by Franklin Bi and Kristie Huang, Nov 2020
In early 2018, serial entrepreneur and longtime Maker community member Fernando Martinelli started exploring mathematical frameworks for DeFi liquidity protocols as a research project. Uniswap didn’t even exist at the time — Fernando was simply searching for a better way to provide liquidity on his own terms. Eventually, Nikolai Mushegian, original architect of the Maker/Dai contract system, and Mike McDonald, creator of mkr.tools, joined Fernando to actualize the idea.
Out of their efforts came Balancer. Balancer is a next-generation automated market maker (AMM) built on top of Ethereum, bringing programmable and customizable liquidity to DeFi.
The current state of AMMs
AMMs differ from order book-style decentralized exchanges, which have suffered from liquidity issues on today’s blockchains because of low transaction throughput leading to similarly low order book depth. Order books work by collecting and matching buy and sell orders for a particular trading pair to make markets and set prices.
In an AMM, users trade directly with a smart contract, rather than being matched with each other, making it much easier to access liquidity and execute a trade quickly. The smart contract acts as the “maker” by drawing from a pool of assets — for example, a pool of ETH and DAI tokens for an ETH-DAI pair — to fulfill trades. Prices are set based on a mathematical formula involving the relative percentages of each token in the pool.
But while other AMM pools typically hold only two assets in a strict 50–50 ratio, Balancer’s protocol is designed to be highly customizable.
How Balancer works
Balancer’s Core Pools allow liquidity providers (LPs) to deposit up to eight ERC20 tokens with any percentage allocation, as low as 2% or as high as 98%, between them. Portfolio rebalancing is a continuous passive process enforced by market dynamics: arbitrageurs are incentivized to buy underpriced and sell overpriced assets, which preserves asset ratios for LPs. In addition, LPs receive two forms of rewards for supplying liquidity: trading fees earned from every trade made on their pools, and the protocol’s governance token, BAL.
In this way, Balancer doubles as an automated portfolio management tool; investors simply deposit their idle ERC20 tokens into a self-balancing portfolio that earns passive income from trading fees. Imagine a robo-advisor that pays you to automatically manage your portfolio of 60% BTC, 30% ETH, and 10% USDC. This unique value proposition has made Balancer the 3rd largest decentralized exchange by total pooled assets, reaching a high of US$1.5 billion during the recent DeFi surge.
Alternatively, Balancer enables highly flexible configurations for liquidity pools. Smart Pools are a type of liquidity pool that can be owned and managed by smart contracts, meaning that the pools’ parameters can be variable and dynamically adjusted by any arbitrary code. This creates a new opportunity for token issuers, who can leverage Smart Pools to bootstrap their token distribution. DAOs can use Smart Pools to implement pools with community-chosen features and configurations, like PieDAO’s “++” tokens. Surge-pricing pools can charge higher fees during periods of higher volatility.
Balancer’s innovation on the supply-side creates a deep liquidity source so that demand-side traders on Balancer are able to execute trades quickly, reliably, and efficiently. Smart order routing draws on the entire Balancer ecosystem to optimize for the best price execution and lowest slippage.
Collectively, this system produces a clever positive feedback loop: as more liquidity is deposited, traders receive better rates and less price slippage. Higher trading volume translates to increased fee earnings for liquidity providers, which, in turn, attracts more liquidity. Since their launch in March, the protocol has grown to support more than 2,200 total pools. From June to August, unique daily active LPs increased by 10 times.
Designed to be highly composable, Balancer has seen dozens of projects, such as PieDAO, Ampleforth, 1inch, RealT, and Hummingbot, integrate with Balancer to bootstrap their liquidity and increase accessibility for their users. These developments bring further capital to the protocol and demonstrate Balancer’s success as a go-to permissionless financial primitive. The total value locked in Balancer is currently above US$350 million, and the all-time trade volume is upwards of US$3.1 billion.
Why we’re excited about Balancer
We believe that DeFi is still in the very early innings.
As the DeFi ecosystem evolves and becomes more complex, decentralized market infrastructure will need to meet that complexity with a high degree of configurability and generalizability. Just eight months old, Balancer has demonstrated its ability to innovate and deliver value for all parts of the liquidity ecosystem.
We’re thrilled to partner with the Balancer Labs team as they build the most flexible and deepest liquidity protocol for tomorrow’s financial system.
The team is currently working on Balancer V2 and distributing a second round of Balancer Ecosystem Fund grants.
Also, the Balancer team is growing — if you’d like to keep up with their open roles and others in the Pantera portfolio, visit our Jobs Board.
If you’d like to read more about Balancer, check out these resources: