Curve (CRV): How it Works

Due to its preference for consistency and composability above volatility and speculation, Curve is one of the most often used platforms in DeFi.

Summary

By only allowing liquidity pools made up of similarly behaving assets, Curve is a well-known automated market maker (AMM) platform that provides a very efficient means to swap tokens while retaining low fees and little slippage. Because Curve integrates with other DeFi protocols and offers incentives in the form of CRV tokens and interest, the liquidity providers who provide the pools with tokens benefit from cheaper fees as a result of this strategy.

What Is Curve?

While Uniswap and Balancer and Curve are both AMM platforms with numerous similarities, Curve distinguishes itself by only allowing liquidity pools made up of similarly behaving assets like stablecoins or wrapped versions of related assets like wBTC and tBTC. With the lowest fees, slippage, and temporary loss of any decentralised exchange (DEX) on Ethereum, Curve is able to employ more effective algorithms.

Let’s quickly review how AMMs operate before concentrating on how Curve is more efficient and lower risk than other AMMs in the DeFi ecosystem.

While Uniswap and Balancer and Curve are both AMM platforms with numerous similarities, Curve distinguishes itself by only allowing liquidity pools made up of similarly behaving assets like stablecoins or wrapped versions of related assets like wBTC and tBTC. With the lowest fees, slippage, and temporary loss of any decentralised exchange (DEX) on Ethereum, Curve is able to employ more effective algorithms.

Let’s quickly review how AMMs operate before concentrating on how Curve is more efficient and lower risk than other AMMs in the DeFi ecosystem.

How Automatic Market Makers Work

Instead of trading between buyers and sellers, automated market makers use liquidity pools to enable automatic, permissionless trading of digital assets. A liquidity pool is fundamentally a pool of tokens that is shared. Users contribute tokens to liquidity pools, and a mathematical formula determines the pricing of the tokens in the pool. Liquidity pools can be optimised for various goals by changing the formula. By contributing tokens to an AMM’s liquidity pool, anyone with access to the internet and some ERC-20 tokens can act as a liquidity provider. For supplying tokens to the liquidity pool, liquidity providers typically get a fee from traders who use the pool.

Stable Liquidity Pools

In 2020, Curve was introduced with the goal of building a low-fee AMM exchange for traders and a productive fiat savings account for liquidity providers. Curve lets investors avoid more volatile crypto assets while still earning high interest rates via lending protocols by concentrating on stablecoins. The Curve model is extremely conservative when compared to other AMM platforms because it steers clear of volatility and speculation in favour of stability.

Liquidity pools on AMMs like Curve are always attempting to “buy cheap” and “sell high.” Here’s a reminder of how that rebalancing works, this time with the USD Coin (USDC) and DAI stablecoins that are tethered to the US dollar. If you were to sell DAI on Curve, the following set of things would happen:

The pool is expanded with more DAI.

Because there are now more DAI than USDC, the pool is no longer balanced.

To encourage equilibrium, the pool offers DAI at a little discount to USDC.

The pool rebalances its DAI to USDC ratio.

The pool is attempting to return the pool to its original condition by selling DAI at a reduced price. Compared to other AMM liquidity pools, trade between the assets in the Curve pool creates the least volatility because their prices are steady relative to one another. Volatility is strong on AMMs like Uniswap or Balancer where liquidity pools can be made up of any cryptocurrency. Curve reduces impermanent loss, an AMM phenomena whereby liquidity providers experience a loss in token value relative to the market value of that token as a result of volatility in a liquidity pool, by restricting the pools and the sorts of assets in each pool.

Impermanent loss isn’t necessarily bad, though. Users who try to benefit by entering and quitting a liquidity pool at the proper time can take advantage of volatility and slippage. Curve draws liquidity providers by trading off the high risk—and occasionally great reward—aspect of volatility by utilising a concept known as DeFi composability. This implies that you can utilise your Curve platform investment to win rewards elsewhere in the DeFi ecosystem.

Contrary to Uniswap or Balancer, Curve does not attempt to maintain constant equality or proportionality between the values maintained in various assets (i.e., balanced). In order to have liquidity where it is most needed, Curve can concentrate liquidity close to the ideal price for comparable-priced assets (in a 1:1 ratio). As a result, Curve can use such assets to achieve a considerably higher liquidity utilisation than would otherwise be achievable.

The like-asset strategy for AMMs is not just applicable to stablecoins. wBTC and renBTC, two tokenized variations of bitcoin (BTC), are also included in Curve’s liquidity pools. Bitcoin is very volatile when compared to stablecoins, but the Curve technique still works since tokens in Curve pools just need to be stable in relation to other tokens in the same pool. In other words, although wBTC and USDC would not work together, wBTC and renBTC can both be included in the same Curve liquidity pool.

Composability: Incentivizing Liquidity Providers

You can make money anytime a trade is done on an AMM exchange like Uniswap. Trading costs are cheaper on Curve than they are on Uniswap, but you can use interoperable tokens to gain rewards from sources outside of Curve.

For instance: On the Compound platform, DAI is converted into cDAI, a liquidity token that automatically accrues interest for the holder, when it is lent out. You have the option to withdraw DAI from Compound plus interest if you own cDAI. Utilizing cDAI in Curve’s liquidity pools allows consumers to get a second layer of usefulness and potential profit from a given investment.

The advantages of composability in the DeFi ecosystem are best demonstrated by the use of Compound’s cTokens on Curve. Additionally, Curve interfaces with a number of external DeFi protocols, Compound being just one example. Additionally, the protocol connects with Synthetix and Yearn Finance to maximise incentives for liquidity providers.

CRV Tokens

The Curve protocol established a decentralised autonomous organisation (DAO) in August 2020 to oversee protocol modifications as it began its path toward decentralised governance. The majority of DAOs are governed by governance tokens that grant voting privileges to their holders. The CRV token in this instance governs the Curve DAO.

Yield farming, in which assets are deposited into a liquidity pool in exchange for token rewards, is a method of earning the CRV token that may also be used to purchase it. In addition to fees and interest, you can earn the CRV token by supplying DAI to a specific Curve liquidity pool. Yield farming the CRV token makes it more desirable to become a Curve liquidity provider because you acquire ownership as well as a financial asset.

Anyone with a sufficient quantity of vote-locked CRV tokens can suggest changes to the Curve protocol. Changes to fees, where fees go, the creation of new liquidity pools, and yield farming rewards are some examples of updates. By securing CRV tokens, holders cast a vote on a proposal, accepting or rejecting it. The more voting power the CRV token has, the longer it is locked up.

Due to its preference for consistency and composability above volatility and speculation, Curve is one of the most often used platforms in DeFi. With the CRV token serving as the governance mechanism and its composable components making it an interconnected centre of the DeFi ecosystem, it is an incredibly decentralised organisation that belongs to its people.