Learning the notes: Weighted Pools
Dear Friends and fellow Ludwigs,
When we went to school back in the days with Mr. Salieri, it was pretty hardcore. So much to learn and even more to practice.
We wish to pass this on in this life and therefore will create a series of posts with more educational content.
With this first article we aim to bring you up to speed on the epicness of what weighted pools are and how they can make your life better.
“Cue the intro please.”
Simply put, weighted pools are a type of liquidity pool that allow for a higher degree of asset versatility and configurability.
“What does this all mean, I hear you ask?”
There are 3 key benefits:
- Put your idle crypto assets to work.
- Limit investment risk.
- Dynamic swap fees.
You could stop reading here and go to Beets.fi however if you’d like to learn a little more about weighted pools and what they can offer, please read on and we’ll guide you through the music theory.
What are weighted pools?
Weighted pools are a type of liquidity pool that allow for a higher degree of versatility and configurability.
Weighted pools use a modification of the standard CPMM algorithm popularised by early DEXs (Uniswap).
Unlike liquidity pools in other DeFi protocols that only provide 50:50 asset weightings, weighted pools enable users to build, invest and trade pools with different asset counts and weightings.
Each pool can contain up to 8 different assets and each asset is assigned a weight defining what fraction of the pool is made up by each asset.
A pool can contain 2 assets with a weighted ratio of 80:20 or 3 assets with a weighted ratio of 60:20:20 or up to a total of 8 assets with a weighted ratio of 12.5:12.5:12.5:12.5:12.5:12.5:12.5:12.5: In fact, the ratios can be anything as long as the total adds up to 100 and anyone can make a pool with the weightings they desire.
“That’s a lot of 12.5’s and I hope you get the point. If not check out the diagram below for a visual representation.”
Image courtesy Balancer Labs.
Benefits in depth?
1. Put your idle crypto assets to work
A great use case example for weighted pools is the ability to put your assets to work instead of simply HODLing.
Weighted pools make use of the Weighted Math AMM to automatically rebalance assets within a pool every time a trade is made, much like a classical Index Fund.
Using a weighted pool allows users to create/join a pool with up to 8 different assets in a variety of weighted combinations. This facilitates flexibility when it comes to providing liquidity and allows users to align more closely with their desired portfolio allocations.
The constant rebalancing within the pool helps to maintain the desired ratio of assets while capturing market volatility in the form of trading fees.
For example, a pool is created with the following asset weightings; 25% USDC /25 %/BEETS/50% FTM
If at some point the price of FTM doubles, the pool will rebalance automatically by reducing the amount of FTM it holds to maintain the desired 25/25/50 value of the pool.
The “excess” FTM is then traded out of the pool to buyers looking for FTM who pay a swap fee to the pool on completion of the swap.
So instead of paying fees for a 3rd party to rebalance your assets, this can now be achieved automatically by using a weighted pool of your choice whilst simultaneously capturing trading fees for providing liquidity.
2. Limit investment risk
Before we can realise the potential benefits that weighted pools can provide, it is important to understand a concept central to liquidity pools — Impermanent Loss.
“Disclaimer: we won’t get into the nitty gritty of impermanent loss here as we will save that beautiful sonata for another day.”
But for a quick summary:
- The difference in value between holding a set of assets outside of a liquidity pool and the realised value after providing liquidity for those same assets is called Impermanent Loss (IL).
- This loss typically occurs when there is an external price fluctuation of an asset therefore changing its value. This change in value is not realised within a liquidity pool until an asset is withdrawn as the price of the asset can return back to its original value.
Standard AMM-based pools, such as those on Uniswap/SushiSwap, follow two basic principles:
- There are two assets in the pool
- Each asset composes 50% of the pool
What this means in terms of IL is that both assets in the pool have identical exposure to IL since price changes in either asset will affect the pool in the same way.
To overcome this limitation, users can make use of weighted pools. Weighted pools that heavily weight one asset over another (95/5) will experience far less IL compared to a pool with more equal weightings (50/50).
For example, a pool containing 95% BEETS / 5% FTM would experience less IL if the price of FTM were to change compared to a pool composed of 50% BEETS / 50% FTM.
There is a caveat however, the higher the asymmetry of assets within a pool, the more likely it is that the pool will incur higher slippage when trades are made. This is because one side of the pool has significantly less liquidity.
80/20 pools have emerged as a happy medium as they can provide enough liquidity to facilitate trading, making the pool profitable, while offering protection against higher rates of Impermanent Loss.
Credit to Balancer Labs
To summarize, providing liquidity in a weighted pool can greatly reduce the risk of impermanent loss and maintain reward for providing liquidity through swap fees.
3. Dynamic fees
A unique feature attributed to weighted pools vs the standard AMM based pools is the ability to change pool swap fees to match the demands of the market.
Due to the nature of both an asset’s life cycle and the market cycle as a whole the optimal trading fee for a pool will continually change over time. As such it is almost impossible to choose the correct trading fee for a pool at the time of its creation.
By making adjustments to trading fees, liquidity providers can be paid optimally in relation to the current market conditions, rather than earn at fixed price.
For example, during periods of high market volatility liquidity providers could take advantage of increased pricing on trading fees when traders are looking to swap assets regardless of cost.
Or liquidity pools could provide lower trading fees during periods of higher competition in order to offer more attractive pricing for traders to use a pool.
The graph shows the liquidity utilisation of a pool featuring dynamic swap fees (bal v2) vs a fixed fee pool (curve).
“A little background on how weighted pools work.”
Weighted Pools use an AMM algorithm called Weighted Math.
Basically, weighted math is designed to allow for swaps between any assets regardless of price correlation. Prices are determined by the pool balances, pool weights, and the amounts of the assets that are being swapped.
The weighted math equation is a generalisation of the CPMM algorithm and is as follows:
Where V is constant, Bt is an asset’s balance, and Wt is an asset’s weight in the pool.
As the price of each asset changes, traders and arbitrageurs rebalance the pool by making swaps. This maintains the desired weighting of the value held by each asset whilst collecting trading fees from the traders.
“You still with us? Wild that you made it this far”.
Now that we have outlined the benefits of weighted pools and hopefully clarified some of the music theory. Here are a couple of steps to help you put your theory into practice.
- Check out our awesome selection of Liquidity Pools at beets.fi
- Compose your own pools with the Beethoven composer tool
- Follow us on twitter to stay up to date.
We also have an amazing community of users you can join through our Discord for tips, tricks and much needed support.
If you would like to learn (even) more, here are a couple of links to help you level up your music theory:
- For info on Liquidity Pools check click here.
- For a better understanding of Impermanent click here.
- For a deeper dive into how weighted pools work click here.
We hope this article has provided you with some valuable information and we look forward to jamming with you sometime soon!
Love and Kindness Always,
Disclaimer: The information in this article is for educational purposes only and is NOT intended as financial advice. Beethoven X is not liable for any Investment/Trading activity of users.