Note: “How to DeFi: Advanced” is an advanced version of the classic DeFi book “How to DeFi” published by CoinGecko in July this year. This book can be purchased through the official website or Amazon, and can also be redeemed by accumulating CoinGecko points, requiring 800 points.
In order to better spread DeFi-related knowledge, Babbitt will continue to translate the entire book. The following is the entire compilation of “Chapter 9: Decentralization Index”.
One way to gain exposure to cryptocurrency risks in your portfolio is to invest in passively managed portfolios such as decentralized indexes without the need to constantly monitor the performance of individual currencies. The operation of a decentralized index is similar to an exchange-traded fund (ETF) in the traditional financial market.
An ETF is a structured security that can track anything, such as an index (such as S&P500), commodities (such as precious metals), or other assets. It can be bought or sold on the stock exchange.
Historically, ETFs have had better returns than active management strategies such as mutual funds. In 2020, the global ETF has an asset under management (AUM) value of US$7.74 trillion, and its trading volume has reached 1/3 of the global stock trading volume. 51,52,53
As of April 1, 2021, the decentralized index field is growing rapidly, and the AUM of the on-chain ETF is approximately $234 million. 54 It is not far-fetched to assume that this data will reach trillions of dollars in the next few years.
In this chapter, we will focus on decentralized indexes, where you can diversify your investment portfolio without spending too much time and energy to research, manage and allocate your investment.
Index agreements refer to asset managers, and index tokens refer to index products (equivalent to ETFs). These index tokens represent your share in the index fund, giving you the right to profit from the capital appreciation of related assets. In addition, there are some protocol governance tokens that allow you to have voting rights when deciding the direction of the index protocol.
First, give an overview of the market structure of decentralized indexes.
DeFi ETF landscape
As of April 1, 2021, Index Cooperation has the largest market share, accounting for 60% of the decentralized index AUM. Followed by PowerPool (14%) and Indexed Finance (12%).
Although there are more than 20 DeFi index tokens on the market, the decentralized index market is not as crowded and competitive as it seems. 55 Decentralization index AUM only accounts for 0.3% of DeFi’s total lock-in value (TVL).
Let’s take a look at the top 3 largest index agreements-Index Cooperation, PowerPool Concentrated Voting Powe and Indexed Finance.
Index Cooperation (INDEX)
Index Cooperative, also known as Index Coop, is the oldest decentralized index protocol. It was founded by Set Labs Inc., which is also the company that established the Set agreement.
Index Coop provides users with extensive exposure to different protocols on different topics throughout the cryptocurrency industry. Index token holders can own, contact, and can directly redeem the underlying assets that constitute the index.
Index Coop cooperates with various methodologists-data providers who are responsible for the strategy of specific indexes to launch their products.
As of April 2021, there are five indexes to choose from under Index Coop:
- DeFiPulse Index (DPI)
- CoinShares Crypto Gold Index (CGI)
- ETH 2x Flexible Leverage Index (ETH2X-FLI)
- BTC 2x Flexible Leverage Index (BTC2X-FLI)
- Metaverse Index Token (MVI)
Indexed Finance is an agreement focused on portfolio management. Users can mint, exchange or destroy index tokens and underlying assets, and the integrated automatic market maker (AMM) mechanism forked from Balancer automatically rebalances their indexes. Indexed Finance has five team members, one of which is anonymous.
As of April 2021, there are seven indexes to choose from under Indexed Finance:
- DEGEN Index (DEGEN)
- Cryptocurrency Top Ten Token Index (CC10)
- Five Indexes of Oracles (ORCL5)
- DEFI Top 5 Token Index (DEFI5
- NFT Platform Index (NFTP
- 484 Fund (error)
- Future Financial Fund (FFF)
PowerPool Concentrated Voting Power（CVP）
PowerPool’s index is a smart pool based on Balancer’s automatic market maker (AMM) with additional functions. Its main purpose is to bring together governance tokens for lending, borrowing, and performing meta-governance. In addition, users can directly exchange one governance token for another. PowerPool is run by an anonymous team.
Currently, PowerPool has four indexes:
- Power Index Pool Token (PIPT)
- Yearn Ecological Token Index (YETI)
- ASSY Index (ASSY)
- Yearn Lazy Ape(YLA)
Comparison Agreement Index
As a contract investor, there are three main indicators to look at:
- Agreement fee
- Protocol strategy
- Fund weighting
The management fee for each index is shared by Index Coop and related methodologists. The fees are as follows-DPI: 0.95%, CGI: 0.60%, FLI: 1.95%. There are no withdrawal fees for DPI and CGI. Only FLI has a 0.1% withdrawal fee.
In order to make up for the impermanence loss, in any token swap, when you mint or burn index tokens from one of its constituent assets, a 2% swap fee will be charged and distributed to LP holders in the form of input tokens . If you use all the underlying assets to mint coins, or redeem all the underlying assets, the 2% fee will not be charged.
However, when destroying any index token, you will be charged a fixed fee of 0.5%, and these fees will be allocated back to the protocol users who pledge the local NDX governance tokens.
PowerPool Concentrated Voting Power
There are three types of fees: entry fees, exchange fees, and exit fees. If you want to mint an index token, you will be charged a 0.1% entry fee. The 0.2% exchange fee applies to users who exchange one governance token for another. Then, the exchange fee is divided equally between the index fund liquidity provider and the financial department. If you withdraw from the index, you will have to pay an additional fee of 0.1%.
From the above cost comparison, Index Coop will get the most revenue because it charges the highest fees. Indexed Finance has only one source of income-the exit fee is 0.5%. At the same time, Powerpool’s income is more diversified, with fees from coin minting, exchange and exit.
As a fund investor, you may be a long-term holder, so fees are important.
In this case, the index token PIPT will be the cheapest option compared to DPI and DEFI5. With PIPT and DEFI5, there are no ongoing costs, unlike DPI, which has an annual cost of 0.95%.
We must understand the strategy of each protocol to understand their vision and direction for their decentralized index products.
The following is a summary of how the team included a product in its agreement:
- Propose new product ideas and discuss with community members.
- Submit product applications to the community on the governance forum
- Conduct the first snapshot vote to advance the review and approval work
- The approved proposal is reviewed by the Index Coop team.
- Conduct a second snapshot vote when the product is released
- product release
Index Coop has a strict procedure that requires a two-stage community vote to approve the product. For example, from the first snapshot vote, it took about three months to launch the Flexible Leverage Index (FLI).
Compared with Index Coop, Indexed Finance moves faster.
For example, ORCL5, the first index fund to vote, took a total of 18 days to launch from the voting stage. 56,57
Powerpool Concentrated Voting Power
Powerpool’s latest index product is Yearn Lazy Ape, which was submitted to governance voting on January 17, 2021. It was launched almost three months later, on March 3, 2021. 58,59
Currently, Index Coop and Powerpool have four index products. Indexed Finance has seven index products.
Although Indexed Finance seems to be the fastest one in launching the index, the Index Coop and PowerPool teams have worked with their methodologists to ensure that their products are safe and take all relevant factors and risks into consideration.
With the launch of their Sigma project, Indexed Finance may start to go slower. The Sigma plan allows Indexed Finance to cooperate with external partners, which will take longer. For example, the DEGEN index fund in cooperation with Redphonecrypto was announced at the end of December 2020, but was officially launched three months later.
Generally speaking, there are three main trade-offs in decentralized index tokens:
I. Market value weighting (for example: DPI)
This method dynamically tracks the market value of each asset, where the allocation of each asset is proportional to their market value relative to other assets in the index. The index using this method will focus on coins with a relatively small market value, allowing the index to closely mimic actual market performance.
II. The square root of the weighted market capitalization (such as DEFI5)
All indexes of indexed finance are based on the square root of the market value of each relevant asset. This approach reduces the impact of market performance tilting toward larger market capitalization tokens.
III. Equivalent market value weighting (such as PIPT)
This method sets the asset allocation equally. For example, there are eight related assets in PIPT. Therefore, each asset is set to a weight of 12.5%. The equal weight strategy is driven by price momentum and will benefit tokens with a small market value. Tokens with smaller market capitalizations are given the same importance as tokens with large market capitalizations.
Here are the three major risks when investing in these DeFi index agreements and funds:
I. Code is law
Although all the top three index protocols have been audited, investors need to remember that audited protocols are not hacker-proof. 60,61,62,63 Although there are audits, many hacking attacks have occurred in the cryptocurrency field, and more often, funds cannot be recovered.
II. Mercenary Capital
Most index protocols have liquidity mining plans to incentivize liquidity providers and guide liquidity for index tokens. However, most of these capitals are often referred to as “mercenary capital.” These capitals are purely looking for high returns, and as soon as another agreement with higher returns appears, they will immediately withdraw. Therefore, once the liquidity mining rewards are exhausted, it may lead to a large number of withdrawals, leading to a decline in the index agreement.
III. Systemic Risk
In DeFi, agreements can be superimposed on each other like currency Lego. However, composability can be a double-edged sword because it introduces systemic risks. For example, PowerPool’s Year Lazy APE (YLA) has ten different risk exposures, each from its five base Year stablecoin vaults.
These assets interact with ten different agreements, so there are ten different risks. The ten agreements involved in Yearn’s stablecoin vault are:
Worth to talk about
BasketDAO-DPI with interest (BDPI)
As a product of the BasketDAO team, BDPI is an interest-bearing version of DPI. The difference is that the underlying assets are lent to loan agreements such as Aave and Compound to obtain income. Therefore, the return of holding the index fund is expected to be higher than the DPI.
Cryptex Finance-Total Market Capitalization of Cryptocurrencies (TCAP)
Created by Cryptex Finance, TCAP gives you the opportunity to access the entire cryptocurrency market. The team also runs the Prysmatic laboratory and is one of the research teams behind ETH 2.0.
to sum up
We are still at a very early stage in the field of decentralized index, and we expect that this field will develop rapidly in the coming months and years. As a long-term investor, we strongly recommend that you investigate the past performance of the fund, check every chargeable fee, and consider the fund strategy used. We also recommend choosing a fund based on your risk appetite and taking into account the asset class you wish to access.
- DeFi index explanation https://newsletter.banklesshq.com/p/the-best-defi-indices-for- your-crypto
- How to buy index with Argent https://www.argent.xyz/learn/how-to-buy-defi/
- DeFi index dashboard https://duneanalytics.com/0xBoxer/indices-products
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/how-to-defi-advanced-decentralization-index/
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