A different perspective on indices in DeFi and Index Coop

I wanted to share an article I wrote on the lack of universally recognised indices in crypto and why I think it might be an opportunity for Index Coop. Thanks to @DevOnDeFi for reviewing it and @reganbozman for feedback.

To sum up, the lack of universally used benchmark indices in crypto could be harmful for several reasons:

  1. Universally recognised, broad market indices are a critical component for both passive and active investment products. There can’t be a passive product without an index it should be tracking. For active products, a universally used index serves as a benchmark, justifying performance and other fees.

  2. Without universal indices, most investors are blind when investing in pooled investment vehicles, particularly the retail investors. There is no way to measure if an investment product is delivering on its stated objective. No way to understand how much risk that particular product is taking to generate its returns. Without benchmarks, investment product managers have no accountability .

  3. Lack of universally used benchmarks could also lead to product saturation . For example, if there was a DeFi benchmark index, we could measure the performance, risk, correlation, beta exposure, etc. of different products to the index. It could be that all products would be broadly interchangeable. We could see a dozen new DeFi sector trackers launched in the next few months, and without a benchmark, we will not be able to tell if any of them have merit.

From the Index Coop perspective, it might make sense to focus on sector indices, making them into adopted benchmarks and managing passive products replicating a benchmark. We could then onboard active management teams that can try to deliver alpha over the benchmark. As a premier benchmark provider, we could unlock some interesting business models by licensing index methodology to other protocols to be used as a benchmark and also providing a platform for active fund managers to build their products on.

Here’s the link to the full article and I’d love to get everyone’s thoughts on it.

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Hey Verto,

I really enjoyed reading your thoughts on this and it seems you’ve spotted a huge gap in the market.

Have you thought about what it would take to be able to deliver this from within the Coop? I don’t have a finance background but at first glance it seems on par with the role we have defined for methodologists, which as you mention is definition of the opportunity and stock selection, in this case just without the implementation of a product.

I think there is a real opportunity for Index Coop to position not just as product maintainer/marketing vehicle, but as somewhere people can go for info and insight into the space as a whole. Creating a trusted set of indices that can be used as a benchmark elsewhere widens our reach and gives more credibility to the brand. It goes hand in hand with the push to broaden our educational content (discussed at the end of the most recent growth call) and working with protocols that we vote on through meta-governance.

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Thanks @DarkForestCapital, glad you enjoyed the article. Apologise for the long response in advance. Here goes.

Technically, yes, the methodologists are the ones defining the opportunity and so-called token selection. Index Coop then does the rest. However, there’s nothing preventing the Index Coop community from delivering a methodology that we can execute on. That’s goes to the point of self-indexing that I mentioned in the article.

I think there are several things we can do if we were to pursue the vision of Index Coop as the premier provider of universally recognised, broad market indices that can be used as information aggregates, benchmarks for financial instruments and reference values for the health of the crypto market.

The first, and the most important, is the product and how we approach launching new products. Think of a benchmark index as essential infrastructure for asset management in crypto. It provides a crucial reference point. It allows us to analyse the performance and risk of all other products in the space. For example, an active DeFi fund on Enzyme could use DPI a benchmark. We could assess their performance, how much risk they are taking to deliver that performance, their drawdown profile – all against a trusted benchmark like DPI. This would give investors sufficient information to decide if a performance fee is worth paying for that particular fund. Obviously, it seems less important now as the data set is limited. But the value of a benchmark index will only grow as more products enter the space and we have longer performance history.

That being said, we don’t need 2 or 3 DeFi indices, we only need one. Our priority, from the product perspective, should be on covering broad swaths of the crypto universe, based on demand for a particular area of the market. I think we have to proactive. The community could vote on which area of the market presents the biggest opportunity – NFTs, supply chain & industrial applications (VET, FIL, etc), hardware-based tokens (Helium, SpiderDAO, etc), L1s outside of Ethereum, data infrastructure layer (LINK, Graph, etc.), web3 (HNS). Once the vote is in, we can actively solicit proposals from methodologists and community for an index covering that area. The goal should be to roll out an index fund within 30 days of the vote. I also think we should be building relationships with investors who could help seed these indices because they want holistic exposure to the sector.

Once the above index fund is launched, we can actually incentivise teams to build other products benchmarked to the index itself. These could be different methodologies, seeking to outperform the benchmark through a more active token selection, and charging a performance fee. We could partner with Enzyme on this, for example. Maybe this is where the Token Terminal product fits in. If benchmarked against DPI, it can help established DPI as the primary benchmark for the DeFi space.

Product aside, I would love us to start publishing a monthly factsheet for DPI. Factsheets are very common in TradFi asset management. It’s a 1-2 pager that cover stats for the product + provides commentary on product performance. For DPI, it could include portfolio allocation at the end of the month vs. end of previous month, performance (1mo, 3mo, 6mo, etc), performance against Bitcoin, Ethereum and maybe a 50-50% Bitcoin/Ethereum blend, volatility (relative to ETH or BTC), downside capture, etc. On the second page, we could go through the performance for each individual token and highlight if there were any major events/votes/news for the underlying projects. This would be published monthly and live on the Index Coop website. As we launch other sector indices, we would do factsheets for them as well.

The way we market Index Coop would change as well. We need to be the trusted benchmark provider for the crypto universe. It’s not about an individual product and not about generating alpha. Instead, we should be in the middle of everything, partnering with every other project that launches an index and getting their product benchmarked against ours. And like you said, this would go hand in hand with the push to broaden our educational content. Which is why a podcast, for example, focused on Index Coop as the premier index provider, not any particular product, would be beneficial.

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Great holistic thinking here!

Dude my mind’s blown. I love ideas that are not apparent but seem obvious in hindsight.

This kind of data content would be an amazing marketing vehicle.

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@verto0912 great article and great idea. From a psychological perspective having a benchmark like the S&P 500 massively helps people contextualize and understand the market as a whole. I really like the vision of the DPI being in the middle of everything, less an alpha generating protocol thank a core product of the DeFi universe against which we can measure performance.

Does the DPI covers a broad enough range of protocols to reflect the markets and can it in the future? In this small ecosystem it is easy to track the market because the market is essentially 10 products. If the DPI eventually grows to an index that tracks 100+ assets will structural changes need to happen?

I agree that focusing on socializing the $DPI is hugely important. I can already see the CNBC (or whatever) tickers scrolling across the bottom of the screen S&P(+1%) Nasdaq (+2%) DPI (+20%)…

Thanks for the great article- learn more from the posts and discussions like these than a year worth of twitter

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thanks for the feedback @BigSky7 much appreciated.

I think the methodology of DPI is sound and the composition of the holdings will evolve with the market. I can see DPI holding a couple of extra tokens in a few months time. As the space evolves, it makes sense for DPI to evolve with it. That said, the selection of tokens is part quantitative, part qualitative. So there’s always room for some judgement there, to exclude tokens that might not belong.

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@BigSky7 and @verto0912

There is no reason for the DPI index to be limited to a specific number of projects. So long as they meet the criteria, then they can be added.

However, issue and redemption / arbitrage to NAV become more expensive as more tokens need to be collected and combined. As most (smaller) trades are on the secondary markets (uniswap etc), they would see no difference.

It will also become more work for the coop to rebalance every month as there will likely be more tokens to adjust.

The good news, is that we are already seeing some adoption of DPI as the benchmark (See the bankless weekly rollup pod caset).

@overanalyser thank you for the thorough write-up. It will be fascinating to watch what new dynamic emerge within crypto indices.

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