Bending the Arch: Guide to the Curve Finance DEX
Every DeFi trader is looking for the highest yields for the lowest fees, and Curve might be the platform to give them what they want.
Updated May 6, 2022
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Everything comes at a price, and this is especially true when it comes to crypto trading. Decentralized exchanges like PancakeSwap have set the standard when it comes to trading one crypto for another for the lowest price possible, but centralized exchanges like Coinbase and Kraken are getting just as competitive as some DEXs with their fees. While trading fees may not be a big deal for most traders since their coins are (hopefully) going to the moon, high fees could pose an issue for those swapping between their favorite stablecoins.
This incredible incentive is what makes Curve Finance one of the best yield farming destinations in all of DeFi.
That's where Curve Finance comes to the rescue. The Curve protocol has done the impossible by facilitating trades between stablecoins like USDC and USDT for dirt-cheap fees while also being completely decentralized and sweetening the deal liquidity providers. Now, let's get into how Curve Finance is a win-win for both traders and DeFi investors.
What is Curve?
What is Curve?
Curve Finance is an automated market maker (AMM) protocol that aims to provide higher liquidity while maximizing profits for liquidity providers. Curve is a decentralized exchange (DEX) similar to Uniswap that enables exchanging between cryptocurrencies, except Curve is different because it makes swapping stablecoins more efficient by minimizing trading fees and slippage caused by price volatility. By offering a variety of liquidity pools (LP), Curve gives more options to both liquidity providers and traders.
Decentralized exchanges require two parties. First, they need liquidity providers to lock their crypto into a pool by depositing it into the AMM protocol. Second, they need traders who utilize the liquidity pool in exchange for a small fee. That fee is rewarded to liquidity providers as an incentive for locking their crypto. The problem with most DEXs is that both traders and liquidity providers suffer when there is volatility, lack of liquidity, or both. Low liquidity can be especially harmful to traders who are exchanging assets that are pegged to the same external value—like different stablecoins that are both pegged to USD, for example—because it creates slippage. Slippage, which is the difference between the expected price on an order and the actual price once the order executes, can result in losses for crypto traders.
Curve pools solve this by refining the AMM formula to allow for concentrated liquidity. This concentrated liquidity reduces loss by adjusting the internal price of the assets in the pool. Not only does this decrease the trade slippage, but it also minimizes the divergence in the internal prices of the assets in order to reduce losses for liquidity providers. Curve V2 introduces new features like internal price oracles and dynamic swap fees to make the AMM protocol even more efficient.
Curve Finance's major innovation over other AMM protocols is the 3pool (or tri-pool). Providing liquidity on most other DEXs requires a deposit of an equal dollar amount of exactly two cryptocurrencies. Tri-pools eliminate the stringency of other AMM protocols by allowing liquidity providers to deposit just one crypto asset and gain exposure to up to three assets in a pool.
Although the 3pool was designed for low fee, low slippage stablecoin trading, new tri-pools have incorporated different asset types. For instance, the sBTC pool was created to trade ERC-20 tokens pegged to Bitcoin, including wBTC, renBTC, and sBTC. Some tri-pools contain assets with even less price correlation, such as the 'tricrypto' pool which provides liquidity between USDT, ETH, and wBTC.
Metapools are Curve liquidity pools where one asset is traded with assets in an underlying base pool. Metapools enable the creation of liquidity pools containing one tri-pool and another ERC-20 asset. This allows for a less liquid crypto token to be traded with crypto assets in a larger LP without diluting the existing pool. Another way to look at metapools is that they allow for a small-cap token to be traded with stablecoins in the larger 3pool without impacting the prices of assets in the 3pool.
Factory pools are metapools that practically anyone can create. The pool factory allows a liquidity provider to deploy a pool containing one tri-pool and one ERC-20 token. While factory pools can provide traders with access to liquidity for more obscure tokens, there are market capitalization, trading volume, minimum liquidity, and other requirements for tokenized assets to be deployed into a factory pool. Tokens that meet the criteria for a factory pool can be deployed in a metapool and traded with assets in a larger tri-pool without the need for creating a dedicated pool with low liquidity and unreasonably high slippage.
Another type of liquidity pool Curve finance introduced to DeFi is the lending pool. The lending pool is similar to regular liquidity pools where crypto assets are swapped, except lending pools also lend assets in the pool via crypto lending protocols like Aave or Yearn Finance. Liquidity providers who deposit crypto into a lending pool earn both trading fees and interest on borrowed assets, but the catch is that they're exposed to more risk because assets in lending pools are utilized by both the Curve AMM protocol and a separate lending protocol.
Curve V2 improved on the AMM formula of version 1 by enabling the creation of pools with crypto assets that are non-pegged or pegged to different values (meaning not stablecoins). They also developed an internal price oracle that reduces losses by adjusting swapping fees based on price slippage.
Internal price oracle
Curve V2 liquidity pools use a system that concentrates liquidity around the current price of the assets to reduce the divergent loss of the pool. So, when the profit made by the AMM system is greater than the loss generated by a trade within a certain pool, the internal price oracle adjusts the price to maintain the same level of liquidity.
Curve V2 introduced variable fees to the DEX. Instead of a competitively low 0.04% flat fee on all crypto swaps, the fees on V2 can range from 0.04% to 0.40%. Curve V2 trading fees depend on the difference between the internal price oracle and the actual price of the assets, although the Curve V2 whitepaper and additional documentation don't go into detail on how exactly the internal oracle impacts trading fees.
Curve is a decentralized exchange, which means the rules of each version of Curve are permanent, and no one needs permission to trade, provide liquidity, or deploy liquidity pools using the Curve AMM protocol. However, those who provide liquidity to the protocol can earn the CRV token, which is used to vote on proposed changes to Curve via the Curve decentralized autonomous organization (DAO).
Individual voting power in the Curve DAO is denominated by the amount of CRV token held in one's wallet, and creating a Curve DAO proposal requires holding at least 2,500 CRV. CRV makes up part of the rewards liquidity providers get to incentivize them to deposit their crypto, and these rewards make up 62% of the total 3.03 billion CRV supply. CRV can also be staked to earn 50% of all fees collected from traders using the Curve DEX. Staked CRV is denominated in the veCRV token—the liquid staking derivative of CRV.
While liquidity providers are essentially rewarded with votes in the Curve DAO, this doesn't mean the entire value proposition of CRV is influencing the protocol by voting on Curve DAO proposals. This is because DeFi staking with CRV doesn't reward stakers with more CRV tokens, but rather with 3CRV LP tokens. These tokens represent the liquidity deposited into the 3pool containing the USDT, USDC, and DAI stablecoins.
This staking reward is what makes yield farming on Curve so appealing. Staking rewards are distributed in LP tokens of Curve's largest stablecoin liquidity pool, and these 3pool LP tokens can be withdrawn from the liquidity pool for actual stablecoins. This incredible incentive is what makes Curve Finance one of the best yield farming destinations in all of DeFi.