[PIP-70bis] New DEFI Index

Summary

As a logical next step to the product revamping initiative, the following post will touch on a series of considerations done regarding the revamp of the DEFI index, its Methodology and resulting allocation.
A recap of the following considerations is reported on the DEFI Index prospectus, while additional details on the asset selection/allocation can be explored on this working spreadsheet.

Proposed New Methodology

First, a slightly new and refined methodology was proposed to select the assets to be listed in the index. While the main driving factor remains protocols’ market capitalization, this time an initial protocol categorization was implemented, followed by further considerations regarding asset liquidity and relative category weight.

Protocols were categorized based on their functionality, namely: DEXes, lending, asset management, derivatives, CDP, Infrastructure, Bridges & NFT DEXes.

After initial mapping into the aforementioned clusters, a first list of indexable tokens was drawn by selecting protocols counting for at least 20% of the market capitalization of their relative category, and/or 1% of the market capitalization of the entire DeFi ecosystem.

Given that a number of categories significantly outweigh the market capitalization (i.e. dexes) of minor ones, a further constraint was introduced to limit the amount of assets per category in the index to 4. This to avoid some categories to be over represented with respect to others.

Selection criteria

After the initial filtering driven by clustering and market capitalization, shortlisted protocols were analyzed based on a number of ad-hoc criteria developed by the team, in order to ensure a sound and consistent asset selection. These criteria are presented and described in the table below.



Asset allocation

As for the maximum and minimum allocations that tokens can have in the index, these figures were capped at 10% and 1% respectively. In other words, no asset can count for more than 10% of the entire index allocation, as well as no asset can hold below 1% of the index allocation.

The rationale behind the choice of these specific figures is aligned with the initial protocol categorization. In order to avoid certain assets to be over-represented in the index (given their much larger than average market capitalization), their maximum index allocation was capped at 10%.

Furthermore, each asset resulting allocation is validated or iteratively adjusted in function of its available liquidity on DEXes, in order to ensure that the slippage incurred while minting $1m worth of DEFI index would not exceed the 3% threshold for each single asset.

Eventually, 17 assets were shortlisted and met all the mentioned criteria, translating in an index allocation distributed as per chart below:

DEFI, A Yielding Index

Given that DEFI aims at being the most representative and inclusive index in the space, leveraging composability the index will also farm all the assets in the index which are farmable in either their native staking protocols or in low risk farms where principal is not put at risk.

Tokens that do not count on native staking could be either lent out on lending protocols as Aave and Compound, or placed into aggregator vaults as Yearn. Moreover, a few assets - CRV and BAL - follow yielding strategies that render them underlying assets of specific derivative products. Such products are deemed acceptable following the rationale below.

CRV will be converted into cvxCRV and staked into Convex which accrues fees from Curve, Convex and the 3CRV metapool. While on one side we do realize that CRV and cvxCRV are not exactly the same asset, we also recognize that cvxCRV provides a liquid alternative to veCRV that accrues value while being tradeable, and still providing exposure to the Curve ecosystem.

In the case of Balancer, BAL tokens will be pooled in the 80BAL/20WETH to obtain veBAL tokens which are then converted to auraBAL tokens for staking, which grant the maximum available boost. While we do recognize that this will diversify 20% of the BAL exposure to WETH, we also consider auraBAL to be a good proxy for the BAL ecosystem that is also able to accrue value.

As shown in the table below, as per current market conditions the weighted yield from all strategies proposed for this new DEFI index allocation would combine into a staggering 17% APY!

Project Allocation Yielding strategy Current yield Productivity
Convex 8.00% Convex 4.00% 0.32%
Yearn 4.00% Aave 0.93% 0.04%
Ren 2.50% Aave 0.17% 0.00%
Maker 10.00% Aave 2.00% 0.20%
Lido 6.30% 0.00%
Rocket pool 1.50% 0.00%
Synthetix 8.50% Yearn 4.40% 0.37%
UMA 3.50% 0.00%
Sushi 5.00% Sushi 11.00% 0.55%
Curve 8.00% Convex 29.90% 2.39%
Uniswap 10.00% Yearn 1.14% 0.11%
Balancer 2.70% Aura 404.00% 10.91%
Looks Rare 2.50% Looks Rare 70.00% 1.75%
Chainlink 10.00% Aave 0.93% 0.09%
Aave 10.00% Compound 3.74% 0.37%
Compound 6.50% Compound 0.60% 0.04%
Dough 1.00% 0.00%
Yield 17.16%

Rebalancing

The proposed rebalancing process is triggered when either:

1. Max allocation of largest holding > 20% for 7 consecutive days
2. Max cumulative allocation of top 3 holdings > 50% for 7 consecutive days

Additional rebalancing policies cover:

  1. To avoid obsolescence, a minimum of 1 rebalancing per quarter should take place
  2. A maximum of 1 rebalancing per calendar month should be deemed as acceptable
  3. The sole inclusion of new underlying assets won’t trigger per se a rebalancing, whose inclusion will be considered during the first available rebalancing.
5 Likes

Hey @gabo thanks for this. Really appreciate the breakdown and rationale.

My first comment is that this feels like a great selection of DeFi protocols that capture exactly what I would want in an index product in a startup industry - exciting yet diversified as much as can be expected given the intrinsically correlated nature of the assets.

I have a few questions about the yield strategy for the index:

On yield - BAL yield jumps out as the obvious main contributor to yield, I have heard good things about aura from people I trust in the space, but it does seem to be an obviously overweight element in the yield profile of the index. 400% Yield is quite clearly a temporary thing, so what is the long term yield target of the index?

Similar story with Looks, high yields at inception suggest to me that either this index is going to be farming yields across different sources, or that the 17% outlined here is more of an initial value and not necessarily representative of the long term target - be good to get more clarity here on the rebalancing strategy and whether it relates to yield.

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I’m excited for this!

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I have a few questions:

While the main driving factor remains protocols’ market capitalization, this time an initial protocol categorization was implemented, followed by further considerations regarding asset liquidity and relative category weight.

Is mcap really the best driving factor? Further considerations include some other general rules, i.e. supply. How do you factor 10% circulating vs 100% circulating? That will significantly affect token performance in the upcoming years. Besides this proposed general methodology completely ignore any financials.

Protocols were categorized based on their functionality, namely: DEXes , lending , asset management , derivatives , CDP , Bridges & NFT DEXes .

Is it supposed to cover all relevant defi categories? What about stablecoin issuers? Or insurance?

As for the maximum and minimum allocations that tokens can have in the index, these figures were capped at 10% and 1% respectively. In other words, no asset can count for more than 10% of the entire index allocation, as well as no asset can hold below 1% of the index allocation.

Maximum capped allocation can cause early selling tokens which have traction from some reason: new product, partnership, acquisition etc…

As shown in the table below, as per current market conditions the weighted yield from all strategies proposed for this new DEFI index allocation would combine into a staggering 17% APY!

10.91% out of 17% represent Balancer-Aura (how sustainable is it?)
15.05% out of 17% represent 3 protocols (i.e. Looks printing new supply to incentivize staking)

So what is gonna be sustainable APY in the long term? Lower single digits imho.

More importantly expected volatility of most defi protocols is about 3, 4 digits in % terms in the upcoming years. So the success of this product is on the right underlyings in the index rather then chasing any extra staking yield.
I would rather read an investment thesis on each underlying, track relevant indicators, watch any changes in the markets, update those thesis, adjust allocations etc…
I believe that would outperform any competition and attract significant capital inflow to the product!

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Hey @jordaniza nice to know you are liking the index revamp.

Your questions are spot on and a good chance to provide further clarity, much appreciated.

The overall yield of the index was computed utilising current protocol APRs, which may indeed not be the best estimate for a sustainable long term yield given that a significant portion of it comes from liquidity mining programs.

A better estimate could be calculated by factoring out the incentives currently being distributed to auraBAL and Looks stakers. In this case, on one hand we could conservatively assume the yield of auraBAL to be similar to the one of veBAL, while on the other we could assume the yield of Looks to be solely the one attributed to the fees generated by the marketplace.

As a result, by assuming all other yields in the index stay constant and factoring in the above considerations regarding BAL and Looks, the index would be then targeting an average yield between 5% and 7%.

Hope you find this helpful and clarifying :slight_smile:

4 Likes

Nice to read a well thought out rational @gabo. Also good to hear a B scenario from @bennet.

A rebalancing is still a manual operation right? Meaning the thesis contains rules to be followed but human intervention is possible. Because, as @m0xt points out:

We should assume that “extenuating circumstances” are bound to happen. One or another token will do the unexpected and a correct response cannot be decided in advance.

Fortunately, it’s a DAO with active members, so monitoring the markets and gauging responses can be part of the Pie’s methodology.

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Hey @m0xt
Thanks for your questions…addressing those here below

The criteria concerning supply does not only cover the amount of tokens in circulation, which should be at least 10% as mentioned, but it also requires future distributions to be transparent and predictable. This is factored in in order to assess whether issuance may cause sudden dilution and as a result the risk of negative price impact as you’ve pointed out. As for financials, one of the criteria outlined covers ‘sustainability’, which is an internal metric we utilize to determine whether protocols effectively generate real economic value.

As for asset categorization, stablecoin issuers were in fact included under the CDP category. Based on its relative dominance, Maker was the only protocol that was selected from this category.
Insurance was not included given the category still being quite small relative to market cap and TVL.

Concerning maximum and minimum allocations in the index, extensive thought had been put into defining them. In our previous iterations, we’ve been for instance simulating a 20% maximum cap for tokens which clearly caused few protocols to significantly outweigh the rest and dominate 80% of the index or more. Therefore, after running a few iterations we found out 10% being an appropriate max allocation for the index to be acceptably diversified and inclusive (Let’s in fact not forget that we are currently including 18 assets)…
The point you are raising is imho more valid when related to the rebalancing thresholds proposed, being in fact those potentially affecting the “early selling” of a token have particular traction: as you can see though such maximum threshold was set to 20%, therefore accounting for quite some space for “out-runners” to express their momentum, to be captured by the index NAV as a whole.

As somehow already mention by @bennet in his answer to @jordaniza, the previously proposed APY were merely intended as a snapshot of proposed strategies at the specific market conditions: some of them already changed quite a bit in a week timespan.
I’d like to stress here that APY maximization was never a criteria for asset selection / allocation, but rather a “nice to have” after assets were selected/allocated as per methodology proposed, which we are confident has quite deep roots in the way we’ve been assessing and segmenting the broad DeFi space. Feedback and suggestions are anyhow always welcome!

Hope this clarifies!

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New Allocation v2

I’d like to propose here some amendment to the previously proposed allocation for the DeFI Index.

As a recap, as per methodology proposed:

  1. assets were shortlisted after mapping DeFi players into categories and selecting those counting for at least 20% of the relative market capitalization within their specific category, and/or 1% of the market capitalization of the entire DeFi ecosystem

  2. subsequently, the application of the proposed selection criteria was potentially rejecting the candidates shortlisted at point 1, when not meeting the imposed requirements: Few assets were originally affected by the imposed requirement on Liquidity, capping the max acceptable slippage for each asset to 3% when trying to mint on DEXes a total of $1m worth of index, broken down as pro-rata liquidity for each asset based on its allocation.

Specifically, regarding this Liquidity requirement, while some assets’ allocation resulted capped in order to align to this 3% max slippage (e.g. $SNX capped to 8.5% and $RPL to 1.5%), other assets like $STG and $CELR were originally excluded from the allocation due to their limited liquidity on DEXes.

We’ve been eventually re-running the whole index allocation while extending the check of this Liquidity requirements also on cowswap.exchange, additionally to the multiple DEX venues already considered (Uniswap, Sushi, Balancer, 1inch). As a result of the liquidity available through the cowswap exchange:
$RPL doesn’t result capped anymore
$STG should now be included in the index allocation

You can therefore find here below the revised allocation (v2) to reflect the points above:

In light of this new allocation and the updated APY of strategies on selected assets, the overall index profitability as per current market conditions would currently result the following

Full details are available on this spreadsheet.

PS: Props to @bennet for his active contribution to this proposal, having worked jointly on the methodology development!

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Do you support the proposed methodology and resulting allocation for the new DeFi index?

  • YES, I support
  • NOPE, I’m against
  • Let’s discuss more

0 voters

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loving this evolution of the DEFI index!

i might push the top yielding allocations higher (cvxCRV, maybe it’s a slippage issue), but overall it’s nice to see a product that has most of what i would be DCAing into for this current market.

jail

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I would like to see LQTY in there as a hedge against MKR. It can be staked for LUSD and ETH yield, and relies only on immutable contracts with 0 governance. Perhaps it was eliminated because of some of the selection criteria, but only having one stablecoin token seems…off.

$.02

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thanks @kitblake for mentioning this…that’s absolutely the case :ok_hand:
The “Social intelligence” enable by its members is indeed one of the strengths of the DAO…

Personally I won’t be against having $LQTY as part of the index, still it doesn’t specifically qualify as per neither of the 2 set selection criteria…

The selection threshold was purposely set quite high in order to narrow down the rose of candidates to approx 20 assets.

Can’t say better than

Let’s go

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Very happy with the STG inclusion.

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Fully in support of this list :raised_hands:

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The time spent on this paid off :muscle:
Lets keep developing well balanced and productive products!

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Happy to see STG in the list :slight_smile: :sunglasses:

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a snapshot is up Snapshot

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:white_check_mark: 99.73%

1 Like