Title: Buying DeFi Pulse Index (DPI)
The following is a proposal to invest 5,000 ETH, which represents ~2% of PCV, into the DeFi Pulse Index (DPI).
The DPI is a capitalization-weighted index that tracks the performance of the top DeFi tokens. It is currently composed of 14 popular DeFi tokens available on Ethereum. The methodologist behind DPI is Pulse, Inc, creators of DeFi Pulse and the criteria for token selection can be found here.
DPI is the most popular DeFi index product with, at the time of writing, ~$ 110M of market cap. It is charged a 0.95% annual fee for the management of this product. It covers the costs with portfolio rebalancing and the implementation of the methodology.
DPI is built on top of Set Protocol and managed by Index Coop. Index Coop is a decentralized and autonomous asset manager governed, maintained, and upgraded by INDEX token holders.
The main purpose of this initial investment into DPI is to grow PCV, by getting exposure to top DeFi projects. A greater and more diversified PCV can help FEI Protocol to protect the peg and drive FEI utility and adoption.
It is also interesting from a brand/vision alignment perspective as DPI represents the most relevant DeFi projects. Fei would be one of the biggest investors in DPI with the proposed allocation and this could help to consolidate Fei vocation to be the most important liquidity source in the entire DeFi ecosystem.
In a second moment, when code for providing liquidity is ready, it could also be considered to provide liquidity for FEI-DPI pair.
The allocation on DPI does not exclude the possibility to also invest in specific DeFi projects, with high synergy with FEI business (such as Aave, Compound, Curve, etc). In these cases, it may be worth it to hold a position, have governance power and provide liquidity against it. It is a complementary approach.
Considering the poll on PCV Guidelines, the proposed allocation for DPI would leave space for this other DeFi tokens allocation (up to the limit of 10% of PCV).
DPI is an efficient way to get exposure to the DeFi sector. The index gives exposure to all the component tokens while only having to hold one single token. The top 7 tokens of DPI represent ~90% of the Index portfolio (Uniswap, Aave, Maker, Compound, Sushi, Yearn and Synthetix). It is more efficient to pay the 0.95% annual management fee than do the implementation alone, spending with gas and development costs to do the rebalances.
As it is possible to see in the table below, DPI has performed in line with BTC and ETH since inception, at the cost of a 1-2% increase in volatility depending on the benchmark. The correlation of DPI with ETH is 0.77 and with BTC is 0.54. It is a way to diversify a bit from only holding ETH.
The table below follow the risk analysis model outlined in the PCV guidelines:
Smart Contract Risk: C-
DPI was audited by OpenZeppelin 4 in September of 2020, launched early October 2020, and has over 131,000 user transactions.
Counterparty Risk: C+
DPI holders have no governance influence on Index Coop or the protocol within the index. The DPI utilises TokenSets V2 smart contract that has privilege roles in many of the contracts. The key findings from the audit are highlighted below:
- The Controller contract has an owner that chooses the contracts that comprise the system. This includes all of the modules, resources and the factories that can be used to make Sets.The owner also has the ability to remove Sets as desired, and specify protocol fees and other fee types that conforming modules will pay. Moreover, user deposits are achieved by granting token allowances to the Controller, so a malicious owner could deploy a module that simply takes these tokens.
- The IntegrationRegistry tracks third party integrations that can be used in the system. It also has an owner that can add, remove and edit the integrations as desired.
- The PriceOracle has a list of oracles and adapters that can be used to retrieve third party prices. It also has an owner role that can choose the supported oracles, adapters and price pairs.
- A malicious or poor choice of token contracts can undermine the value of the Set, so it is up to the set creators to choose sensible component distributions, and users will need to trust the creator or validate the choices.
There is a multisig responsible for initiating rebalances, performing meta-governance, adding / removing new protocol functionality. It does not have the ability to arbitrarily move underlying assets, mint tokens, etc. The signers are currently members of the Set team with the intention to add Index Coop community signers over time. While the multisig can’t arbitrarily move assets, it theoretically could rebalance assets into a fake token. The mitigating factors for these risks are the Set Labs, DeFi Pulse and individuals personal reputation.
Liquidity Risk: B-
Minting and redeeming DPI represent the primary market of the indices, but many users can buy and sell indices on the secondary markets. The price on the secondary markets are kept at Net Asset Value (the market value of all the underlying components) through a network of market makers that redeem the tokens when price is below NAV and vice versa.
When considering liquidity, the average daily trading volume is $7.75M, based on over a trailing 90 day trading period. However, as DPI holders have the option to mint/redeem the underlying tokens within DPI, it draws on the liquidity of the underlying assets and also allows for any deviation from NAV to be arbitraged away by traders. As the liquidity goes beyond the secondary market for DPI, this was considered for elevating this score.
Market Risk: C
As DPI is a basket of tokens, it has less volatility than the component assets by themselves. This is reflected by DPI having a standard deviation of 7.58% considering the last 6 months.
For large trades TokenSets offers investors the ability to “Buy” DPI via exchange issuance. Investors are able to send ETH, receive DPI and in the background the individual underlying assets are purchased. The “Buy” functionality draws on the liquidity of the underlying assets within DPI.
The above figure shows the Uniswap and Sushiswap liquidity as of 7th June. The below figure shows the percentage of liquidity of the underlying assets consumed when an investor uses exchange issuance to purchase large amounts of DPI. A 1% increase in circulation supply is ~$1M or 500 ETH at $2,000/ETH.
We would need a new code to call the exchange issuance 10 times to complete the total allocation.
One alternative to the exchange issuance would be to use PCVSwapper code written by @Eswak and already audited to buy DPI on secondary markets over ~2 months (~ $200,000 per day). Another would be to introduce a new DPI-FEI bonding curve.
We are open to discuss what would be the best implementation strategy.
Depending on the feedback from community about this post, we would suggest a snapshot with two options to vote:
- 5,000 ETH @ DPI
- No buying of DPI
Additionally, we would like to know the community’s initial impression on also buying INDEX, the governance token of Index Coop. This could be done using the PCVSwapper over some months or via an OTC trade. The benefits would be taking advantage of meta-governance and having influence in a project that is well structured and growing fast in DeFi. The INDEX token can be used as leverage to have more voting power in related DeFi protocols. The suggested allocation would be around $ 2M (0.4% of PCV) that represents ~5% of INDEX circulating supply, which is the quorum for voting with the shares of DPI in other protocols. If there is enough interest we can prepare a separate analysis focusing on INDEX.
Would you support a purchase of INDEX?
Disclosure: In addition to being a contributor to Fei Protocol @Matthew_Graham is also a core contributor at Index Coop.