A Comprehensive Interpretation of Balancer’s Innovations in DEX: 7 Types of Liquidity Pools and Architecture Logic
Understanding Balancer's DEX Innovations: 7 Liquidity Pool Types and Architecture Logic
Balancer has made many innovations in the development of DEX, but lacks visibility in competition with Uniswap and Curve. According to DeFiLlama’s data, Balancer’s liquidity in DEX ranks fourth after Uniswap, Curve, and PancakeSwap. The dashboard compiled by Dune co-founder shows that in June this year, Balancer’s trading volume was only surpassed by Uniswap, PancakeSwap, Curve, and DODO, ranking fifth.
In the development of LSD, Balancer also occupies a good market. Among the top five liquidity pools on Ethereum, wstETH/WETH, rETH/WETH, wstETH/sfrxETH/rETH, R/DAI, these four liquidity pools belong to LSD or LSDFi. In the following text, BlockingNews will take an inventory of Balancer’s innovative initiatives.
Boosted Pools: Using Idle Liquidity for Mining
Balancer partnered with Aave at the end of 2021 to launch Boosted Pools, which can use idle liquidity for liquidity mining in protocols such as Aave. In actual use, Boosted Pools usually only retain 20% or even a lower ratio of total liquidity for trading, and invest the remaining funds in lending protocols such as Aave and Morpho to earn additional income. For example, liquidity providers in the Balancer Boosted Aave V3 USD pool composed of DAI, USDT, and USDC can simultaneously receive trading fees in the DEX, deposit interest in Aave, and $BAL mining rewards issued by Balancer.
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Combining Balancer’s composability with lending protocols, this innovation can incentivize deeper liquidity, more efficient trading routing, higher capital efficiency, and higher returns. However, due to composability, liquidity providers in Boosted Pools may also suffer losses when underlying lending protocols have security issues. For example, in March of this year, the Euler attack resulted in a loss of $11.9 million for liquidity providers in the Balancer Boosted Euler USD pool. Fortunately, the hacker returned the funds in the end.
Composable Stable Pools
In August 2021, Balancer announced the launch of MetaStable pools with Lido and launched liquidity incentive measures. Although Uniswap and Curve previously dominated the main markets in non-stablecoin and stablecoin trading, the emergence of new types of highly correlated and incompletely pegged assets also led to new demands, such as Lido’s wstETH and Compound’s cDAI. These income tokens are close in value to the underlying assets but will change over time. If the Stableswap mechanism of Curve is used to provide liquidity, as time passes, one of the asset’s value changes, and the appreciated portion of the asset is obtained by arbitrageurs.
Metastable pool takes into account the constantly changing exchange rates between assets and concentrates liquidity around the real exchange rate by changing the slope of the Stableswap curve, making liquidity providers more capital-efficient and precise.
Later, Balancer upgraded all stable-type liquidity pools (stable pool, metastable pool, etc.) to composable stable pools. Composable stable pools can directly trade with their own LP tokens, i.e. “nested” transactions, or with WETH and other assets to form trading pairs in other pools, reducing gas fees for joining and exiting liquidity pools.
As mentioned earlier, four of the top five liquidity pools on Balancer on Ethereum are LSD-related, and the mechanism of composable stable pools is more suitable for wstETH, rETH, and sfrxETH, as their profits accumulate into the value of the tokens.
Liquidity Bootstrapping Pool: Over 130 Projects Funded
Uniswap’s popularity allowed anyone to provide liquidity and let others trade after the coin was issued, and also started the IDO craze in 2020. Some projects provided liquidity on the DEX, and the token price rose tens of times in a short period of time, with early returns earned by a small number of whales or bots through scripts. The team did not raise much money during this process, and providing liquidity also required a lot of funds.
As an old-fashioned DEX, Balancer introduced Liquidity Bootstrapping Pool (LBP) in March 2020. This is an intelligent pool that allows teams to issue tokens while establishing deep liquidity.
Balancer allows project teams to allocate their token pool weights, and change weights over time. For example, in the TKN token auction, a liquidity pool with a ratio of 90/10 TKN/USDC can be created, with 90% of the tokens being TKN and 10% being reserve asset USDC.
Over time, the proportion of TKN decreases. According to the programming, the TKN/USDC ratio can reach 50/50 or 10/90. In this process, if there is no external purchasing behavior, the price of TKN will continue to fall, as shown in the figure below.
This is a fairer way to sell initial tokens because early pricing is high, making it unprofitable for robots to rush and likely to suffer losses. When the price falls to the expected value, users spontaneously trade. The project team does not need to provide a large amount of funds initially, and the tokens are sold at reasonable prices, which is friendly to the token issuer.
Fjord Foundry (formerly Copper Launch), a front-end website for using Balancer liquidity bootstrapping pools, shows that more than 130 communities on multiple chains have been auctioned, with an auction value of US$750 million (Balancer and Fjord Foundry charge a fee of 1% of the sales amount respectively). The Xirtam scam project was raised on Fjord Foundry.
The sale of $AKITA tokens donated to Gitcoin is a successful use case of Fjord Foundry. Meme token $AKITA issuers sent some tokens to Vitalik’s wallet. Vitalik donated the token to Gitcoin, but selling the token became a problem. Later, Gitcoin sold $AKITA through Fjord Foundry, and the slow sales process avoided a lot of slippage, accumulating some fee income through the pool.
Weight Pool: Provide liquidity with weighted tokens
Weight Pool is the main feature of Balancer, which is an extension of the AMM formula x*y=k proposed by Uniswap. In Uniswap, only two tokens are allowed to provide liquidity, and before Uniswap V3, the values of the two tokens must be equal.
However, the risks between tokens are not the same, and a 50/50 weight liquidity pool is not suitable for all liquidity providers and all assets, and sometimes multiple assets need to be stored in the same liquidity pool. The birth of Balancer solved this problem, allowing users to build liquidity pools with two or more tokens and customize the weight, such as a 60/20/20 weight pool for three tokens.
Yearn has used Balancer’s 80/20 weight pool as YFI’s liquidity incentive pool when distributing tokens.
Managed Pool: Suitable for fund managers, can charge management fees
Managed Pools is a derivative of Weight Pool, which allows the pool creator (Owner) to update the token weight, allowing the creator to adjust the distribution of internal assets to adapt to different strategies.
However, the development of DEX has become more and more homogeneous. Balancer’s original inspiration may have come from Uniswap, and the recently released Uniswap V4 also plans to implement an architecture that manages all funds in a single Vault and allows developers to develop various functions on Uniswap. The competition in DEX is becoming increasingly fierce.
