Tokenomics 101: Balancer
revenue sharing & voting escrow
Balancer is a core building block of DeFi. Traders, builders and investors all use it to interact in trading of tokens. Balancer is an automated market maker and trading platform just like Uniswap, Sushiswap, Curve and many others (read this to learn how they work). The competitive advantage lies in the flexibility.
Most automated market makers work with one party providing token pairs like ETH<>USDC into a pool and the other party accessing that pool to trade ETH for USDC. Balancers flexibility comes into play by offering a set of options to customise how these pools are set up.
Why would someone need such flexibility?
Take a small token that wants to launch and does not have a lot of funds to fill a 50/50 pool with USDC and their new token. With Balancer they can launch a bootstrapping pool that works on balancing a 20/80 pool towards 50/50 with a low investment of USDC.
Liquidity bootstrapping pools are just one of the many possibilities Balancer offers on Ethereum, Arbitrum and Polygon.
Investors can deposit fixed allocations to have their portfolio of tokens automatically rebalanced along their preferred weighting while collecting fees from traders.
Traders can access deep liquidity and profit from low gas trades.
Builders get flexible, programmable liquidity and use it in protocols such as Aave and Ocean Protocol.
For those new to automated market makers and Balancer, this video provides a great intro:
The token mechanisms at play are interesting in that Balancer gives token holders a share of their revenue for holding and locking up a version of their token. A zoomable diagram can be found here. I’ll walk through the different components down below.
Balancer protocol: Liquidity Pools
The main feature of Balancer is the liquidity pool. Users deposit token pairs and receive a fee when others trade against these tokens. Unlike Uniswap and Sushiswap, up to 8 tokens can be paired in a pool and users can add custom logic (fees, liquidity and weighting).
With version 2 (launched in feb 2021), Balancer split up the token holding and the logic of each pool into separate components (details here). A single vault - think of it as a large wallet - will hold all tokens within Balancer while the accounting of which pool owns what is recorded in a smart contract. The smart contract takes care of the fees and weighting too.
The advantage is that Instead of actually executing trades against pools, the trade info can be sorted out on paper between the pools smart contracts so that just the actual end result needs to be traded.
The image below shows a trade of DAI for MKR. In the previous version of Balancer this trade might have been settled between multiple pools whereas now with one big vault only the end result needs to be sent.
Depositors of tokens don’t just receive a fee, but an additional incentive in the form of BAL tokens from the genesis supply (~7.5M are distributed to liquidity providers / year). How the liquidity mining reward is distributed, is decided weekly in a decentralised snapshot vote and veBAL holders are eligible to vote.
The biggest pool according to Messari is the BAL/WETH pool which is not surprising as this is the pool required to receive veBAL token (more on this below).
Balancer Protocol: Asset Manager & Flash Loans
Tokens held in the vault belonging to a pool are idle capital most of the time. Asset Managers are external applications such as Aave that can put the capital in pools to use and increase yield. The external application is nominated by the pool and in the case of Aave lends out tokens to collect yields from borrowers.
Flash loans - loans paid back in the same transaction - is another service offered by Balancer and used for quick arbitrage opportunities.
Asset Manager, flash loans and swapping of tokens all are charged a fee that is collected in the Balancer DAO treasury. The fees accumulate to a nice, more or less diversified sum in the treasury (from Messari).
Ultimately token holders decide how the funds are distributed and how high fees should be. Governance is split across two tokens:
BAL: the regular governance token, which enables voting on how to use the DAOs treasury.
veBAL: the newly introduced vote-escrow governance token which gives token holders governance rights by locking up tokens over a period of time (max 1 year). The difference to Curve (who pioneered this model) is that it’s not $BAL that is locked up, but the liquidity token $BTP, received for adding to the $BAL / $WETH pool. Whoever locks up 1 $BTP receives 1 $veBAL and by that gets a part of 75% of the collected protocol fees. veBAL holders decide how liquidity providers are rewarded with BAL from the genesis supply.
The Balancer forum has a handy diagram on how fees are distributed:
Value creation and value capture
Balancer creates value as a decentralised exchange but has a lot of competition. The competitive advantage comes from the split up of vault and pool logic described above.
Just try to swap two, not so popular, tokens (e.g. BANK for SUSHI) on Sushiswap and have a look at the route proposed to get to the end result of swapping. There are multiple steps (hops) along the way that in most cases will cost gas.
Balancer, instead of transferring tokens on each step of a multi-hop trade, lets the pools simply keep internal records of which pool is holding what part of the vault, transferring tokens only at the input and output step. This reduction in token transfers ultimately saves a considerable amount of gas.
This makes Balancer not only valuable for individuals but also as a backend for protocols. On top of this, having all liquidity in one place allows for potentially deeper liquidity than protocols that split pools. One big pool with USDC, UNI, BAL, DAI can offer deeper liquidity than isolated USDC:UNI, USDC:BAL, … pools as in the latter USDC can only be in one pool at a time.
Gas efficient trades and liquidity create value for users. The value capture ultimately comes from the fact that BAL / veBAL holders decide how the treasury is used, how high fees are and who receives liquidity mining rewards. Token holders are often also liquidity providers and want influence over how their pools might be incentivised or rewarded.
By paying 75% of protocols fees to veBAL holders, Balancer creates a strong incentive to bring in additional fees through new liquidity and with the 1 year lockup adds a long term thinking component that should get all holders more on the principal side.
Supply: Distribution and Unlocks
The maximum supply of BAL tokens is capped at ~100M (the token was launched 23/06/2020) with a halving of supply every 4 years, similar to Bitcoin. New token supply is minted into circulation every week via liquidity mining, following a supply schedule shown below.
This BAL supply for liquidity mining, is part of the community distribution and makes up by far the largest chunk of the allocation besides Founders, Ecosystem and Fundraising.
Vesting and unlocks are scheduled in the following way:
65M Community allocation is minted at 145k BAL tokens per week or 7.5m per year.
25M for Founders, Options, Advisors and Investors with 25% available immediately and 75% unlocked over 3 years (most tokens are unlocked by now).
5M Ecosystem with no vesting, distributed based on BAL holder governance.
5M for initial and future fundraising at a seed price of $0.6 / BAL.
At the time of writing Balancer has reached about 35% of its fully diluted valuation and it will be about 9 years until 90% of max supply is reached.
The majority of emissions via the community liquidity mining is quite predictable but will introduce a lot of tokens into circulation, diluting current holders shares. On top, founders received quite a large share.
Governance gives power over liquidity mining allocation, fee reduction and use of treasury. All drive demand. Similar to how Curve works, the main demand from these drivers is return on investment. Holders of the governance tokens want to impact and improve their own personal return on investment by allocating rewards to their pools or manage fees in favour of their asset allocation. That’s why they would consider buying and holding the BAL token.
Additionally, the veBAL token gives holders a direct share of Balancers` revenue. This does indirectly drive demand for BAL as in order to receive a share of revenue, BAL/WETH needs to be added to the pool and BTP tokens need to be locked up for veBAL.
From Token Terminal, the revenue figures look quite interesting (Messari goes into even more detail here) and in many traditional businesses cash flow is a demand driver of its own regardless if it’s paid out or not - just look at Amazon.
The question to ask is then why traders would use Balancer over Uniswap, Curve, etc. and if Balancer can sustain these revenues? The competitive advantages are the higher gas efficiency achieved by avoiding hops between currencies on trades (described above) and also the deeper liquidity of combining all tokens in one vault instead of pairing them across pools.
Market share measured by total value locked could be an indicator for how well this competitive advantage plays out (seems to be somewhat holding up).
From a pure token perspective the veBAL token seems quite attractive and well linked to what Balancer is trying to achieve - getting more volume / revenue on their platform as token holders directly benefit from it.
The competitive advantage rests upon technical implementation of pools. I’m not an expert, but I can’t see why competitors wouldn’t implement similar models. The good thing here is always being early and attracting and maintaining good liquidity while innovating faster than the competition.
Balancer has been around for a while and most of the cheap, early tokens allocated to investors have been unlocked by now. However, more than 50% of tokens will still be distributed and while the distribution is very predictable, it will have to be met by demand.
The unlocked BAL tokens will have to be invested to bring more users to the platform, to increase revenue, to keep demand for BAL tokens up. If this happens, more BAL could be locked up in pools so veBAL holders collect a stable yield. If not, the yield likely would need to be shared across too many holders and thus decrease per holder.
Regardless of how this unfolds, the revenue sharing mechanism of veBAL is a very exciting concept that almost turns Balancer into a dividend paying blue chip stock.
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