What is Curve?

Curve Finance is a widely used decentralized finance (DeFi) protocol that provides an easy way to trade fixed-price tokens, or stablecoins, without suffering slippage and losing money. Like other protocols it comes with its own token and various rewards for participation. It has also spawned a “fork,” called Swerve. Curve Finance is compatible with several other popular protocols, such as Compound and Yearn.finance, which provide lucrative “yield.”

Price generation

To understand what exactly Curve Finance is and does, it’s important to understand its context. On typical, centralised cryptocurrency exchanges, prices of assets are determined by order-books, a long ledger of buy and sell orders for an asset, the aggregate of which generates a rough price.

On decentralized exchanges, however, there isn’t always sufficient liquidity in a market to produce any meaningful aggregate. If only one person is selling BananaCoin against, say, PICKLE, there won’t be enough data for the order-book to scan.

This is where protocols like Curve Finance come in. Curve is what DeFiers call an Automated Market Maker, or AMM. These protocols are used by decentralized exchanges to provide liquidity and also generate pricing when it is otherwise difficult. They use smart contracts: pieces of code that automate complex transactions. Indeed when a trader places a buy or sell order he is not interfacing directly with a human counterparty (the other participant in a financial exchange); when it comes to protocols like Curve Finance, rather, the counterparty is the smart contract.

Pricing algorithm

Curve works particularly well for so-called stablecoins, coins which are pegged to the value of another asset, often the dollar. Trading stablecoins, which flutter only very slightly in price, can be an effective way to perform “arbitrage,” which takes advantage of these tiny fluctuations to generate profit on large trades.

What makes Curve so effective in automating stablecoin matchmaking/pricing is its “pricing algorithm,” called “StableSwap,” which it includes in place of an order book. Many AMMs use these, including the popular Uniswap, which bases price on the ratio of the number of assets being sold and the number being bought. If there are three $BananaCoins and four $PICKLES in a “pool,” and a trader tries to swap a $Banana for a $PICKLE, the number of $PICKLEs will go up relative to the number of Bananas, and the asset’s price will increase.

In thinly traded markets, however, this can lead to a phenomenon called “slippage,” in which the price of an asset changes dramatically when the sale is executed. This is especially annoying when it comes to stablecoins, which are designed to be pegged within a narrow price range. If you’re selling a dollar-pegged DAI for $0.70, you’re losing out.

Curve Finance has its own pricing algorithm that responds to this, and is well suited for these sorts of tokens, especially when traded against each other in roughly the same price range (i.e., DAI for USDC).

While the Curve algorithm is densely complex, one concept worth attempting to understand is “rebalancing.” Basically, Curve offers over a dozen “pools” of funds which are accessible through its website and contain various combinations of stablecoins.

The stability of these combinations (50 percent USDT, 50 percent DAI, for instance) is calculated to minimize slippage and is vital to the success and health of the protocol. Curve’s innovation is to introduce a “rebalancing fee” to traders, which essentially offsets any shift in these finely tuned proportions caused by their trade. It will either cost a user extra to make up for a shortfall or refund them in the event they have actually added a surplus of one of the tokens in the pool.

The result is that the pools, like the value of their contents, remain stable.

It’s also pretty easy to use. To access Curve, users simply have to connect their digital wallet to the Curve website, and select whichever coins they want to trade. Many trader use the popular, accessible MetaMask, an Ethereum standard.

Pool

Curve Finance also enables market participants to profit from the arrangement by depositing their own funds in a pool and acting as a sort of market maker, ensuring that there are always enough funds for traders to buy and sell against. Increasing the amount of money in a pool in this way also reduces the possibility of slippage, since the fixed ratios of tokens is less likely to be disrupted by a small trade if that trade makes up a smaller proportion of the sum pooled.

There are, of course, rewards. On the more typical decentralized exchanges these rewards come principally in the form of trading fees levied on users’ individual trades (and denominated in the token traded). Previous attempts at AMMs for stablecoins, however, flatlined because the winnings to be gained from trading fee commissions in fixed-price tokens were slim pickings compared to the high “yield” achieved through other platforms, which allowed liquidity providers to benefit from tokens with wild, speculative gains. The result was a failure to attract people willing to pay liquidity providers.

Curve’s solution was to basically make the rewards better, and it seems to have worked. Users who pool their money, called “liquidity providers,” are rewarded in several ways. First, they are rewarded with transaction fees. On every trade there is a 0.04 percent fee levied, 50 percent of which goes out to the liquidity providers and the other 50 percent to the holders of the veCRV token, one of the many tokens associated with the Curve platform.

Second, Curve can be integrated with other complicated Defi protocols such as Yearn and Compound, which allow users to “stake” tokens and generate a certain amount of interest. The Curve-Compound intersection, for instance, permits the liquidity provider to generate that interest from funds deposited in pools, increasing earnings. This interoperability is known as “composability” and also comes with serious risks—with multiple highly complex DeFi protocols working interdependently the risk of a huge collapse will be higher.

Finally, Curve provides liquidity providers with CRV tokens, which, unlike stablecoins, can fluctuate dramatically in price. There are 3.03 billion of these tokens, 62 percent of which are distributed to liquidity providers. Each token is currently worth $3.3, which means that there’s 6.1 billion in total for the providers. A further 30% goes to token-holders, 3% to Curve employees and 5% to a community reserve.

The Curve coin also plays into a “governance” system that allows holders to vote on changes to the protocol.

Governance

Holders of CRV can choose to “lock up” their holdings and in turn generate a new token, “veCRV,” which vests holders with the ability to either vote or — with enough veCRV — to submit their own proposals for consideration. Last year the CRV became the native token of a new decentralized autonomous organization, or DAO, which is a kind of blockchain-based decentralized governance entity that runs on smart contracts.

Curve, the company

The development of Curve Finance is a bit of a mystery. There is a single known contributor, a man named Michael Egorov, a PhD and a graduate of the Moscow Institute of Physics and Technology. Egorov, who released the software in 2020, has also been embroiled in minor controversy, after he assumed 71 percent of Curve’s voting power late last year in response to a single liquidity pool run amassing over 50 percent of the voting power. That controversy, along with suspicions about the protocol’s awkward initial rollout, spawned a hard fork of Curve, called “Swerve,” which sought to return the protocol to its users.

Despite all this, the smart contract for Curve is well-regarded and efficient, and has been audited by Trail of Bits, a leading auditor. “However,” Curve adds in a proviso, “security audits don’t eliminate risks completely. Please don’t supply your life savings, or assets you can’t afford to lose, to Curve, especially as a liquidity provider.”

Indeed, recently a vulnerability was discovered by Egorov himself, who described in a blog post how, briefly, it would have been possible for a trader to essentially drain an asset from the pool, effectively robbing it, by trading it with the same asset. Egorov said that the bug alone couldn’t be flagged up or fixed without drawing the attention of malicious hackers so instead patched it in an all-encompassing update.

By DeFi standards, Curve is used widely and is the sixth largest DeFi product by users. According to Defi Pulse there is $4.34 billion worth of cryptocurrency currently “locked” on Curve, 0.24 percent of which has been turned into voting power. The stablecoin most heavily bought is $USDC, the stablecoin built by Circle.