The demand for decentralized finance (Decentralized Finance (DeFi) takes the decentralized concept of blockchain and applies it to the world of finance. Build...) brings rise to decentralized exchanges like Curve Finance. and Uniswap. Primarily a decentralized liquidity aggregator, Curve Finance allows users to swap tokens for stablecoins and to provide liquidity to the liquidity pools and earn fees.
On contrary to Uniswap, Curve Finance aims to provide users an alternative to swapping tokens faster, more direct, and at a cheaper rate. Instead of swapping token A for ETH, then ETH to token B, the use of Curve Finance eliminates the hefty transaction fees and processes swapping token A to B directly in a single transaction.
What Is Curve Finance?
Curve Finance is an Automated Market Maker (AMM)-based decentralized exchange (Decentralise Exchange (DEX) is a crypto exchange platform that is built upon blockchain technology and negates the need ...) running on Ethereum. It’s focused on swapping between different stablecoins, and it features low fees and minimal slippage. Since AMMs work with a pricing algorithm instead of an order book, Curve Finance is also useful for swapping between tokens that remain in a similar price range, like different tokenized versions of Bitcoin such as WBTC, renBTC, or sBTC.
As of June 2021, there are 39 active pools available for swapping between stablecoins and assets on the platform. However, these pools are subject to changes based on the market demand. Some of the stablecoins available include USDT, USDC, DAI, BUSD, TUSD and sUSD. One of the known stablecoin pools is 3CRV, which consists of DAI, USDT and USDC.
Curve Finance also supports yield-bearing tokens like those from Yearn Finance, with yUSD pools consisting of yDAI, yUSDT, yUSDC and yTUSD. Users that participate in this pool receive the swap/gas fees generated by the Curve pool, as well as the yield from the underlying yield-bearing tokens.
There are pools within the platform in which liquidity providers receive a percentage of the exchange fees, while there are also lending pools that include separate DeFi protocols that offer a higher rate of interest to providers. Curve is moving toward decentralized governance by launching a Decentralized Autonomous Organization (As an open sourced blockchain ledger, Decentralized Autonomous Organization (DAO) is determined by a clear set of rules ...) in which the Curve DAO is controlled by the CRV token for voting rights.
What Is an Automated Market Maker?
An automated market maker (AMM) is a type of decentralized exchange (DEX) protocol that depends on a mathematical formula for pricing assets. Instead of using an order book, assets are priced according to a pricing algorithm. This allows digital assets to be traded using liquidity pools, instead of having buyers and sellers.
Think of AMMs as peer-to-contract (P2C), in that there’s no need for counterparties since trades happen between users and contracts. Liquidity pools are actual shared funds made of digital tokens that are locked in smart contracts. Users supply liquidity pools with tokens, and the prices of the tokens in the pool are determined by a formula. Thus, by adjusting the formula, liquidity pools are optimized.
Anyone with ERC-20 tokens becomes a liquidity provider by supplying tokens to an AMM’s liquidity pool. Liquidity providers earn a fee for providing tokens to the pool. This fee is paid by traders when interacting with the liquidity pool.
How Does Curve Finance Work?
Assets are priced according to a formula which is designed for swaps in a similar range. Let’s say for example that 10 USDT should equal 10 USDC, which should equal 10 BUSD. If you convert 5 million dollars worth of USDT to USDC and then convert it to BUSD, there will be slippage. However, Curve’s formula aims to minimize this slippage, even when converting large amounts.
In addition, the liquidity pools help to guarantee the lowest amount of slippage when exchanging digital currencies. By focusing on stablecoins, Curve guarantees a lending protocol that is less volatile while still giving high interest on the liquidity provided.
The pools are controlled by the AMM, which rebalances pools after exchanges are made. For instance, let’s say that a pool contains USDC and TUSD. A trader at Curve Finance wants to sell USDC and uses this liquidity pool. The pool becomes unbalanced because there is now more USDC. In order to rebalance it, the price of USDC drops to encourage traders to buy USDC with TUSD. Arbitrage traders then buy TUSD with USDC. In this way, the liquidity pool rebalances the ratio of USDC to TUSD. The price incentive keeps the liquidity pools balanced.
Stable Liquidity Pools
Curve is known as an AMM exchange with low fees for traders, while also providing efficient fiat savings accounts for liquidity providers. By focusing on stablecoins, Curve allows investors to avoid volatile cryptoassets while still earning high-interest rates from lending protocols. At the same time, its model is considered conservative because it avoids volatility and speculation in favor of stability. Curve’s liquidity pools are permanently trying to buy low and sell high.
With Uniswap or Balancer, liquidity pools are made up of any token and volatility is high. By limiting the pools and the types of assets in each pool, Curve minimizes impermanent loss. This occurs when liquidity providers suffer a reduction in token value, relative to the market value of that token, from volatility in a liquidity pool.
Curve attracts liquidity providers using what’s called DeFi composability. This simply means that you can use what you’ve invested on Curve’s platform to earn rewards elsewhere in the DeFi ecosystem. Curve’s liquidity pools also contain tokenized versions of Bitcoin, such as wBTC and renBTC, which can be in the same pool, whereas wBTC and USDC cannot function together.
Incentivizing Liquidity Providers
Since trading fees on Curve are lower than those on Uniswap, you can also earn rewards from outside of Curve with so-called interoperable tokens. Let’s say that DAI is lent out on Compound Finance’s platform, and then exchanged for a liquidity token called cDAI. Curve users can use cDAI in its liquidity pools, thus achieving another level of utility and potential earning.
The possibility of using Compound’s cTokens on Curve Finance demonstrates the composability benefits in the DeFi ecosystem. As mentioned before, Curve is also integrated with Yearn and Synthetix to maximize incentives for liquidity providers (LPs). Curve is unique for stablecoin trades because its liquidity and unique automated market maker attract high trading volume. Every trade earns a 0.04% trading fee paid to LPs. However, there are other ways (below) to profit from providing liquidity to Curve.
Trading fees: Every trade conducted through the pools where you are a LP earns profits paid in proportion to your share of the pool.
Yield farming: Deposits in liquidity pools that aren’t utilized are deposited into other DeFi protocols to generate additional revenue.
High Annual Percentage Yields (APY): Annual Percentage Yields for stablecoin deposits on Curve are high because Curve also yields farms with pooled assets.
veCRV token: Locking CRV tokens converts them into veCRV, which is used to boost your deposit APY.
Boosted pools: For additional liquidity, some pools offer incentives, such as high yields for LPs. Curve Finance is well-known for the yield farming of stablecoins. As a liquidity provider, you can mix and match any of the income streams mentioned above to maximize your yields.
What Are CRV Tokens?
CRV is Curve Finance’s native token. It is mainly used for governance, LP rewards, boosting yields (such as veCRV), and token burns. Since Curve is community-governed, its decisions are made by CRV holders who vote-lock their tokens to convert them into veCRV. Incidentally, veCRV stands for vote-escrowed CRV, meaning CRV that’s been locked into the Curve protocol for a defined time. The longer you lock CRV, the more veCRV you receive.
Keep in mind that veCRV holders earn profits from exchange fees. Curve’s protocol can be complex. Consequently, veCRV adoption is low, but increasing as yield farmers begin to understand its potential.
Liquidity pool rewards and incentives are paid in CRV to LPs based on the size of their poolshare. Because not all trading fees are redirected to LPs, a small portion is collected and used to buy and burn CRV, reducing CRV supply.
The CRV token can be bought as well as earned through yield farming when you deposit assets into a liquidity pool and earn tokens as a reward. By providing DAI to a designated Curve liquidity pool, you can also earn CRV tokens on top of fees and interest. Yield farming the CRV token increases the incentive to become a Curve liquidity provider because you gain a financial asset and ownership of a DeFi protocol.
Anyone with CRV tokens can propose updates to the Curve Finance protocol. These updates include changing fees, modifying where the fees go, creating new liquidity pools, or adjusting yield farming rewards. Holders vote on proposals by locking up CRV tokens. Therefore, the longer the CRV token is locked up, the more voting power you have. If you’re looking to stake a long-term claim on Curve DAO fees, Yearn developers have built the Backscratcher Vault, which allows you to permanently deposit your veCRV for a lifelong claim on Curve’s yearly fee earnings.
Curve Finance vs. Uniswap: The Differences
The main difference between the two is that on Uniswap you can swap any ERC-20 token, whereas Curve is specifically for trading stablecoins on Ethereum. Curve is an AMM platform with many similarities to Uniswap. However, Curve differentiates itself by only accommodating liquidity pools made up of similarly behaving assets. These can be stablecoins or wrapped versions of similar assets, such as wBTC and tBTC. This allows Curve to use efficient algorithms and to display the lowest levels of fees, slippage, and impermanent loss of any decentralized exchange (DEX) on Ethereum.
Uniswap is ranked below Curve Finance in terms of TVL (Total Value Locked), which is an estimate of the potential of a DeFi yield farming platform. This indicator tells you the amount of digital currency locked and serves as a health measure for the DeFi ecosystems and yield farming market.
According to DeFi Pulse charts, Curve now has nearly $7.5 billion worth of liquidity locked in, while Uniswap has only $6 billion. The reason Curve keeps adding TVL is its focus on swapping stablecoins, a niche with less competition. Being a purpose-built market also means that Curve offers advantages to both traders and liquidity providers:
Minimized slippage: Whale traders and high-volume trading pairs are subject to slippage, but Curve’s similar asset pools minimize it.
No impermanent loss: Liquidity providers on Curve supply stablecoin pairs that nearly eliminate impermanent loss.
Uniswap trades against ETH. In order to accomplish as direct a trade as possible, you need to either trade using ETH, or trade for ETH. If you trade from USDT to USDC, Uniswap turns your USDT into ETH, then trades ETH for USDC. Your swap then requires two trades, making it more expensive. Obviously, trading stablecoins on Curve is cheaper because Curve doesn’t require ETH as a base pair for trades.
When the cryptocurrency market dips, Curve retains TVL, whereas other exchanges lose theirs. This is due to the way Curve protects liquidity providers from impermanent loss. Impermanent losses are LP profits lost when crypto price volatility unfavorably rebalances the pair assets. Since all liquidity pools require you to deposit a pair of assets, the risk increases when one of them rises or falls faster than the other. Ideally speaking, you should maintain an even 50/50 value balanced between your pooled assets.
Curve uses stable pools to walk around the impermanent loss problem. All Curve pools are either 1:1 stablecoin pools (i.e., USDT/DAI) or 1:1 synthetic token/token pools (i.e., sETH/ETH). In keeping liquidity pool pairs restricted to assets that reflect one another in value, the impermanent loss is not an issue. This makes Curve a safe haven for liquidity providers.
Overall, Curve is better than Uniswap for trading stablecoins, and it’s also a safer place to place your stablecoins, ETH and wrapped Bitcoin for steady yield income.
Limitations and Risks of Curve Finance
It should be noted that Curve Finance and other DeFi protocols are currently in the experimental phase, and are thus works in progress. Funds deposited into Curve Finance or other DeFi protocols are at risk of smart contract vulnerabilities, malicious developers, and hacks. Risks are always present with digital currencies. Evaluate these risks before entering into a new protocol or purchasing any cryptocurrency. As always, only invest what you are willing to lose. Although Curve Finance has been audited, the protocol is not exempt from risk or failure.
Curve Finance is mainly built on stablecoin pools, and stablecoins are pegged to an underlying asset. If a peg fails on a stablecoin, resulting in falling prices, liquidity providers of that pool will only hold the unpegged stablecoins. Curve supplies liquidity to other partners such as yearn.finance and Compound.
This practice, known as composability, achieves higher returns for liquidity providers. However, with this interaction comes a risk of chain collapse. Any problem with a connected DeFi protocol or partner could result in damage to Curve Finance.
The Bottom Line
Curve is one of the most popular platforms on DeFi because it favors stability and composability over volatility and speculation. However, their best reason to stay is that there is no other DeFi protocol that is so deeply interconnected with the entire DeFi ecosystem as Curve. Ethereum-based DeFi apps and protocols which are able to natively plug and play with each other are called money legos. Like these money legos, Curve and other DeFi protocols connect with each other to build financial structures so that the whole is greater than the sum of its parts.
DeFi applications like Yearn, Compound, Aave, Synthetix, SushiSwap, Pickle Finance and Fantom all use Curve pools. The volume of liquidity coming into Curve from these sources drives Curve’s overall TVL and puts pressure on the CRV Circulating supply is the number of cryptocurrencies or tokens that are publicly available and circulating in the crypto....
For instance, as part of their automated farming strategy, Yearn offers high-APY stablecoin vaults that deposit tokens into CRV pools. To increase returns to vault holders, Yearn buys CRV and automatically escrow-locks it into veCRV for a maximum of four years to gain an APY boost. Indeed, CRV tokenomics appear to have been created with a higher level of perfection. A nexus of incentives and rewards around stablecoin pool yields turn protocols like Synthetix into CRV holders, along with retail farmers looking for the best yields for stablecoin deposits.