Balancer (BAL): A Deep Dive into Automated Market Making

Balancer is a DeFi protocol based on Ethereum that allows for automatic market-making (AMM). Unlike a traditional market maker/liquidity provider which buys and sells financial instruments, an AMM is a market-making agent that is controlled by algorithms that define rules for trades.

Other DeFi platforms like Uniswap and Curve also support AMM. Bringing Balancer as an AMM into Ethereum’s DeFi ecosystem, the assets in a market, along with the algorithm controlling that market, and the ability to create such a market all become decentralized.

Balancer stands out because its growing assets per market, and growing, along with custom trading fees set by the pool creator.

As between Uniswap and Balancer, please see the table below:

Features Uniswap Balancer Labs Supported assets ETH & ERC20 ETH & ERC20 # supported assets per LP 2 8 Weighing of LP assets 1:1 Arbitrary LP token Yes (for bookeeping) Yes (functional ERC-20 token) Price oracle No outside oracle, asset prices change based on trades No outside oracle, asset prices change based on trades Trading fees 0.3% Set by the liquidity pool creator Protocol fees No No Native token No No

Uniswap vs. Balancer Labs. Source: Token Terminal

The “Flywheel Effect” and Balancer Pools

Under the pooling system, users create the “flywheel” network effect, resulting in increased liquidity, traders, fees, and profits for liquidation pools (LPs). Consequently, users can use pools in two different ways:

Example Balancer pool with five assets: Basic Attention Token, Augur’s REP, DAI, Wrapped Ethereum, and 0x’s ZRX

#1 - Providing Liquidity

Users are able to deposit supported assets* into pools, providing liquidity to users of the pool. For those users who choose to deposit their assets into the pool, they earn a fee. However, when users provide liquidity, there’s never a guarantee they keep their assets, as there are cases where some liquidity providers may lose them.

#2 - Trading

Pools also allow for users to trade tokens, with Balancer’s smart order routing system, which helps ensure the exchange of crypto at low fees and at quick speeds.

Comparing Balancer to centralized exchanges like Coinbase and Binance, which use order books to derive prices (think of Kelly Blue Book for motor vehicles). The price of tokens in a pool is based on their deviation from their set weighting. Based on Balancer’s flexible parameters, pools serve as more than just a locale for crypto holders to exchange their assets. Balancer Labs has released pool schematics to remove the risk of LPs losing their assets.