Originally published in the NOWNodes blog.
The DeFi sector is creating new records almost every month now. Its growth is such that the DeFi’s locked in value has surpassed $9 billion. When it comes to the locked-in value, Balancer is the third-largest DeFi project currently. The total locked-in value of Balancer stands at $1.36 billion. It proves that Balancer is one of the most popular DeFi projects today. So, what is Balancer? Our 5-minute guide will help you know more about it.
What is Balancer? – A Quick Introduction
Balancer Labs is the name of the company that is behind the Balancer protocol. It has been in operations since September 2019. Balancer Labs’ founders are Fernando Martinelli and Mike McDonald.
At its core, the Balancer protocol is an automatic market maker. So, what exactly does it do? It helps reduce the two most common issues when it comes to trading between two cryptocurrencies. These two issues are cost and slippages. You can also call Balancer as the decentralized option of traditional market-maker. A traditional market maker is a third party providing liquidity to assets that are traded on exchanges.
Any decentralized trading platform can leverage the Balancer protocol. They can call the Balancer protocol and it will use Smart Order Routing to find out the optimum trading prices and best rates for them. They can also use the funds from the available Balancer pools to complete the trades.
There is also a direct relationship between the Balancer and the Uniswap dapp. Wonder what it can be? The answer is the N-dimensional invariant surface. Yes, Balancer uses it and the N-dimensional invariant surface is built upon the Uniswap protocol. Just like Uniswap, Balancer, too, uses automated market makers.
The Balancer pools are not dependent on portfolio management fees from the users. Instead, they collect fees from the traders who are following arbitrage opportunities to rebalance their portfolio.
With Compound Protocol’s governance token gaining prominence in the crypto market, Balancer’s BAL token, too, established itself as one of the leading governance tokens in DeFi. It led to an increase in users on the Balancer’s exchange. Thus, establishing Balancer as one of the top names in the DeFi space.
How Does Balancer Improve Current Financial Tools?
Let’s first start with a question. Why do exchanges exist? Any guesses? The exchanges exist because they fulfill buy and sell orders. They are important for the cryptocurrency ecosystem. The exchanges help in creating a space for many diverse orders and then match them to execute the orders.
The size of the orders, diversity in orders, and varying prices are crucial for all exchanges. But both sell and buy orders will rarely match perfectly. Hence, both buyers and sellers will have to make some compromises to complete the order.
For example, one crypto trader may wish to sell 1.5 ETH for $405 per ETH. But a buyer wants to buy only 1 ETH at $395. As there’s a mismatch between the selling price and buy price, neither order is filled. Hence, the seller will lower their desired price to $400. The buyer, too, will raise the buying price to $400. It will lead to the completion of the portion of a trade.
During low demand, the sellers will have to reduce the prices. It means that they have to make compromises. Thus, it results in a decrease in the price of an asset. When there is an increase in the number of buyers with the limited number of sellers, the opposite will happen. In the end, both buyers and sellers aim to complete their orders without losing too much during the process.
The technology that we described above may look simple at first but implementing this in blockchain, more specifically smart contracts, creates additional issues. Regardless of the number of trades happening between sellers and buyers on an exchange, the process is quick and inexpensive. The traditional exchanges do not require any gas fees. The exchanges also don’t require additional verification from the parties to complete a trade.
When it comes to smart contracts, they require more time to validate the transactions. They also charge gas fees from the users for transactions. It means that whenever a buyer or seller creates an order, the smart contract will charge them gas to complete the order.
Automated Market Maker Makes The Entry
We have already discussed above that a buy or sell order requires multiple calls before the trade is completed. Hence, the traditional way of settling orders between a seller and buyer won’t work in smart contracts. It will prove very expensive for smart contracts. The automated market maker can change this equation completely.
The automated market maker involves interacting directly with a smart contract for both buying and selling. There’s no trading between buyers and sellers in automated market makers. The price determination also happens directly.
How Balancer Does it?
Balancer uses a more detailed version of the automated market maker protocol – known as the constant mean market Maker. Unlike the traditional automated market maker protocols, Balancer allows its users to include many more assets. Yet, the underlying principle between the automated market maker and constant mean market maker are the same.
What is BAL Token?
Balancer has a native governance token and it is known as BAL. The Balancer team believes that BAL is important to establish a truly decentralized governance model in Balancer ecosystem. It will also help diversify the governance. Hence, BAL holders will have the power to guide Balancer to its true potential.
There are plans to deploy the Balancer protocol on other blockchains too. The Balancer team does not want to limit the protocol to the Ethereum blockchain alone. The Balancer team is also implementing a layer two solution. Additionally, they are also aiming to generate revenue by introducing fees at the protocol level. Yet, there is no formal governance structure at Balancer.
We believe that when Balancer comes out with a governance structure, it is likely that it will be similar to the other protocols.
How can you get the BAL Token?
The maximum supply of the BAL is set to be 100 million. But it does not mean that there will be 100 million BAL tokens in circulation at any point in the time. The decision about ending the distribution before the cap is reached is in the hands of the governance – The BAL token holders.
Balancer Labs have set aside 25 million BAL tokens for the stakeholders. It includes the founding team, current, and future employees, investors and advisors. 10% of these 25 million BAL tokens are set aside to act as stock options.
The Balancer Ecosystem Fund will receive 5 million BAL tokens. This fund will be used to grow the Balancer ecosystem by attracting and incentivizing the strategic partners within the ecosystem. The decisions regarding the Balancer Ecosystem Fund will be in the hands of the BAL holders.
5 million BAL tokens will go to the Fundraising Fund. It will enable Balancer Labs to support the operations and growth of the Balancer project.
To distribute 65 million BAL tokens, Balancer activated liquidity mining in June. The Balancer team has decided that almost 7.5 million BAL tokens will be distributed through the liquidity mining process every year. If it continues at this rate, it will take only around 9 years to touch the cap of 100 million BAL tokens in circulation.
Do you want to earn the BAL tokens? You can do it by providing liquidity to the Balancer pools. In return, you will receive rewards every week.
Balancer has seen excellent growth so far. It has been in operations since March 2020 and yet, it has achieved so much during this short time. Balancer is among the most complex DeFi projects currently. Yet, it was able to achieve tremendous popularity.
Today, Balancer Labs is at the third position in the list of the DeFi projects in terms of locked-in value. This is regardless of the hack that it had faced just after the fourth month of its existence. The hacker stole approximately $500K worth of tokens from Balancer.
Balancer may feel a bit more complicated but it has an excellent UI. It is also quite easy to become a liquidity provider on Balancer if one has an understanding of the DeFi space. It will be interesting to see how Balancer does in the future.