Request for comment from Index Coop Community
This post is intended to communicate to the community an offer for a new fee split for any future FLI products, and the reasoning for this suggested fee split. Of primary importance, we must remember that the FLI product line is the result of a successful partnership between Index Coop and DeFi Pulse.
We believe that it is in the best interest of all parties to work together. Index Coop seeks to enhance our partnership with DeFi Pulse and to continue working with DeFi Pulse on launching innovative DeFi products. DeFi Pulse are significant and important community members, and the long term strength of that partnership is without a doubt the primary objective of these discussions. However it is impossible to enter into a successful partnership - in good will - when the balance of the relationship is heavily tilted in the favour of one party. Also of importance, Index Coop was not part of the agreements that led to the creation of the FLI products.
We recognize that the path forward with our partners is based on mutual trust, and that we should have a say on the agreements that we are expected to keep. We open this discussion with the community in order to ask for DeFi Pulse’s trust and understanding, so that we can aim to redress that imbalance, and to negotiate a viable long-term agreement from first principles.
Following on from the discussion - Request for Discussion FLI-Fee Split , the next step in this negotiation is to make an open offer to DeFi Pulse for what we consider to be a fair fee split and seek the input from the community. What has been deemed a “fair” suggestion is based on evidence which will be provided below. The current fee split is 60:40 in favour of Index Coop. This split is based on revenue and not on profit. Because Index Coop is responsible for the maintenance and gas costs of the products, the current arrangement results in an extremely inequitable outcome.
As of the end of July, the ETH2x-FLI product had generated over $400,000 in revenue. This resulted in DFP receiving $163,657 of income. Conversely, after accounting for operational expense and gas cost to transact, the Index Coop has made $5,474 in profit . During the same time-frame, the BTC2x-FLI product generated a total net loss of $54,644, while DFP received $20,838 of income.
DFP is making more from a loss-making product, than the Index Coop is making from one generating close to half a million in revenue. This is a completely unsustainable arrangement. To address this major imbalance, we suggest a new fee split whereby Defi Pulse will receive 15% of revenue from all the future FLI products.
Why a 15% fee split is appropriate
This suggested fee split has been put forward for two reasons.
- This kind of licensing agreement, whereby Index Coop enjoys the right to operate a product with Defi Pulse’s methodology, and pays a reasonable royalty rate on income in order to do so, more closely reflects normal practice in the software industry. DFP’s methodology for the FLI products is a unique innovation in the space. It adds value to our products. However, we believe the majority of the value add that it takes to make our products a success comes from within the Index Coop itself.
- This change in the fee split is suggested to more fairly reflect the operational expense required by the products to date, as well as the expense that will be required to maintain the existing products in future and to launch further products in this range.
We see expenses falling under three categories:
- Gas Costs
- Maintenance Costs
Average daily gas costs for the products have reduced, largely due to changing market conditions but also due to upgrades and improvements made by Index Coop and Set - such as the trade splitter and trade router upgrades. However, in recent weeks, gas costs have remained constant, and no further reduction in gas expense will be easily achieved. We are now utilizing a near optimal split between the three major liquidity pools on Sushiswap and Uniswap V2 & V3, and further engineering efforts to improve this would likely yield diminishing returns.
What does this mean? We can only reduce gas costs relative to revenue by growing the products AUM. To date, Index Coop has engaged in meaningful work and allocated resources to achieve this, but what DeFi Pulse has contributed in that regard is not clear.
Also, In this environment, the products are still vulnerable to elevated gas costs and large spikes in volatility. The vast majority of expenditure on gas is not during routine rebalancing, but during periods of market volatility, where it can be in excess of 1,000% of daily revenue. In the case of BTC2x-FLI, this is particularly relevant as the product has essentially been operating at a loss since shortly after the release. It will likely begin to operate at a profit soon, but any heightened volatility could quickly return it to a loss. Our current thesis is that future FLI products will operate with a level of success that falls somewhere within the range between ETH2x-FLI and BTC2x-FLI. However, it is equally valid that BTC2x-FLI will be our second most successful product (being a derivative of the biggest asset in the market), and that future products will produce a marginal revenue, and costs will have to be managed aggressively in order for them to be profitable. We need to construct a licensing agreement that reflects that possibility.
Crucially, it is essential to address the suggestion that gas costs will not be an issue of concern in the future. This is patently untrue, and cannot be taken into consideration. The assumption that gas costs will decline significantly is based on multiple hypothetical scenarios, which don’t reflect the actual environment we find ourselves in.
A large portion of the AUM of the products is likely to remain on L1 and not on L2. Yes, we have the capacity to launch FLI products on L2 and gain the advantages of doing so. However, as of today, L2 introduces additional centralization, and changes the risk profile of the product. For this reason, the FLI products will still have a large allocation to L1.
Optimization on L1 is possible, but is entirely contingent on the network first being upgraded to PoS, and then upgraded again to enable sharding. These are not trivial upgrades, and may take years to occur and for the results to enable cheaper transactions. If demand for the Ethereum network continues to scale, it is perfectly reasonable to assume that future upgrades to enable more bandwidth may lag increased demand. Conversely, it is unreasonable to suggest that the (at best) nebulous roadmap for the ethereum network determines that gas will be a trivial expense within any kind of reasonable time-frame.
Cryptocurrency is an incredibly volatile asset class. The majority of our gas costs are incurred to protect our product during periods of heightened volatility. This will be a feature of both the market and of our products for the foreseeable future.
The FLI products have proven to be extremely complicated products to manage post-launch. This has been a point of contention within the Coop on many occasions, as these products have been allocated resources to the extent that it has obstructed other projects and initiatives from proceeding. Overcoming these challenges and equipping ourselves to grow other aspects of our business has been an enormous hurdle to overcome, and took concentrated effort by many teams over several months. This included massive infrastructural upgrades to the underlying tech by Set, the development of new UIs and interfaces in order to scale safety parameter management, an innovative rebalancing algorithm to enable optimized transactions on multiple DEXs, and the hiring of a full-time team of in-house members to manage risk, general operations and communications on the product, of which I am a member. More info on the extent of our work is included in the original fee split discussion post.
It is difficult to quantify some of the above costs, but costs relating to the FLI team are straightforward to produce. To date, we have been paid $52,850. The PWG has budgeted $20K-$35K p/m for the next quarter. Annually, we can expect to spend $240K-$420K on this team. Preemptively, I want to state that as our capabilities stand today, it would be extremely challenging to grow the product range to its potential. It would either require the hiring of a full time member to monitor and report on risk, or the automation of much of our risk management, and communication around that. We have selected to go with the second route, and the team is currently developing an update that will automate risk management. This encompasses design, project management and engineering all happening exclusively within our team.
Longer term, we anticipate that competitors will enter the market, and ensuring that the products continue to be successful will be contingent on Index Coop to optimize and improve upon what we have today. This will involve the future creation of new technology, and the hiring of technical experts to fill emerging roles. For this reason, we strongly suggest that it is inaccurate to assume the IC’s costs relating to R&D and maintenance of the products are fixed and can be amortized across future products. Instead, these are real costs that will continue to grow as we scale the product range and the market matures.
In the event of a major product failure, DeFi Pulse will not assume responsibility. DeFi Pulse is a data company. Index Coop manages the product and assumes all responsibility for any negative outcomes. There are multiple risks associated with managing these kinds of products, and Index Coop shoulders the full burden of responsibility for navigating them. As such it is unreasonable to suggest that Defi Pulse can expect 40% of revenue, while having zero exposure to the underlying risk.
These risks include:
Dependencies such as Compound or USDC could fail.
Regulatory Risk - Circle or Coinbase could be forced to shutdown USDC
Liquidation of the product due to an oracle failure - MakerDAO 2020
Smart Contract exploit
The Leverage Indices Pod is ready to launch products
The leveraged indices pod has spent the last 4 months successfully managing both FLI products, and in that time has developed the skill and knowledge to be able to launch our own range of simple leveraged index products that do not use the FLI methodology. The team outlined their vision in this post.
The purpose of this post is to communicate to all of our stakeholders, and to our partners in DFP, what we believe is a fair outcome of these discussions. The intention is to present this evidence and reasoning to all of the wider community to invite further debate and discussion. If we need a community call to discuss this and align as a community we will schedule one.
This issue is central to the wider debate about autonomy - and the nature of the methodologist role - that is already taking place in the community. We appreciate the sensitivity of these discussions, and welcome the concerns of any community members. It is our responsibility to address those concerns. We promise to uphold our central principles of empathy and understanding in this conversation. All voices will be heard. To reiterate our primary objective from the start of the post, we believe that this is a crucial step in restoring equilibrium in our partnerships, and to secure and strengthen our relationships with Defi Pulse going forward.