.
This is released on a weekly basis of 145,000 BAL tokens.
These are governance tokens that represent a user’s stake in the Balancer ecosystem. It gives users voting rights, too. These tokens are a lot like curve rewards or compound’s COMP.
Balancer didn’t launch with a native token. But in June 2020, they launched BAL as a governance token, following the success of Compound’s token COMP.
The main purposes of this token are to allow for more decentralization and to give as an incentive for liquidity providers.
Of the total 100M tokens that were created, 25M of them were reserved for the team, core developers, investors and advisors.
5M tokens were allocated for the Balancer Ecosystem Fund, which will be used as incentives for strategic partners. Another 5M were allocated for the fundraising fund. This fund will be used by Balancer to support its operation and growth at future fundraising.
The remaining tokens are to be mined by liquidity providers on the platform and are released at the rate of 145,000 per week. This means in the first year of BAL’s existence there would be a 30% supply inflation off the initially allocated supply of 25M tokens.
This high rate of supply inflation was meant to kickstart the distribution of governance rights of the protocol out to those who earn it.
The schedule of BAL distribution for the coming years is planned to be extensively discussed by the Balancer community, and they plan for it to be ultimately decided-upon by BAL holders through voting.
Provided the distribution rate is kept constant, it would take about 8.6 years to finish distributing the tokens.
Balancer has so many features packed into one. On one hand, it’s a decentralized exchange. On the other hand, it’s like a cryptocurrency index fund that will allow you to deposit one crypto coin and expose yourself to price movements from a pool of eight different cryptos.
It’s a place for earning trading fees. It’s a way to get distributions of the BAL token.
There’s likely a lot more to come with Balancer. Balancer’s protocol also allows developers to build DeFi dApps to create new, innovative types of ways to invest and trade crypto. So we’ll potentially see this platform adapt and evolve with the emerging DeFi space.
The number of current and future possibilities for generating your own decentralized financial instrument using Balancer are unlimited. And it’s the first and only crypto project to introduce the idea of a decentralized index fund. This might even help investors feel like they’re taking safer risks and even attract more investors -- both retail and institutional -- to crypto in general.
This data report is provided by Keystone Investors Research. Keystone is the only Cryptocurrency research firm that is Officially partnered with a government regulated Cryptocurrency Trading Platform.
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