DeFi Decrypted: What Is Balancer and BAL? — AAX Academy
As part of the DeFi boom, an increasing number of decentralized finance projects appear on the market every day.
Launched in March 2020, the automated market maker protocol Balancer is no different.
However, the DeFi project introduced an exciting concept that allows crypto enthusiasts to manage digital asset index funds in a unique way.
What Is Balancer?
To achieve this, Balancer uses liquidity pools where providers contribute tokens to earn trading fees.
However, instead of the standard 1:1 token pair model (e.g., 50% DAI and 50% ETH), Balancer allows users to create customizable pools with up to eight digital assets with arbitrary weight (e.g., 20% DAI, 30% BAL, 10% MKR, 40% ETH for a four-coin pool).
Unlike Uniswap or Curve, Balancer doesn’t use fixed fees for trades. Instead, liquidity pool creators set how much is charged for trading, ranging from 0.0001% to 10%.
Furthermore, the platform utilizes the Constant Mean Market Maker (CMMM) protocol that allows users to enter, swap, and remove cryptocurrencies from liquidity pools without friction. As a result, Balancer’s pools are self-balancing (hence the name of the project).
For better understanding, think of Balancer as an inverse exchange-traded fund (ETF).
On the traditional market, investors pay fees to fund managers for rebalancing their portfolio. On the other hand, liquidity providers (investors) earn fees on Balancer while traders and arbitrageurs are responsible for rebalancing the pools.
As Balancer lacks an external price oracle, cryptocurrency prices in a pool only move when a user makes a trade. Also, if a digital asset’s value in a pool becomes distinct from the market price, arbitrators will step in to eliminate the difference and earn a profit on the spread.
Users can create three different pools on Balancer:
- Private pools: Here, the creator has full permission over the pool where only he can contribute liquidity and update its parameters.
- Shared pools: In shared pools, the tokens inside, their weights, and trading fees are set permanently. Unlike the previous type, the creator has no special privileges here. Instead, anyone can provide liquidity to shared pools. Balancer tracks the ownership of the pool’s liquidity via the Balancer Pool Token (BPT).
- Smart pools: Instead of the creator, this pool is managed by a smart contract. Anyone can supply liquidity to smart pools while allowing users to make adjustments to the fees, balances, and weighting.
In terms of Balancer’s decentralized exchange, the protocol uses Smart Order Routing (SOR) to optimize all pools and execute prices efficiently. Before initiating a trade, users can preview the expected price and slippage on the platform.
What Is BAL?
Like most DeFi projects, Balancer didn’t start as a fully decentralized project.
Instead, the protocol used a centralized governance model where the company Balancer Labs was responsible for managing the project. Interestingly, the firm collected $3 million in a seed round, right after the platform’s release in March.
To decentralize how the project is managed, Balancer issued its own BAL token and started distributing it to liquidity providers in June.
BAL is a governance token that gives voting rights to holders, allowing them to decide on future protocol upgrades.
What Happened During the Balancer Hack?
In late June, a hacker successfully exploited a flaw in Balancer’s smart contracts. As a result, the perpetrator was able to steal over $500,000 in Ethereum (ETH), Wrapped Bitcoin (WBTC), Chainlink (LINK), and Synthetix (SNX).
To achieve the above, the attacker borrowed $23 million in ETH via the dYdX protocol. After that, the hacker used the deflationary token Statera (STA) that automatically burns 1% of every transaction.
Since Balancer did not take this function of the token into account, the attacker exchanged STA and ETH numerous times to exploit the smart contract’s flaw and raise the deflationary token’s price.
As the final step, the hacker used weiSTA (a billionth of the token) to do atomic swaps to ETH, WBTC, LINK, and SNX until the STA pools were drained. Due to the coin’s burning mechanism, the hacker was able to do the swaps without actually exchanging weiSTA, allowing him to make a significant profit on the trades.
Following the event, Balancer has taken measures to prevent similar attacks in the future. Also, the project’s smart contract has recently been audited by the OpenZeppelin team that found only minor issues in the code.
However, we encourage you to do your own diligence before investing in a DeFi or cryptocurrency project to ensure your funds’ safety.
How Did BAL Perform in Terms of Price?
After a short period of decline, BAL entered into a bull run from early August, surging from $10.34 to as much as $36.74 in less than a month.
However, after the over 250% increase, the cryptocurrency started downtrending from early September.
Since then, the token has been continuing its fall, currently trading at $10.07 on October 30.
Originally published at https://academy.aaxpro.com on October 30, 2020.