What Is Balancer AMM Protocol?

| Updated
by John Caroline · 6 min read
What Is Balancer AMM Protocol?
Photo: Unsplash

Yet to know about popular Automated Market Makers (AMMs) and decentralized exchange on the Ethereum network? Here’s a guide to give a proper understanding of what Balancer AMM is and how it works.

While looking closely at the latest trends in the crypto ecosystem, you can observe that the decentralized finance (DeFi) space is increasingly gaining popularity thereby approaching mainstream. As a matter of fact, institutions and traditional finances are beginning to venture into the DeFi space. As such, DEX exchanges continue to see expansion in volume and funds. There are several automated market makers (AMMs) and decentralized exchanges in the crypto space. One of the most highly recognized and popular AMMs and decentralized exchanges is Balancer AMM which runs on the Ethereum (ETH) network.

Most of the DEXs in the market use an AMM, with liquidity pools made up of two tokens. However, Balancer has proven to be unique in this aspect as the Balancer Protocol offers liquidity pools with up to eight tokens.

The protocol features a mechanism that allows users to instantly swap tokens and earn fees when they provide liquidity to different pools, thereby attracting the interest of users with this mouth-watering feature. Let’s dive further to better understand all that is embedded in the protocol.

Balancer: Automated Portfolio Manager

Balancer AMM protocol is an open-source protocol, automated portfolio manager, and liquidity provider. Built on the Ethereum blockchain, Balancer offers new solutions to the problems present on traditional and centralized exchanges. Designed for user accessibility, the Balancer protocol allows for trustless and permissionless trading of ERC-20 tokens.

Balancer protocol allows users to trade tokens, create liquidity pools, and invest in existing pools while earning yields from trades. The ultimate goal is to become the leading platform for programmable liquidity.

With around 25,000 liquidity providers, over three billion dollars locked in liquidity, and thousands earned in trading fees daily, the Balancer protocol offers users several ways to optimize their crypto experience.

How Balancer Works

Just as an index fund can be composed of different stocks, Balancer pools are composed of up to eight different cryptocurrencies.

A Balancer pool’s value is determined by the percentages of each token within it, a weight is chosen during the pool’s creation.

Balancer uses custom programs called 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% LEND. If at some point the price of LEND doubles, the pool automatically reduces the amount of LEND it holds so that it can retain 50% of the pool’s value.

So, where does the LEND go? Balancer’s smart contracts make them available to traders looking to buy LEND as prices go up. Of note, liquidity providers still earn fees while their index funds get rebalanced, compared to traditional index funds where investors pay fees for the rebalancing services.

Balancer Products and Features

Balance provides users with several products and features, some of which include Balancer pools, exchange, and vaults.

  • Balancer pools. Balancer pools run smart contracts and maintain value by having two or more ERC-20 tokens. Every token has its weight, and users can trade them with other tokens within that pool. The smart contracts readjust the pool to maintain a proportional and equal value of liquidity in it. Doing so keeps the value of each token proportional to the value of liquidity in the entire pool. Pool owners receive fees from the trades that happen within the pool. The protocol offers two major types of pools which include a public pool and a private pool.
  • Balancer exchange. Balancer allows users to trade at optimal prices. The protocol encourages efficient trading via pooling crowdsourced liquidity from investor portfolios while using its Smart Order Routing feature to find the best prices for traders. Users can exchange any combination of ERC-20 tokens on Balancer and get access to intelligent pricing, MEV protection, and gas subsidies/optimizations.
  • Balancer vault. The vault is Balancer’s central component. It is a smart contract that controls and stores all tokens in each Balancer pool. In addition to being an important part of the ecosystem, the vault serves as a gateway through which users carry out most operations like joins, swaps, and exits. Token management and accounting are separated from the pool logic in the Vault. Balancer claims Pool contracts become easier since they don’t need to manage assets actively and only compute exits, swaps, and joins.

Balancer AMM Uses

The protocol features three main use cases. These include liquidity providers who can create and contribute to existing pools, traders and arbitrageurs looking for liquidity sources, and developers building on top of the protocol.

  • Liquidity providers. The protocol efficiently supports the provision of liquidity. Being a renowned decentralized exchange, the Balancer protocol allows users to swap their assets or provide liquidity without the need to depend on centralized third parties.
  • Arbitrage opportunities. Balancer protocol provides users with arbitrage opportunities in form of flash swaps and flash loans.
  • Building access. Developers can easily build their own Balancer apps using its libraries.

Pros & Cons of Balancer AMM Protocol

Users of the Balancer protocol are entitled to enjoy the exclusive features of a fully decentralized and permissionless exchange. Moreso, the protocol does not place a limit on the use of its liquidity pools. The liquidity pools are open to all users of the platform. Furthermore, users of the Balancer protocol are provided with customizable AMMs.

However, the protocol also has some disadvantages. Firstly, it provides support only for ERC-20 tokens. Besides, users are no longer allowed to use mobile applications. Being based on the Ethereum network, Balancer charges its users with high gas fees. And finally, the use of the protocol requires special knowledge and skills. As such, it is not beginner-friendly.

BAL Token

The BAL token is the native token of the protocol. Users can earn this token by providing liquidity or trading on the Balancer protocol. Moreso, BAL tokens are claimable and used to participate in the Balancer governance protocols. In that case, liquidity providers are assigned voting rights depending on the percentage of tokens they hold or stake in the pool.

Conclusion

Balancer protocol has not only emerged as a popular AMM and decentralized exchange but also operates as a convenient protocol for crypto investors who wish to exchange digital assets at optimal prices or have idle portfolios they would like to leverage.

Private liquidity pools on the platform are standout features that portfolio managers and large-scale investors may find useful. Multi-token pools offer access to a solid index of cryptos that can rebalance automatically.

Share:

FAQ

What is the Balancer protocol?

Balancer AMM protocol is an open-source protocol, automated portfolio manager, and liquidity provider. Built on the Ethereum blockchain, Balancer offers new solutions to the problems present on traditional and centralized exchanges.

How does Balancer work?

Balancer operates with pools that are composed of up to eight different cryptocurrencies. It also operates as a self-balancing index fund.

What are Balancer pools?

Balancer pools run smart contracts and maintain value by having two or more ERC-20 tokens. Every token has its weight, and users can trade them with other tokens within that pool. The smart contracts readjust the pool to maintain a proportional and equal value of liquidity in it.

What is a Balancer exchange?

Balancer exchange is a decentralized exchange that allows users to trade at optimal prices. The protocol encourages efficient trading via pooling crowdsourced liquidity from investor portfolios while using its Smart Order Routing feature to find the best prices for traders.

What is a Balancer vault?

Balancer vault is a smart contract that controls and stores all tokens in each Balancer pool. In addition to being an important part of the ecosystem, the vault serves as a gateway through which users carry out most operations like joins, swaps, and exits.

How many BAL tokens are there in circulation?

The BAL token has a circulating supply of 42,085,509 BAL coins and a maximum supply of 96,150,704 BAL coins.

guides
What Is Zero-Knowledge Proof (ZKP)? September 12th, 2022

Zero-knowledge proof (ZKP) is a cryptographic technique that allows one party to prove knowledge of a certain fact without reveali...

-->