[BAL] Collateral Onboarding Risk Evaluation

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Proposed Risk Parameters

Risk Premium: 5%
Liquidation Ratio: 175%
Debt Ceiling: 4 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

Outline

  1. Background
  2. Token metrics
  3. Exchange activity
  4. Defi presence
  5. Risk parameters

Background

Protocol summary

The Balancer protocol v1 serves three unique use cases. It is a non-custodial automated portfolio manager, liquidity provider, and price sensor.The big idea of Balancer is, it is a financial primitive that combines asset management and decentralized exchange. It is like combining an exponentiation of Uniswap AMM and the Set protocol where up to eight tokens can be allocated to a pool following customisable arbitrary weights, fees and strategies. Balancer pools charge traders for swapping any two tokens in pools and pays liquidity providers with fees collected.

In Balancer v1 pools can be either shared (“finalized”) or private (“controlled”). Shared public pools are immutable. They have fixed weightings and fees and allow anyone to deposit assets. Private pools enable the creator to alter parameters interactively. Balancer also allows pools to be smart-contract owned allowing more complex logic to dynamically adjust weightings and fees. Changing a pool from private to public is a one way direction only.

Balancer originated as a research project with a team of engineers and mathematicians led by Fernando Martinelli and Mike McDonald. The team has spun out the BalancerLabs entity to coordinate the development of the protocol. It has three releases planned, currently operating in v1 released in February 2020.

Sources: Whitepaper, Balancer docs

BAL token use

Balancer has no native protocol token embedded in v1. BAL is used as a governance token over the network. BAL can be used to vote on proposals such as adding new features, adjusting liquidity mining dynamics or changing fee structure and steer the direction of the protocol. BAL tokens are not intended as an investment, but as a way to decentralize governance.

Liquidity mining & inflation:

Balancer Labs implemented the concept of liquidity mining, where Balancer governance tokens (BALs) are distributed to liquidity providers.

Every week 145,000 BALs, or approximately 7.5M per year, are distributed to LPs. In the first year, there would be 30% supply inflation from the initial supply of 25M vested tokens. At the current rate of 145,000 BAL per week, it would take 8.666 years to distribute the whole 65M BAL remaining, before reaching the 100M cap. The schedule of BAL distribution over the next few years is subject to governance adjustments.

Assets eligible to be deposited to gain BAL from liquidity mining are whitelisted by governance. Here is the most up to date whitelist.

Liquidity staking:

In August 2020, BAL token holders voted to incentivize liquidity that have BAL in the pool. About 31% (45K) out of BAL distributed through liquidity mining (145k/week) goes to liquidity providers of key BAL pairs such as BAL/ETH,BAL/USDC, BAL/WBTC.

Token metrics

Active addresses

Data shows very regular spikes in active addresses using BAL rather than a continuous increase in numbers. This is probably not uncommon given the regular weekly interval at which liquidity mining rewards are distributed to LPs. Maximum activity happened on 22 Sept with 8,929 active addresses. Given the short timeseries, no further conclusion should be drawn on the long term trend of this metric for now.

image

Source: Santiment

Fees generated

The whitepaper covers two types of fees in balancer v1: trader token swap fees and liquidity removal fees (i.e. pool exit fee). In controlled pools, these fee structures may change through time. 100% of swap fees go to liquidity providers as well as most of exit fees.The protocol also enforces a “feeFactor” calculation that weighs down pools according to their fee (in %) in order to incentivise pool usability. This calculation is constantly revised by the community. For further details see here.

Balancer pools have generated 14.75M in swap fees on a cumulative sum basis by Sept end. Daily fees generated kept steady in the last 2 months. The protocol pools have accumulated more than 200K on average daily.

Source:Balancer

Token allocation & issuance

Key general information

Variable Value
ID balancer
TOTAL_SUPPLY 37,465,000
CIRCULATING_SUPPLY 8,208,450
CURRENT_PRICE 15.89
MARKET_CAP 130,482,359
MARKET_CAP_RANK 82
TOTAL_VOLUME 99,289,722
ATH 37.01
ATL 6.65
FULLY_DILUTED_MARKETCAP 595,318,850

Initially, the total supply of BAL tokens is capped at 100M, subject to adjustments.

  • 25M BAL tokens were allocated to founders, stock options, advisors and investors, all subject to vesting periods.
  • 5M were allocated for the Balancer Ecosystem Fund to incentivise protocol development
  • 5M were allocated for the Fundraising Fund to support Balancer Labs’ operations and growth.
  • The remaining 65M tokens will be distributed to LPs in the coming years through liquidity mining, at a rate of approx. 7.5M annually.

Given vested tokens and rate of liquidity mining, estimated circulating supply is approximately 8,2M out of 37,3M total supply at end of September. source:coingecko


Source: Coingecko, Santiment

Downside risks

BAL had negative daily returns 50 times out of 99 trading days. 14 of those declines were sharper than -10%, the worst (-29%) was on 26 June . The average negative daily decline was -7% in the period. However, it is important to note BAL was launched after Black Thursday so it has not been truly stress tested yet. ETH and BAL had a light positive correlation to each other at 0.74 in the period.

BAL has a very high short term volatility with a 90d std deviation of 6.78 (634 yearly). For comparison, LINK recently assessed is a much more liquid asset with only 1.43 90d stdDev. This volatility is not surprising for BAL given how recent and illiquid it is.


Source: Santiment

Exchange activity

Exchanges and trading pairs

This analysis adopts Messari’s methodology for “Real volume” for exchange data to prevent reporting wash traded activities. Click here for further details.

The majority of trading activity for CEX goes through Binance, Okex and Huobi. They account for 67%, 20% and 9.29% of CEX trades, respectively. Note that Okex and Huobi have a 50% haircut to reported volumes according to the above methodology.

Aggregated exchange volume (snapshot)

market.name volume volume %
Binance 788,887 67.22%
Kraken 19,669 1.68%
Gemini 3,626 0.31%
Poloniex 90 0.01%
OKEx 234,778 20.00%
Huobi Global 109,022 9.29%
Bithumb Global 17,559 1.50%
Coinone 0 0.00%

Source: Coingecko

In centralised exchanges, BAL/USDT and BAL/BTC and dominating trading pairs. Together they make up 96% of all CEX trades.

coin_id base target market.name volume volume %
balancer BAL USDT Binance 476305 41.03%
balancer BAL BTC Binance 293423 25.27%
balancer BAL BUSD Binance 16003 1.38%
balancer BAL USD Gemini 3626 0.31%
balancer BAL USD Kraken 7625 0.66%
balancer BAL XBT Kraken 4305 0.37%
balancer BAL ETH Kraken 743 0.06%
balancer BAL ETH Poloniex 0 0.00%
balancer BAL USDT Poloniex 90 0.01%
balancer BAL USDT Bithumb Global 17559 1.51%
balancer BAL USDT Huobi Global 97673 8.41%
balancer BAL BTC Huobi Global 5635 0.49%
balancer BAL ETH Huobi Global 3199.5 0.28%
balancer BAL USDT OKEx 147856.5 12.74%
balancer BAL BTC OKEx 86921.5 7.49%

Source: Coingecko

Centralised exchange volumes

“Real” trading volume fluctuated somewhat across exchanges in the short term period of the timeseries. The charts show a mean of 262,514 BAL with a maximum daily volume of up to 1,4M BAL in CEX. It is too early to determine whether this will become a trend or decentralised exchanges will continue to eat on CEX volumes for BAL, given Balancer’s own importance.

The second chart below, the real volume metric on a 30 day rolling value shows how activity picked up between mid Aug and mid Sept, daily trading above the mean on CEXs.

Source: Cryptocompare, Santiment

DEX volumes

BAL trading volume in decentralised exchanges and liquidity pools remains lower in comparison to CEXs, but on the rise. The main trading venue is Balancer with a mean of 25,208 BAL and up to a maximum of 94,4K BAL daily traded across its main BAL/ETH weighted pools in the last 30 days. Uniswap V2 and 0x also have some BAL/WETH volumes, but minor in comparison. It is expected volumes to continue to grow in Balancer pools given continued incentives from liquidity mining and staking programs.

Sources: Cryptocompare, 0xtracker, Blocklytics

Defi presence

At the time of writing, no major defi project has directly onboarded BAL assets as part of its lending or borrowing activities. However, the use of Balancer’s liquidity bootstrapping pools (LBPs) is a growing use case among Defi advanced protocols. LBPs are smart pool templates that allow teams to release a project token while at the same time building deep liquidity.

These pools enable teams to create token liquidity without the upfront cost of capital of a constant product 50/50 AMM rule. From an initial 80/20 XYZ/ETH for example a team can slowly adjust pool weights and distribute tokens dynamically.

Aave is one of the first major Defi projects integrating a version of a LBP in its Safety Module (SM). An 80% AAVE/20% ETH liquidity pool using Balancer will be used to provide benefits in terms of market depth for the AAVE token and earnings from locking AAVE. On top of that, as a liquidity provider, the SM in Balancer unlocks further rewards from BAL tokens through liquidity in the protocol. In simple terms, Aave here acts as a “controller”(owner of a “controlled” pool) in Balancer and governs its own self-contained contract using Balancer technology.

It is expected that future projects in defi may leverage similar mechanisms for bootstrapping liquidity using balancer flexible architecture.

Another clear use case for DeFi and CeFi will be the use of “controlled” index funds using balancer customisable and adjustable weights. The generated BPTs (Balancer Pool Tokens), which represent proportional ownership in the pool’s liquidity, can serve as derivative versions for diversifying loan portfolios such as MakerDAO’s (e.g. managed properties).

Summary of Noticeable Risks

  • Circulating supply inflation risk: Due to vesting schedules BAL tokens have a very limited free supply in the open markets outside Balancer and Binance. However, their liquidity mining program will be increasing supply inflation by about 30% this year. Should this extra supply not be utilised in pools, this could create problems for keepers at liquidation events. We believe that a clever combination of liquidity mining and liquidity staking incentives by the protocol will solve this issue in time.
  • Volatility risk: The project is very new and still suffers from significant volatility orders of magnitude higher than more liquid collaterals in the Maker Vault portfolio.
  • Complexity & competition risk: Despite the novelty of implementation of multidimensional pools provided by Balancer which combine both AMM and asset management use cases, the project could suffer from its complexity to less technically minded users. Those may decide to stick with simpler implementations such as Uniswap or TokenSets.However, as a protocol primitive to other higher level applications, Balancer offers a powerful use case.
  • Smart contract exploits risk: Two balancer pools suffered from a sophisticated exploit which implemented a deflationary token hack mechanism draining 500K of pools in June despite the contract been audited twice by then. The extensibility and flexibility of balancer contracts may be one of their core strengths but also their weakest points.

Proposed Risk Parameters

Risk Premium: 5%
Liquidation Ratio: 175%
Debt Ceiling: 4 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

For parameter suggestion, the team has used the model described in the governance call here: a credit risk model that estimates the loss distribution of a portfolio of BAL Vaults. Risk parameters are estimated from this hypothetical loss distribution. Inputs to the model are derived from trading volume data along with stressed input parameters. A link to our model specification with inputs and outputs can be found here. Auction parameters have been selected to mirror those for ETH, with the exception of the lot size that has been normalized to a ~$50,000 amount.

Lead Researcher: Will Remor

Audits

  • Trail of Bits Audit Report: Audit
  • Consensys Diligence Audit Report: Audit
  • OpenZeppelin Audit Report: Audit

MakerDAO forum posts

Sources

Below is a list of commonly used primary resources for information and methodology.

Articles:

Tweet & interviews

Data sources consulted

  • santiment, cryptocompare, coingecko, defiexplore, 0xtracker, uniswap, kyber, bancor, alethio, glassnode, coinmetrics, messari, loanscan, aave, intotheblock, defipulse
9 Likes

Confirming risk parameters from my side. This should get us closer to onboarding Balancer LP tokens as well. Good work @williamr

6 Likes

Thanks, Primoz. From my due diligence over the project and its evolution, I think BPTs tokens can be a rather interesting future addition that match MakerDAO’s needs. Will be happy to work on them too :slight_smile:

1 Like