The “Automated Market Maker (AMM)” track has become the hottest track in the current DeFi field. More and more on-chain trading platforms or decentralized exchanges (DEX) are beginning to integrate AMM as a liquidity for the bottom Guarantee. Previously, the decentralized trading platform Uniswap earned enough attention, and the Balancer heat index, which was just launched two months ago, is also rapidly rising.
Balancer is an unmanaged auto maker General (AMM) protocol, the chain had heard had issued a detailed analysis of the project through excels.
To put it simply, Balancer is ” Advanced Uniswap “. It can not only become a trading tool, but also expand into a popular “index fund investment tool”. The investment return is expected to exceed professional investors, bringing AMM tools. More imagination.
In mid-May, Balancer released a proposal to introduce the community governance token BAL (Balancer Governance Tokens), and announced on June 1 that it officially began to implement the “liquidity mining” token mechanism, trying to use its token BAL injection as Early adopters of the Balancer protocol provided economic incentives to promote the participation of more liquidity providers and participate in community governance.
Balancer’s governance token and its distribution mechanism
When the Balancer protocol was initially launched, there were no native tokens, but Balancer Labs believes that if the protocol is to remain decentralized, it must introduce a decentralized community governance model, so that the people who use the protocol the most have more power to speak throughout the governance process. The introduction of the community governance token BAL is the beginning of the transformation of the community governance model. The holder of the BAL decides the future of the Balancer agreement.
BAL can be used to carry out the community governance of the Balancer protocol and make resolutions on major events in the community, such as adding new functions, deploying smart contracts on public chains outside of Ethereum, Layer 2’s expansion scheme, introducing protocol fees, and so on.
The total supply of BAL is 100 million, of which 25 million are allocated to founders, core developers, consultants and investors, and all have a certain unlocking period. The remaining 75 million tokens are planned to be distributed to users who provide liquidity to the Balancer capital pool. This process is called “liquidity mining.”
According to the official announcement of Balancer Labs, from 00:00 on June 1, UTC, a total of 145,000 BAL tokens will be distributed to the liquidity providers of the Balancer capital pool every week, about 7.5 million BAL per year. Subsequent allocation may be determined based on governance. The token price of its seed round is 0.6 US dollars. If estimated at this price, Balancer will allocate approximately 87,000 US dollars of tokens per week.
Why introduce “liquidity mining” design?
Considering that early liquidity providers often have to bear more risks and opportunity costs (such as contract risk, lower initial Balancer pool profitability, etc.), Balancer launched the “liquidity mining” token mechanism, which aims to Adopters create a truly powerful incentive to stimulate their initiative to increase liquidity and participate in community governance processes.
Earlier, Compound, a decentralized loan agreement, also announced the launch of governance tokens, and stated that its users will begin to receive COMP tokens in mid-June. A total of 4.23 million of the 10 million COMPs will be distributed to Compound users for free through smart contracts, provided that their users use the Compound protocol for loan transactions, and the more the amount of the loan, the more COMP you get Therefore, the distribution mechanism of COMP is also called “borrowing is mining”.
Compound’s ” borrowing and mining ” mechanism is essentially similar to Balancer’s ” liquidity mining ” mechanism, both of which deeply bind community governance tokens with their own business logic, so that token holders and the entire ecological interest Binding, which is more conducive to the development of the entire DeFi product ecosystem than a pure voting governance model, the increase in such mechanisms also indicates that the design of the token model in the DeFi field is constantly evolving.
Liquidity is crucial to the growth of DeFi products such as Balancer, and it is also a decisive factor in its ability to complete a cold start.
In the Balancer agreement, any Ethereum user can create a Balancer capital pool and add liquidity to its agreement. Liquidity attracts traders, and the transaction incurs transaction fees. Eventually, the profitability of the entire liquidity pool will attract more liquidity, thereby forming some kind of “flywheel effect.”
Therefore, Balancer Labs believes that the most important stakeholders in its ecosystem are Liquidity Providers.
How to implement “liquidity mining”?
In view of the importance of liquidity in the Balancer agreement, the distribution of BAL tokens is designed to be proportional to the liquidity on the Balancer. BAL tokens will be distributed according to the proportion of the liquidity contributed by each address to the total liquidity of the Balancer.
Due to the liquidity calculation of diversified tokens, the community decided to adopt the US dollar as a unified measure of liquidity. All liquidity providers will receive BAL tokens, as long as there are at least 2 tokens in their liquidity pool, and the tokens can be withdrawn from CoinGecko to U.S. dollar prices (the liquidity of U.S. dollar-denominated tokens cannot be withdrawn from CoinGecko Failed).
Specifically, Balancer Labs calculates and distributes BAL tokens according to the following steps every week:
- Determine the “start block” and “end block” of the week. The standard is to select the nearest block based on a fixed time (for example, Sunday at 1 PM UTC). For example, the starting block for a given week is # 10,100,000 and the ending block is # 10,140,000.
- Determine all “snapshot blocks”. Every 64 blocks (that is, every 15 minutes) are counted backward from the “end block” until reaching the “start block”. According to the above example, the “snapshot block” is # 10,140,000, # 10139936, # 10139872 and so on.
- Calculate the USD liquidity in each Balancer pool. Each “snapshot block” and each type of token in each Balancer ’s pool are denominated in US dollars (withdrawing the USD price of various types of tokens from CoinGecko).
The coolest thing about Balancer’s liquidity mining is that it is designed to incentivize various fund pools to charge lower transaction fees.
The BAL token income obtained by each fund pool is obtained by multiplying the dollar value of the tokens in each fund pool by a “fee factor”. The calculation formula is as follows:
As a result, FeeFactor will show a bell-shaped curve (as shown in the figure below). The higher the transaction fee, the lower the FeeFactor, and the less BAL tokens the liquidity provider of the pool will receive each week. For example, a Balancer Pool FeeFactor with a fee of 0.5% is 0.94, while a Balancer Pool FeeFactor with a fee of 1% is 0.78.
The design logic behind it is that the lower the transaction fees, the pool of funds will attract more users who are willing to use the Balancer protocol for transactions. Therefore, the greater the contribution of these pools of liquidity to the entire Balancer ecosystem, the greater the return.
Is “liquidity mining” the best way to stimulate liquidity?
As mentioned above, the “liquidity mining” mechanism designed by Balancer based on its community governance tokens is an idea for DeFi products to achieve a cold start, and Balancer introduced the feeFactor factor in the design to try to achieve lower transaction fees. At the same time, it can still stimulate liquidity growth.
However, this mining mode may trigger more arbitrageurs. For example, for more small coins that are not well-known, they only need to be placed in the Balancer pool to maintain a low handling fee. Even if not doing too many transactions, you can get a certain amount of governance token BAL, but This kind of liquidity is of little value to the entire Balancer system.
In addition, although “liquidity mining” is currently proposed as a new type of token distribution mechanism in the DeFi field, in fact similar incentive mechanisms have already appeared in China.
Yang Mindao, founder of the decentralized financial platform dForce, believes that the “liquidity mining” of the Balancer is exactly the same as the “trading mining” model previously implemented by the FCoin exchange. If this mechanism is used alone, it is not considered.
FCoin has used this strategy to guide and stimulate its trading volume to climb. To this end, it once surpassed Huobi and Binance, and traders and arbitrageurs have emerged to “provide liquidity” for the FCoin exchange in exchange for replacement currencies, and then quickly sell off for profit, thus forming a People are willing to hold a negative cycle of tokens, which caused the price of FCoin tokens to plummet. The price of FCoin collapsed faster than arbitrage profits. Active users stopped providing liquidity, and finally FCoin collapsed due to the depletion of liquidity.
According to Yang Mindao, there are several prerequisites for the “liquidity mining” mechanism to really work: the DeFi protocol is indeed useful (in the absence of tokens), and the incentive behavior can produce a lock-in effect, locking extra liquidity to The most important thing in this agreement is to stimulate the increase in the demand for tokens in this agreement.
But the reality is that most governance tokens are just to propose a distribution plan, but they have never considered how to maintain the value of their tokens in the context of constant issuance (inflation), and this is an incentive Feasibility is crucial. In DeFi, the effectiveness of governance and cash flow does not create holding power, and this is necessary to maintain monetary value and encourage continued participation. Once its token value is difficult to maintain, the entire incentive mechanism will also lose its viability.
However, unlike the FCoin transaction mining mechanism, the Balancer ’s BAL token allocation is a constant amount each week, which is equivalent to setting a certain “hard cap” for its liquidity incentives, which may avoid FCoin to a certain extent. In that way, the long-term development dividend will be released in a short period of time, which will lead to its brush list and arbitrage team become the main group of the platform and deteriorate the entire ecosystem, and then fall into the negative feedback mode and the risk of collapse.