Balancer multi-token pools offer liquidity providers a higher level of control compared to traditional 50/50 pools
Liquidity pools have revolutionized the world of cryptocurrency trading, allowing investors to earn income from idle funds and allowing traders to instantly swap one asset for another. However, as with any new paradigm, first generation liquidity pools and automated market makers (AMMs) are not perfect. Ask any DeFi user and they’ll likely admit they’ve had to contend with high gas fees, limited trading pairs, or the looming risk of fickle loss.
Fortunately, a solution is on the horizon – multi-asset pools offer liquidity providers greater control over their assets while reducing trading costs. Here’s everything you need to know about balancer multi-token pools and how they benefit both sides of the liquidity equation.
A multi-token pool: balancers
Most traditional AMMs like Uniswap v2 create 50/50 liquidity pools. In this scenario, two tokens can be traded against each other and given equal weight or importance. If the demand for either of these two tokens increases, the AMM will ensure that its price increases accordingly.
Liquidity providers that add tokens to these pools earn fees on every trade, making AMMs an extremely lucrative source of passive income; However, these 50/50 pools are actually quite inflexible – most users rarely want to own exactly the same amount of two tokens. For example, a risk-averse investor may only want to own a small percentage of volatile assets.
This is where the balancer protocol comes in – it is an AMM network specifically designed to handle many tokens in a single pool. Even better, it allows liquidity providers to set up their own pools with custom token splits and weights. This level of customization helps providers take full control of their portfolios and plan to reduce their exposure to risky assets. It also allows traders to do swaps with low fees as we will discuss in the next section.
Balancer’s ability to create a pool of multiple tokens also allows it to act as an index fund, where you can create custom portfolios or baskets of tokens depending on your investment philosophy. Instead of manually rebalancing your portfolio to maintain the correct proportion of tokens, the pool automatically adjusts prices as traders switch between different tokens.
An 8 asset pool: balancers
So what does a multi-token pool look like? With Balancer, this is fully customizable – you could create an 80/20 pool consisting of WETH and WBTC, or an 8-asset pool with an equal allocation of 12.5% to each token.
Traders looking to switch between lesser-known assets will also benefit from a multi-token pool. With traditional AMMs, if a direct trading pair does not exist, you would first need to convert your token to a more liquid token such as ETH or stablecoin before proceeding with your final exchange. However, with multi-asset pools, the number of possible trading pairs increases many times over.
While older two-token pools result in only a single trading pair, a four-token balancer pool results in the formation of six distinct pairs. Not only does this provide traders with an easier exchange experience, but it also increases the potential revenue streams for the liquidity providers participating in this pool.
Multi-token pools with custom weights also solve one of the biggest problems of traditional liquidity pools: volatile losses. In short, impermanent loss refers to the scenario where liquidity providers lose money to market volatility while their tokens remain locked in a pool. Liquidity providers typically stay away from volatile tokens, which could differ significantly in value from the other assets in the pool. While this strategy helps avoid fickle losses, it is an imperfect compromise.
The ability to create liquidity pools with different weights helps limit exposure to volatile assets that may be subject to price fluctuations. In other words, a liquidity provider would be exposing themselves to less risk by participating in an odd pool. This is because the volatile component can be as little as 5 or 20% compared to a flat 50%.
In fact, Balancer’s customizable pool feature also helps other DeFi projects to control and mitigate risk. For example, Aave uses an 80/20 liquidity pool to hold a reserve of tokens for its security module. According to Aave, “Holding AAVE/ETH liquidity with unequal weights comes very close to simply holding AAVE, with the benefits of earning additional trading fees.”
In a previous section, we discussed how multi-token pools yield more trading pairs than traditional two-token pools. If you have an 8 token pool, you need 28 two token pools to provide the equivalent number of direct trading pairs!
However, there are also some other benefits worth mentioning. More specifically, since multi-asset pools contain many more potential trading pairs, traders can switch between tokens for lower fees.
Additionally, Balancer’s unique Smart Order Router ensures traders always get the best price, even if it means going through multiple pools. Balancer can intelligently calculate which route yields the highest number of issue tokens, depending on the liquidity available in each pool. The feature also accounts for gas fees, ensuring the extra pool hops make good business sense.
With Balancer V2, the Smart Order Router becomes even more efficient as assets across all pools are kept in a single vault. This means that a multi-hop swap can be processed internally without having to create expensive on-chain transactions for each individual hop. This concept is similar to Layer 2 scaling networks that consolidate multiple transactions into a single on-chain record.
For a practical example of how much a trader can save using Balancer V2, see our dedicated post on Smart Order Routing.
Final Thoughts
All in all, multi-token pools offer flexibility to both liquidity providers and cryptocurrency traders. And that’s not all – the Balancer protocol’s unique feature set is taking DeFi to the next billion investors through a combination of lower fees and unprecedented simplicity.
Learn Crypto Trading, Yield Farms, Income strategies and more at CrytoAnswers
https://nov.link/cryptoanswers
Comments are closed.