Time to say Good Pie 👋

In this post I make the case that it’s in the best interest of the DAO to move away from the product line of pies due to lack of profitability and insufficient market fit in the DeFi industry.

When talking about DeFi index products, the first question which comes out is: Why passively managed funds overtook tradfi while defi indexes are comparatively tiny? It’s a great question to ask and the answer might not be so obvious.

The most accredited theory speculates that there is a fundamental mismatch between the customers and the product offering, as Jnova puts it:

The same argument has been made most recently by the Founder of Babylon finance in the last post communicating the shutdown of operations.

It’s a solid hypothesis and I believe there is some in truth to it, however I’m going to argue technical limitations also play a role. In fact, at the current stage of the industry, it is not feasible to build index funds having sufficiently diversified market exposure, a characteristic which makes these products fundamentally unappealing to the market and therefore unprofitable for the issuers.

Let’s make a step back first, what is the value of a crypto index fund?
Whenever you hear about index fund investing the most common highlighted benefits are:

  • Portfolio diversification
  • Low risk, Low volatility
  • Low fees
  • Better long-term returns
  • Passive exposure

The aspect of diversification is a matter of paramount importance and the de-facto foundation of all the other benefits listed above.
Broad market exposure of an index product allows holders to get exposed to less risk while providing greater stability and better returns over the long-term, which is at the core of the idea of passive investing. Take for instance the Standard and Poor’s 500 (S&P 500), which is the most commonly followed equity index tracking 500 leading companies and that covers approximately 80% of available market capitalization in the United States.

It’s easy to understand that the ability to track hundreds of stocks it’s at the very core of the value proposition of such products, in fact it’s not uncommon to have indices covering thousands of securities in a single product (i.e.: Russel 2000) or with a composite product (i.e.: S&P Composite 1500). Without the ability of tracking hundreds of assets the risk increases and with it the utility as a passive-exposure vehicle proportionally decreases.

While theoretically possible, creating a tokenised fund with hundreds of tokens, quickly becomes practically impossible. This is the reason why in the entire segment of Defi indexes (32 projects according to DefiLlama) the most diversified portfolio contains only 16 assets, that being achieved by BCP via composition. Unfortunately, composition comes with challenges, including high costs of re-balancing and does not represent a scalable solution to the issue. To provide some perspective, DPI which is perhaps the largest crypto index by market cap, holds 13 different assets in its portfolio. Likewise, the Degen index of Indexed finance only has 10 assets in its portfolio. Quite a stretch compared to the diversification that can be obtained in TradFi products.

Note: For the sake of brevity I will avoid going too deep into the technical reasons on why this is the case, which can be explored on a different venue should that be needed.

Considering that the utility of an index product is strictly correlated to its ability to track broad market exposure, it’s not a surprise that the segment of indexes has not captured much interest and have had low demand relative to other DeFi offerings. To provide some numbers, the cumulative TVL of all indexes combined, roughly $200 million spread across 32 protocols (according to DefiLlama) is half of the TVL Aura Finance, a Convex fork launched on top of Balancer that has existed for less than 6 months.

As someone close to PieDAO told me once:

In tradfi I like to hold both indices and single stocks, they serve different purposes to me but pies have little amount of assets and it’s easier to make my picks.

It’s relatively easy for customers to look at an allocation of 12-15 tokens and conclude they don’t like some of the assets and would rather build and manage a similar portfolio on their own. The same conclusion is a lot less likely to happen when hundreds of assets are pulled together into one product.

On profitability

With limited utility, demand goes down and revenues with it. DeFi indices make money on streaming fees, in TradFi many index funds charge fees which are often less than 0.1%, whereas active funds often charge 1%. The average fee charged by DeFi indeces today is around 1% which is considerably higher compared to the traditional standard, in particular considering the limited utility they provide. Part of the reason why DeFi indexes have higher fees is related to the maintenance costs of low AUM products, such products bear the cost of:

  • Gas to rebalance
  • Time to rebalance
  • Promotion
  • Liquidity incentives

There are as well reputational costs related to run “Poor market-fit” products with high-access costs (high slippage buy-and-sells) for the users.

It’s quite common for such products to operate at a net loss. To put that into context, with $100M in TVL and a 1% fee, the DAO would accrue $83,333 in revenues which is not sufficient to operate an average growth-minded organization of medium size. A TVL of $500M is a better target but since it’s hard for a single product to attract that much TVL the DAO would be forced to effectively produce and operate an array of products which would further increase expenses and would as well need more resources (avg $50M/product = 10 Successful Indices).

In the specific case of PieDAO, since launched (early 2020), the DAO released 7 different products (Pies) namely: Play, YPie, BCP, BTC++, USD++, DeFi+S and DeFi+L. The latter two where then blended into a single product named DeFi++. Different products had different fee tiers, from Play and YPie that charged a 1% streaming fee to BTC++ and USD++ that had no fees at all. The table below displays each of these products in terms of their time in the market, the all time high in supply of each of them, and the revenue they generated for the DAO. To note, values in each row for ‘max supply’ and ‘all time revenue’ are expressed in the same unit of account, being the specific Pie in question. As visible, products as DeFi+S and DeFi+L have been in the market for over two years, however the value they’ve accrued to the DAO has been minimal, 0.6% and 0.13% of their max supply respectively. Interestingly, the Pie that has been on the market for the shortest period of time (Play) is also the one that has relatively generated among the highest return for the DAO (0.69%). Perhaps because of the underlying hype behind NFT and GameFi. Products as Ypie and BCP have also contributed in limited fashion to total revenue, generating 0.5% and 0.7% of their max supply respectively in a little less than 2 years.

Cumulatively, the all time high TVL for these products briefly surpassed the $28 million mark in early May of 2021. Nonetheless, revenue generated by the protocol was orders of magnitude lower and far from being enough to run operations sustainably.

Conclusions

It’s hard to say if the limited success of indices it’s only due to their constrains or only related to lack of customers that value such products, it’s likely to be a combination of both factors.

In the early days of the industry, the lack of good market exposure options made the idea of index funds very appealing for the market, however the demand for a broad exposure product has been weak and now with the evident technical limitations and empirical data on profitability, the DAO would be better served with more focused revenue-generating operations (farming, yield generation) rather than a series of products which are unlikely to grow in the short term.

The industry is still in a relatively early stage of development, there’s still a lot of room for innovation and change, in a few years there might be a need for broader exposure products, but at the current stage, it’s quite unlikely.

It’s time to say goodbye to Pies and move on to other products which have a better chance to be successful and generate value to our holders.

As mentioned in the kitchen, in the following post I will outline a proposal to reposition operations towards revenue generation activities, implementation of dynamics to expand the treasury principal, change of tokenomics and implementation of on-chain governance. Stay tuned.

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Please let us know if we will figure out a way to exit the pies without taking a haircut. The discounts on NAV at the moment for BCP are jaw dropping at 19.4%.

I can’t figure out why that discount exists, don’t arbitrage bots find this?

Thank you for the summary.
I’m looking forward to see what PieDAO will build next!

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I believe you already found the solution on Discord but for future reference, BCP can be exited single asset with good rates compared to sushi.

Check out The rise of Auxo!

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