11/16/2020
Demystifying DeFi: What is Balancer & How Can You Make Money With It?
Balancer is one of the most popular automated market makers (AMMs) in the burgeoning DeFi market. An understanding of what Balancer is and how it works can help you decide if you want to use it to dip your toe in the DeFi liquidity pool to earn investment income.
What Is Balancer?
Balancer is an automated market maker protocol that enables users to seamlessly exchange Ethereum-based assets in a decentralized manner.
In many ways, it functions in a similar way as Uniswap. However, Balancer’s prime differentiating factor is that it supports as many as eight assets for each market.
Also, the creator of the pool is allowed to set custom trading fees for transactions.
How Does Balancer Work?
BalancerA market maker in a traditional market acts as a liquidity provider. They buy and sell financial instruments, buying from sellers and selling to buyers.
When they buy an asset, they mark up the price and then sell it to a buyer. Market makers make their money off this mark-up, which is called the bid-ask spread.
An automated market maker like Balancer accomplishes the same purpose but through the use of algorithms; they set the rules for trading.
A user creates a balancer pool and then adds liquidity to the protocol by depositing digital assets. This is where the Balancer process gets different because instead of limiting users to the normal 50/50 split between the pair of tokens, Balancer allows as many as eight tokens to be included at once. Also, users can decide how much of each token makes up the pool.
For example, you could choose four tokens: MKR, DAI, USDC, and LINK. You could then set your own percentages for each token. For instance, you could spread it out like this:
MKR: 20%
DAI: 30%
USDC: 35%
LINK: 15%
To route trades to the pools in a way that provides the best rate possible, Balancer makes use of smart order routing (SOR).
How to Use Balancer to Earn Investment Income
As an investor, you can earn with Balancer by depositing tokens into a liquidity pool to receive a portion of the trading fees. In addition to earning trading fees, liquidity providers are also rewarded with BAL tokens, the protocol’s governance token, that is minted to incentivize users to provide liquidity.