Balancer’s Smart Pools: Emerging Use Cases

Balancer is an automated market maker (AMM) platform. An AMM is an exchange protocol that relies on the interaction between liquidity providers who provide assets to liquidity pools that provide tokens for a decentralized exchange. These liquidity pools are managed according to a pre-established algorithmic formula that determines prices on the platform. On Balancer, liquidity providers can deposit any combination of up to eight different tokens into a particular crypto liquidity pool, each of which mathematically maintains a fixed ratio of token values.

An example of how it works in practice: a Balancer pool can be made of 80% ETH, 10% DAI, and 10% GUSD. As the market prices of those assets fluctuate and the ratio begins skewing too far from the intended ratio, the protocol automatically rebalances the ratios by adjusting the price of the assets until the balance returns to equilibrium.

Balancer Liquidity Pools: Smart Pools vs. Core Pools

A recent innovation by Balancer has been the introduction of smart pools, which are dynamically adjusted, actively managed crypto liquidity pools that are open for participation to anyone. Prior to the creation of smart pools, Balancer had two types of core pools: shared and private.

Shared/public pools are open for anyone to participate in as a liquidity provider. Shared pools have their parameters permanently finalized, meaning the type of tokens, the ratio of tokens, and the fee of a shared pool can never be changed once created. By contrast, private pools have open and variable parameters that can be changed at any time by the pool’s owner. As opposed to shared pools, the owner of a private pool is also the only one who can contribute liquidity to the pool.

Smart pools combine the best of both shared and private core pools by allowing the pool’s parameters to remain flexible while also letting any Balancer user participate as a liquidity provider. In other words, conditional investing strategies can be encoded into a Balancer smart pool. This means the factors of when, where, and what assets to allocate can be dynamically controlled. As a result, the introduction of smart pools on Balancer opens up a whole new realm of possibilities for crypto lending and for managing digital assets on the Ethereum network.

Smart Pool Parameters 

There are six variables that determine a smart pool’s staking strategy. When setting up a new smart pool, these variables can be left open to allow for future readjustments or permanently sealed to prevent future changes. The parameters that can be set as open or closed by the smart pool’s creator are:

• Swap Fees: The swap fee is the fee paid by traders to liquidity providers whenever a token exchange occurs.

• Pool Weights: A Balancer pool’s weights are the ratio of assets in a pool. Leaving this parameter open means a smart pool can change its token composition from 80% ETH and 20% BTC to 20% ETH and 80% BTC.

• Liquidity Provider Restrictions/Pre-approved Lists: A restrictive list controls who is allowed to become a liquidity provider for a smart pool.

• Allowable Tokens: Changing tokens allows different ERC-20 tokens to be added or removed to an existing smart pool.

• Limit Total Balancer Pool Token (BPT) Supply: Limiting the total BPT supply controls how big a smart pool can become by restricting the total value of a smart pool.

• Swapping Pauses: The pool has the ability to stop trading using the “pause swapping” feature.

For the purposes of this article, we will examine several common use cases enabled from making use of smart pool parameters:

Surge Pricing

If a smart pool’s swap fee variable is left open and managed by a smart contract, surge pricing becomes an option for a liquidity pool. Through the ability to change trading fees depending on demand, liquidity providers can maximize income by raising fees during times of increased trading activity. By dynamically adjusting fees depending on demand, a smart pool can attract more liquidity providers who are enticed by the possibility of earning more fees.

Liquidity Bootstrapping Pools

Thus far in the history of cryptocurrency, the launch of new tokens has been an asset distribution event driven by speculation. For example: during the Initial Coin Offering (ICO) boom of 2017, token launches were commonly characterized by volatile prices. In 2020, when DeFi lending tokens such as UMA were launched on the Uniswap AMM, buyers also rushed to be the first to buy new tokens — driving up prices and transaction costs.

Balancer’s smart pools are enabling a novel way to distribute a new token that avoids the issues once inherent to token launches. Through a Balancer smart pool, projects are able to “bootstrap” a token by gradually introducing the asset into a Balancer pool. Issuing teams are able to incrementally adjust the pool’s token ratio over time to create liquidity and value at a more steady pace. This allows teams to strategically distribute project tokens in a way that is less volatile.

Smart Treasuries

The final Balancer use case we will examine is smart treasuries, which can be used to automate the management of an organization’s funds. By controlling who can be a liquidity provider for a given smart pool, organizations can control who can withdraw or deposit capital. If only official team members are allowed to move assets in and out of a smart pool, the team can take money out when they need to spend it or add money to the pool when there is an excess.

Furthermore, the assets staked in the smart treasury are always working — earning fees as a liquidity provider and executing a diversified portfolio strategy. This smart pool can therefore serve as the automated investment manager for a team’s assets, buying and selling tokens when prices reach a predetermined threshold thanks to the smart pool’s automated rebalancing feature.

Emerging Use Cases

The three cases above are only some of the use cases enabled by Balancer’s adjustable smart pool variables. When the flexibility of smart pools is increasingly combined with dynamic smart contract code, it is possible to actualize and automate nearly any conceivable investment strategy. Balancer’s smart pools open up a hitherto unattainable range of possibilities, further building upon the exciting promise of decentralized finance.