Automated market makers (AMM) have had a great impact on the crypto landscape. Liquidity protocols like Uniswap, Balancer, and PancakeSwap allow anyone to become a market maker and earn fees on many different market pairs.
Can these AMMs meaningfully compete with centralized exchanges? Maybe. But there is one segment where they are already showing great potential – and that is stablecoin trading. Curve Finance is at the forefront of this space and in this article, we are going to find out how does Curve work in order to achieve that, as part of exploring Curve Finance.
What is Curve Finance?
Curve Finance is an automated market maker protocol designed for swapping between stablecoins with low fees and slippage. It's a decentralized liquidity aggregator where anyone can add their assets to several different liquidity pools and earn fees. AMMs work with a pricing algorithm instead of an order book.
Due to the way the pricing formula works on Curve, it can also be extremely useful for swapping between tokens that remain in a relatively similar price range. That means it's not only great for swapping between stablecoins but also different tokenized versions of a coin. As such, Curve is one of the best ways to swap between different tokenized versions of Bitcoin, such as WBTC, renBTC, and sBTC.
In fact, there are many Curve pools available to swap between many different stablecoins and assets. These are, of course, constantly changing based on market demand and the ever-changing landscape of DeFi. Some of the most popular stablecoins available include USDT, USDC, DAI, BUSD, TUSD, sUSD, and more.
How Does Curve Work?
As mentioned, assets are priced according to a pricing formula instead of an order book. The formula used by Curve is specifically designed to facilitate swaps that happen in a roughly similar range.
For example, we know that 1 USDT should equal 1 USDC, which should equal roughly 1 BUSD, and so on. However, if you'd like to convert 100 million dollars of USDT to USDC, then convert it to BUSD, there's going to be some slippage. Curve's formula is designed to minimize this slippage as much as possible.
One thing to note here is that if they weren't in the same price range, Curve's formula wouldn't work efficiently anymore. However, the system doesn't have to account for that. After all, if USDT would be worth $0.7, somETHing else outside of Curve would be terribly wrong. The system can't mend things outside of its control, so as long as the tokens maintain their peg, the formula does its job very well.
This leads to extremely low slippage for even large sizes. In fact, the spread on Curve can meaningfully compete with some of the centralized exchanges and OTC desks with the best liquidity.
What is the CRV token?
CRV is the governance token of CurveDAO, a decentralized autonomous organization (DAO) running the protocol. CRV is continually distributed to liquidity providers of the protocol, with the rate decreasing annually.
Risks of Curve Finance
Although Curve has been audited by Trail of Bits which is a good sign, risks are always involved when using any smart contract, no matter how many audits it has. Only deposit as much as you're willing to lose.
As with any other AMM protocol, you'll also need to take into account impermanent loss. In short, impermanent loss is a loss in dollar value that liquidity providers can suffer while providing liquidity to an AMM.
Behind the scenes, the liquidity pool may also be supplied to Compound or yearn.finance to generate more income for liquidity providers. In addition, thanks to the magic of composability, not only can users trade on Curve, but also other smart contracts. This introduces additional risks, as many of these DeFi protocols become reliant upon each other. If one of them breaks, we may see a damaging chain reaction effect across the entire DeFi ecosystem.
Closing Thoughts
Curve is one of the most popular AMMs running on ETHereum and any crypto user is bound to search up “how does Curve work” sooner or later. The protocol facilitates high volume stablecoin trades with low slippage and tight spreads in a non-custodial way.
Another thing that places Curve Finance at the core of the DeFi space is how other blockchain protocols are heavily reliant on it. Composability between different decentralized applications does have its risks, but it's also one of the strongest advantages of DeFi.
