DeFi Unlocked: How to Earn Crypto Investment Income on Balancer
In our Defi Unlocked series, we delve into the most popular protocols to show you how you can generate an investment income in the decentralized finance market.
In this article, we will discuss Balancer (BAL), how it works, and how you can use it to earn crypto investment income.
What is Balancer?
In March 2020, a research project named Balancer Labs announced that it closed a USD 3 million seed round, after developing the Balancer protocol.
Similar to Uniswap, Balancer is based on Vitalik Buterin’s concept of Automated Market Makers (AMM). In contrast to market makers in traditional markets, where market makers place orders in the orderbook to provide liquidity and generate trading revenues, AMMs are software protocols that define how trades work in a specific ecosystem.
Balancer describes AMMs as “automated agents, controlled by algorithms, that define rules for matching buyers and sellers to facilitate trades. Usually, AMMs are continuously active in both directions of a trading pair. The liquidity provider’s profit comes from the spread between buy and sell prices.”
Similarly to a number of players within the DeFi market – most notably Uniswap – Balancer is an open-source AMM that allows any party to add its tokens to a liquidity pool in exchange for a cut of the fees charged for facilitating trades.
However, Balancer’s biggest distinction is the ability to create pools with up to eight tokens while simultaneously supporting the customization of the ratios and trading fees for each asset.
The BAL Token
The Balancer Protocol leverages its native token as its main governance tool. The native token, called BAL, was introduced into the protocols ecosystem after its initial launch.
The token was designed as a way to reward those who chose to participate in pools as liquidity providers. In markets, early liquidity providers typically have to contend with more risk. To adequately reward early liquidity providers, Balancer Labs used the concept of liquidity mining.
Liquidity mining refers to the process through which a protocol distributes its native token as an incentive to liquidity providers in its ecosystem.
The total supply of BAL tokens is capped at 100m. A quarter of the total BAL tokens, 25m, was allocated to founders, stock options, advisors and investors. 5m BAL tokens were set apart for the Balancer Ecosystem Fund and the Fundraising Fund. The ecosystem fund is to help facilitate strategic partnerships while the Fundraising account is to support Balancer Labs’ continued operations. The remaining 65m will be distributed to liquidity providers.
To make the token distribution as fair as possible, distributed BAL tokens are shared in direct proportion to the amount of liquidity each address contributes, relative to the total liquidity on Balancer. Moreover, because liquidity is provided in several different tokens, USD is used as the base currency in these calculations.
How to use Balancer
To use Balancer, access the protocol’s website here. To begin providing liquidity to earn trading fees and BAL tokens, click on exchange.
You will then be directed to this page, where you will need to connect a suitable wallet in order to access Balancer.
You can choose between MetaMask, Portis or WalletConnect.
Once you have connected to your wallet, you will then be directed to the exchange. There, you can convert one token for another. However, if you want to add liquidity to the protocol to earn an investment income, you will need to click “Add Liquidity” on the top right.
Then you will be taken to https://pools.balancer.exchange/#/ where you can view all the available trading pools.
Next, you pick a pool you want to provide liquidity to and connect your Ethereum wallet again, so that you can start depositing tokens.
Once you have chosen a pool that contains the asset you want to deposit, click on it and click “Add Liquidity.”
You will then be asked to set up a proxy, which you will need to confirm using your Ethereum wallet and then you are able to deposit your tokens.
Finally, you can deposit your tokens and start earning the “Swap fee” as well as BAL tokens.
As with all AMMs, there is the risk of impermanent loss. This refers to the fluctuations in the market that affect the price of the token while it’s locked up in a protocol versus held in a personal wallet.
Additionally, the software is subject to coding errors which can be leveraged by a malicious party to game the system for profit.
For instance, in June, a hacker stole over USD 500,000 in ethereum (ETH), wrapped bitcoin (WBTC), chainlink (LINK) and Synthetix (SNX) tokens by exploiting a bug on Balancer’s smart contract.
Like with all DeFi protocols, investors need to be cautious, and only put amounts at risk that they feel comfortable to potentially lose.
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