[Proposal] Buying DeFi Pulse Index (DPI)


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Title: Buying DeFi Pulse Index (DPI)

Status: Discussion

Author: @Bruno @Matthew_Graham


Basic Summary

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.

Motivation

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.

Source: Volatility Strikes $DPI in May Following Stellar YTD Performance | by Accelerated Capital | The Index Coop | Jun, 2021 | Medium

Risk Analysis

The table below follow the risk analysis model outlined in the PCV guidelines:

Date: 06/23/2021

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.

Specification

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.

Voting Rules

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

0 voters

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?

  • Yes
  • No

0 voters

P.S. Thanks to @Eswak for the comments on this proposal and for @trx314 for pointing to this opportunity.

Disclosure: In addition to being a contributor to Fei Protocol @Matthew_Graham is also a core contributor at Index Coop.

10 Likes

@Bruno,

Thank you for the analysis. I think a purchase into DPI is sound and would be growth-focused for the PCV. However I think that a purchase in DPI is useless without the governance aspect so an INDEX purchase should also happen in conjunction.

I somewhat find that minting DPI at Set seems to be slightly more expensive than purchasing on secondary markets using ETH. It would be great to compare the cost of buying via both avenues - but in either case, buying in tranches (via Eswak’s code or otherwise) would be my preferred approach.

As an aside, have you looked into a similar index token by BasketDAO (BDI)? I’m curious on your opinions on it.

1 Like

Your analysis shows that DPI is a poorly (C) rated, and inferior performing (x3) product to ETH, its tied to ETH’s trends with a much lower upside, so it doesn’t meet requirements to be considered as a PCV growth mechanism - as a possible diversification/hedging strategy for PCV possibly, somewhat lower volatility but I’m not seeing a compelling argument for it in this post.

Additionally, I’m not sure I see the link between PCV owning DPI and FEI being the most important liquidity source in DeFi - this would be better reflected by TRIBE becoming a part of the DPI.

Investment in INDEX is a more obvious choice, meta-governance in the DPI portfolio protocols is valuable to a protocol focused on integrations. Also, INDEX vs. DPI performance aligns fairly closely, so by diversifying (or deploying) PCV into INDEX we would still get the same financial impact/benefits of investing in DPI while getting far more value from the governance aspect. Although, this could be perceived adversely by some of the DPI portfolio protocols’ communities.

2 Likes

Hi @arcology

I can provide some insight on why Exchange Issuance is the preferred sourcing option.

Purchasing DPI via Uniswap V2 with about 2% slippage has a trade size around 40 ETH. Purchasing DPI via Exchange Issuance with less than 1% slippage has a s trade size around 500 ETH. Slippage or purchasing away from Net Asset Value (NAV) is the most significant cost to consider. We are very fortunate gas is low at the moment, sometimes even single digits.

Purchasing the underlying assets and wrapping it to make DPI via exchange issuance means the trade size is determined by the liquidity of the underlying tokens. Exchange Issuance can accommodate a 500 ETH trade size and only move some of the smaller, more illiquid tokens, around 2.87%. The net affect would be less than 1% slippage on the DPI purchase. It also means that DPI is purchased at NAV, where as any drip feed buying of DPI on market risks buying above NAV.

6 Likes

This is a really good point and I can provide some context here. INDEX price does tend follow the broader trends in DeFi, so it could be a case a rising tide lifts all boats. Or perhaps DeFi rallies and DPI’s AUM goes up and therefore INDEX’s revenue goes up. For the early part of Index Coop’s life, DPI was the sole product and it wasn’t until recently that the FLI product ranges has surpassed DPI for revenue. In time, as Index Coop brings more products to market two keys things will happen. Metagovernance influence will only grow in time and Index Coop will develop a more diversified revenue profile. This may have the affect to reduce the correlation of the price of INDEX to DPI. Or the correlation can remains as everything in DeFi is heavily correlated.

Fei would need to then incorporate voting with TRIBE to determine how the community is to vote on Index Coop metagovernance proposal’s. This has the potential to enhance TRIBE’s metagovernance influence. Especially if Fei’s INDEX holding remains significant relative the governance voting thresholds.

Something to note here is DPI was launched at the height of DeFi excitement in 2020. A local top one could say. This has pretty dire consequences on statistical analysis. Looking at the DPI-ETH price chart, it is apart that DeFi as a whole is trading down relative to ETH. It could be said DPI is at the bottom of the DPI-ETH range. Therefore implying DeFi is relatively cheap compared to ETH atm.

DPI is a more volatile asset then ETH, because DeFI is in nature and it would provide some diversification to the PCV but in doing so would increase the risk profile. The recent stable coin proposal/purchase will act to reduce PCV’s risk profile.

The Aave risk assessment concluded DPI was B- which is the same as Maker & xSUSHI.

5 Likes

thanks for the additional context, especially about ratings and circumstances around historical info… some quick takeaways

defi is highly correlated - so, is there a point in diversifying from ETH within the highly ETH dependent ecosystem, seems a more meaningful approach is to focus on PCV deployments (which could require the acquisition of different assets beyond ETH) and yield generation

reinforcing my point on INDEX vs DPI - Index Coop itself is diversifying beyond DPI and is likely to loosen its correlation with ETH (still dependent but maybe less so)

1 Like

To date there has been a small allocation away from ETH to stables which is the beginning of diversifying the PCV. But I do agree, holistically PCV in general will need further diversification. There are probably more proposals in the works for that.

DPI has a correlation coefficient of 0.77 with ETH and 0.54 with BTC. I would generally say, the PCV does need some DeFi exposure as it is the largest sub asset class on ethereum. I will go even further to say having exposure to the metaverse asset class in general would be good.

In terms of overall asst allocation, that should be defined by the IPS document. From a PCV perspective, DPI is the more liquid, the more readily trade-able and is the more productive asset and therefore a better selection for DeFi exposure.

2 Likes

Hey @arcology , I see that their traded volume is considerably lower than DPI and the market cap is only $ 12M.

The difference is that our analysis was done in June comparing with Aave that was done in May and we considered this recent increased volatility in the markets. Anyway, the scores are very close (C+ and B-).

I think we could do both. As @Matthew_Graham said, we are at the beginning of DeFi, so looking to the past months everything had a high correlation. As DeFi evolves (use Layer-2 networks to scale and other blockchains as Compound Gateway) we may see a decrease in the correlation with ETH. In the case of INDEX, as it develops new products and strengthens revenue lines besides DPI they can also become less correlated with DeFi and ETH.

For the future, I also see the opportunity to provide liquidity against DPI and earn some LP fees, when code is ready. It will be good if THE stablecoin for DeFi could be the most liquid way to buy THE DeFi index.

2 Likes

@Bruno @Matthew_Graham thank you for the responses. I am wondering based on the volume of the purchases and also with @Matthew_Graham’s relationship to Index Coop I wonder if there is any scope for integrations, even if it simply means cross-promoting each other’s platforms.

Eg - would Fei be able to get any discount on DPI based on the bulk buy if INDEX is also purchased?

1 Like

Great analysis and great proposal, FOR

5 Likes

Very much for! Love to see PCV using DPI to gain simple DeFi exposure.

2 Likes