Introduction to Balancer Finance and the veBAL System

This is the first piece of a series of two articles that introduces the Balancer and Aura ecosystems by going through the mechanics of these platforms, with the first article focusing on Balancer and the second one on Aura.

Introduction

Balancer (Twitter) is one of the main DEXes on mainnet, which is now expanding to other chains like Arbitrum and Polygon. It has a history of innovating in the swap space by introducing new elements such as weighted liquidity pools and Liquidity Bootstrapping Pools. This post will dive into how economic and governance power flows through Balancer. We will mainly describe it from the perspective of liquidity providers and governance participants (veBAL holders).

Understanding Balancer

In terms of workflows, Balancer has two (sometimes overlapping) stakeholders: Liquidity Providers and BAL holders.

Liquidity Providers

As in many other AMM pools, liquidity providers will add tokens that compose the liquidity pool. Balancer allows them to add liquidity in different proportions as well. In exchange for the risk undertaken and to compensate for the value of money in time, LPs receive value from two different venues:

1. Swap fees, which are paid by pool end users, and shared with other ecosystem stakeholders.
2. BAL rewards, which are allocated to the pool the LP is participating in.

Let’s get into the weeds of these two revenue flows.

Swap fees (1.) come from transactions in each pool. Half of them are allocated to such pools, which results in an increase in the position of each LP token. The other half of the swap fees are divided among BalancerDAO, veBAL holders, and voting incentives or bribes, which will be explained later.

The other potential stream of income for LPs comes from BAL weekly emissions. Through governance, the Balancer community has decided to adopt a vote escrow ‘ve’ model based on Curve’s model. This means that BAL weekly emissions — 145k at the moment — are allocated to each gauge pro rata to the votes received. Gauges need to be proposed and voted for to get deployed. More information about this can be found here.

With the acceptance of the proposal “Decide on Gauge Unexpected Behavior”, BAL is now allocated proportionally to the number of votes received on each gauge. After BAL is allocated to a gauge/pool, liquidity providers receive a portion of the BAL proportionally to a user weight based on the liquidity provided and their voting power. As illustrated in the following figure, the LP weight on the pool is the result of a min function that picks the minimum of two values:

1. liquidity provided
2. a weighted sum between liquidity provided and a term proportional to the voting power

where S is the total liquidity in the pool, bi is the liquidity provided by the user “i”, wi refers to user i’s voting power, and W to total veBAL power. Protocol documentation and the UI typically show that there is a “boost” in the user weight that ranges between 1x and 2.5x, and it is actually because user weight varies between 0.4bi and bi (1 is equivalent to 2.5 times 0.4 😉). The maximum boost (bi) is achieved when voting power equals W*bi/S.

BAL Holders

Let’s now move on to the BAL Holder flows. BAL is a governance and utility token within the Balancer protocol. Unlike CRV, governance rights to BalancerDAO are obtained by locking a liquidity pool token that holds 80% BAL and 20% ETH. This mechanism allows Balancer to maintain deep, durable, and free on-chain liquidity as part of its governance process. Locking the 80/20 BAL/ETH Pool Token grants access to BalancerDAO governance, including the ability to perform the following tasks:

1. Participating in the protocol governance by voting on Balancer Improvement Proposals (BIPs)
2. Participating in defining the allocation of weekly BAL emissions to the different gauges.
3. Receiving a share of fees earned by the protocol.

This BAL BPT (Balancer’s acronym for liquidity pool tokens) can be locked to receive veBAL. As mentioned above, this is a vote escrow mechanism based on the Curve veCRV model but with minor differences. One of them is that BPT can be locked in for 1 week up to 1 year (as opposed to 4 years on Curve). As illustrated by the graph below, one BPT locked for one year is equivalent to one veBAL, and that value starts to decrease linearly until it reaches zero at the end of the locking time. Some interesting Dune analytics dashboards, which illustrate how veBAL power has evolved, can be found here.

Users that stake BAL BPT tokens, i.e. veBAL holders can benefit from different revenue streams, mainly:

• BAL emissions allocated to veBAL holders (with a 10% cap on weekly emissions)
• A portion of the protocol fees, which come out of the swap fees
• Rewards for voting specific pool gauges (discussed further below)

As previously mentioned, 50% of the swap fees are reinvested in the pool, while the remaining 50% is considered protocol fees and split between the DAO treasury (25%) and veBAL holders (75%). Holders of veBAL receive this 75% of protocol fees through different routes, depending on the blockchain and the pool they come from. For most pools:

1. Fees collected in BAL are subsequently distributed in BAL
2. Fees collected in tokens that are paired with BAL in any Balancer Pool are then swapped for and distributed in BAL
3. Fees collected in any other token are swapped for and distributed in bb-a-USD tokens.

The image below illustrates the current protocol fee allocation.

As per BIP 19 “Incentivize Core Pools & L2 Usage”, which aimed at resolving an incentive misalignment with protocol revenue, certain pools are categorized as strategic or “core” pools because they grow Balancer’s footprint in L2 blockchains, or because they represent the largest protocol revenue stream. In a nutshell, 75% of protocol fees coming from these pools are allocated as voting incentives to Hidden Hand for votes toward them. Voting incentives are implemented as follows:

1. Protocol fees coming from mainnet are to be swapped for USDC and allocated to each pool proportionally to the fees generated in them.
2. Protocol fees coming from all L2 chains are to be swapped for USDC in the L2 and bridged to mainnet to be allocated to each L2 core pool proportionally to their TVL.
3. Voting incentives are allocated proportionally to bribing markets that control at least 20% of the total veBAL supply.

The following image illustrates the flows of value for veBAL holders explained so far:

Conclusion

This article covered how liquidity can be deposited in Balancer and staked to receive incentives. We have also explained how these incentives are allocated by participating in governance through the veBAL system and how the value from fees flows to the different stakeholders.

In the next article, we will cover Aura Finance and how it seeks to maximize boost through the social aggregation of veBAL while separating the yield generation aspect from the governance one.

Further Reading

• Here’s our second article on Aura.

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