IIP: 091
Title: DG2 - Final - Launch the NFT Index token (JPG)
Status: Proposed
Authors:@JosephKnecht (MoonRock), @oneski22 (Index Coop)
Reviewer: @DocHabanero
1.0 Simple Summary
The NFT Index (JPG) is a diversified portfolio of blue-chip and leading NFT collections. JPG provides exposure to the top NFTs through a single liquid token.
2.0 Abstract
JPG is a index token of blue-chip and premier NFT collections. The index is composed of fungible versions of NFTs including fractional and liquidity vault tokens, curation DAO tokens, NFT currencies, and wrapped NFTs.The JPG token can be implemented using the simple (aka composite) Set Protocol with a medium amount of additional engineering effort.
2.1 Motivation
Non-Fungible Tokens (NFTs) are a revolutionary cultural, artistic, and financial phenomenon. However, despite the massive size and growth of the NFT market there is no NFT index token.
For institutional investors, benefits of an NFT index token include access to a highly illiquid and fragmented market, a single instrument for long/short positions, enhanced diversification, faster order fulfillment, reduced transaction fees, and automatic rebalancing. Advantages for retail investors, in addition to the above, include easier onboarding, mitigating unit bias, and lower capital entry requirements.
2.2 Rationale
JPG is designed to provide liquid access to the top NFT collections though a ‘simple’ Set index token. The tokens are drawn from fractional and liquidity vaults, curation DAOs, and currencies. The tokens were selected based on having high liquidity and sufficiently high market cap. The allocation uses a very high liquidity weighting to minimize the price impact and transaction costs for issuance, minting and redeeming.
In general, there are 4 ways to make NFTs liquid: liquidity vaults, fractional vaults, collection DAOs, and wrappers. Liquidity vaults (eg NFTX, NFT20) let you exchange your NFT for tokens and vice versa. NFTX vault tokens are termed vTokens. Fractional vaults (eg Fractional, SZNS, Unicly) let you turn an NFT or collection into tokens but then require an auction to sell the NFTs. Collection DAOs (eg WHALE, uJENNY, BPT, FISH, APED and many others) have membership tokens, the value of which is backed by the DAO vault. And wrappers (eg WGK, WG0) let you wrap your NFT and receive tokens in exchange.
Feedback from the community included the following points:
- ‘Launch with a simple index.’ Based on this feedback we have decided to launch with a simple index that requires only medium engineering effort according to EWG. We have deferred the ability to trade NFTs directly and restricted ourselves to ERC-20 tokens which provide NFT exposure. We have also relaxed our inclusion criteria to include not only fractional and liquidity vaults, but also curation DAOs, and wrapped NFTs. This has had the added benefit of dramatically improving the underlying liquidity. The sole engineering request is to add support for claiming the ETH from auction proceeds.
- ‘Allocate 10% to Ether’. We have added a 10% allocation to Ether based on a recommendation from @overanalyser. This allocation serves to reduce the price impact at issuance. Additionally, it provides a reserve for acquiring future tokens without incurring the price impact of selling a low-liquidity position. The index may also acquire Ether in the future following a successful auction of a fractional vault.
- ‘The maintenance costs will be very high because of the low underlying liquidity.’’ To address this we have heavily optimized the token inclusion criteria and weighting for liquidity. Also, we have removed rebalancing and dramatically reduced the recomposition frequency in order to minimize the associated AUM decay and gas costs. As a result the maintenance costs will be minimal.
- ‘There are not enough vaults from the Fractional protocol.’ The Fractional vaults tend to have very low liquidity. Only 2 Fractional vaults (i.e., DOG and NFD) met our liquidity requirements and so were included in the index. We will monitor new Fractional vaults for future inclusion in the index.
- ‘Consider using synthetics.’ We are open to using synthetics provided they satisfy the inclusion criteria. The only potential synthetic is $uPunks from Yam Synths. However, this token has negligible liquidity and expires monthly so it would be very expensive to constantly rotate.
3.0 Specification
3.1 Overview
JPG is a liquidity-weighted index of NFTs represented by NFT vault tokens, curation DAO tokens, NFT currencies, and wrapped NFTs. The index consists of ERC-20 tokens exchangeable for or backed by NFTs. The token can be implemented as a simple (ie, composite) TokenSet with medium engineering effort.
3.2 Differentiation
As the first major NFT index token on the Ethereum blockchain, JPG is a highly differentiated product. The JPG token is unique in providing liquid access to the NFT market at scale. The product does not overlap with any existing Index Coop products and could be cross-sold with MVI and P2E.
NFT-related index products currently on the market include:
- NFT platform indices such as NFTI and NFTP hold NFT protocol tokens (ie, AXS, ENJ, SAND, SUPER, etc) and not NFTs themselves.
- PFP index is a profile pic index planned by PieDAO.
- Strudel Finance has an NFT index consisting of a Balancer pool of 25% each of wBTC and the NFTX vaults PUNK, BAYC, and COOL.
NFT index tokens approaching launch include:
- Bitwise’s NFT blue-chip index is off-chain, has a $25k minimum investment, US accredited investors only, 6-month lock-up, 1-month redemption notice period, cannot be redeemed for underlying NFTs, has not launched yet, and will likely have very poor tracking error.Alongside Finance plans to launch an NFT index in Q1 2022.
- Scalara (formerly Pulse Inc of DeFi Pulse) has announced an NFT index called NFTI based on NFTX vaults. The proposal has been submitted to Kuiper finance for launch. Many of the components are highly illiquid.
JPG is based on the NFTX Vault Index (NFTVI) which fair-launched on Uniswap v2 on August 28, 2021. See Zerion for NAV performance and index composition.
3.3 Example composition
Example composition as of 03 Feb 2022
The Overallocation Factor (aka Overanalyser Factor) is the ratio between the allocation for a hypothetical $1M AUM and the trading depth. According to the Liquidity Manifesto, OA Factors greater than 1 for >5% positions suggest a heavy allocation relative to the available underlying liquidity.
We anticipate that the liquidity of the NFTX vaults (PUNK, GLYPH et al) will improve dramatically prior to JPG’s launch due to uptake of NFTX’s single-sided staking program and the launch of FloorDAO. We will reevaluate JPG’s composition prior to launch accordingly.
The contents and valuations of the curation vaults and individual NFT tokens are below.
- uJENNY: Vault contents and Portfolio Appraisal - Nov 2021
- WHALE: Vault contents and Valuation Report - Nov 2021
- APE DEO: Vercel dashboard
- K21: Gallery
3.4 Backtest data
For the period 01 Aug 2021 to 31 Jan 2022, JPG would have returned 111% versus 0.4% for ETH.
Back-testing results from earlier periods are not representative since the NFT market underwent explosive growth during that period.
4.0 Size of Opportunity
The market cap of the top 20 NFT collections is $9.4B and growing extremely rapidly. Assuming 5% of the top 20 market cap can be made liquid, accessing 25% of that market represents a $117M opportunity.
We expect the NFT market to become substantially more liquified over the upcoming months and years with the explosive growth in NFT fractional protocols, curation and production DAOs, treasury holdings, wrappers, and marketplaces.
Given the very low underlying liquidity, we will start JPG with an initial AUM of $2M. We predict AUMs of $20M, $50M, and $200M at 6, 12, and 24 months post launch.
5.0 Market & Customer Research
An NFT index token ranked as follows in Index Coop’s market research surveys fo 18 Aug 2021 and 20 Dec 2021:
- Rank 1. Most demanded product (7 out of 59 respondents) followed by a Social and Community index token (4 out of 59 respondents). [18 Aug 2021]
- Rank 1. Greatest growth opportunity (8 out of 26) followed by Social and Community tokens (2 out of 26) and New Platforms (2 out of 26). [18 Aug 2021]
- Rank 1. Most demand physical/digital asset (9 out of 26) [18 Aug 2021]
- Rank 3. Third-most requested product after a gaming index and a metaverse index [20 Dec 2021]
On Twitter, there are approximately 1-2 requests per day for an NFT index token:
Expressions of interest from Twitter
5.1 Target Customers
- Institutional investors seeking straightforward, liquid access to the NFT market at scale.
- Retail investors seeking to enter the NFT market but lack the resource, time, skill or risk appetite to invest in individual NFTs.
- Expert NFT collectors seeking to diversify their portfolio as well as ‘collect’ the first NFT index token.
5.2 User stories
Frieda: “As Fund Manager for Private equity shop Alpha, we have a long NFT thesis based on emerging cultural trends. We are crypto savvy and have crypto holdings, but are not interested in purchasing individual NFTs. We are interested in buying the NFT index token for the broad diversification, fast fulfillment, and exit liquidity.”
Hans: “As Fund Manager for Family Office Beta, we have a mandate to invest 25% of our client’s portfolio in art, 50% of which can be alternative assets. We have taken notice of high-profile NFT auctions and recognize the nascent asset class, but are uncertain how to access the market as we have no familiarity with crypto. We are interested in purchasing the NFT index token OTC because of the blue-chip collections they recognize from auction, the diversification and liquidity, and the trust and support provided by the Index Coop institutional business team.”
John: “As a retail crypto investor I am excited about NFTs as a new cultural phenomenon and asset class but I don’t have the wherewithal to invest in individual NFTs. In particular, I’m worried about the lack of diversification and exit liquidity. I have DPI and MVI and like the idea of applying indexing to NFTs. I’d like to buy the NFT index token because of the simplicity, diversification, low correlation with other crypto, easy tradability, and the strength of the other Index Coop products.”
Jane: “As an NFT enthusiast and avid NFT collector, I am interested in JPG because it looks rare as the first NFT index token. It also gives me a core position that I can then complement with more curated acquisitions. I also appreciate that the team is positively engaged with the NFT community.”
5.3 Product economics
We estimate monthly revenue of $9,916 and rebalancing costs of $1,000 for a gross profit margin of 90%. This is based on a $2M AUM, 100 bps non-aggregated trade size for rebalancing, 5% average monthly turnover, $25k weighted-average trade depth, $250 gas cost, and a 5.95% streaming fee. We have not included the mint/redeem fee income as this is difficult to estimate.
6.0 Methodology
6.1 Token Inclusion/Exclusion criteria
- Token must provide a claim on, be collateralized by, or provide currency for NFTs. Examples include fractional, liquidity, and guild vaults, curation and production DAOs, wrapped NFTS, and NFT currencies.
- NFTs must represent art or collectibles. No virtual land, domain names, financial instruments, real world assets, etc. Due to their diverse holdings, some vaults may contain ineligible tokens as well as non-NFT-related fungible tokens.
- Market cap (circulating supply) >$2M. Note that the market cap threshold is set extremely low because NFTs not in the vault nor wrapped represent an additional source of economic value and liquidity. If the circulating token supply is not available then the risk-free treasury value is used instead to calculate the market cap.
- Liquidity
- For 0.3% LP fee pools, >1 ETH trading depth @ 100 bps including the LP fee
- For 1% LP fee pools, >3 ETH trading depth @ 150 bps including the LP fee
- The above and >$1M in liquidity
- ERC-20 token tradable on Uniswap, Sushiswap, Balancer, Kyber, or Unicly.
Audits
The Fractional protocol was audited by PeckShield on April 19, 2021. NFTX was audited by Level K in November 2020 and an additional audit is planned by Trail of Bits.
6.2 Index weight calculation
The allocation is 25% liquidity-weighted and 75% square root market cap-weighted. The liquidity measure is defined as the aggregated trading depth at 100 bps for 0.3% fee pools and and at 150 bps for 1% fee pools with empirical 5x penalties for 1% fee pools and an additional 5x penalty for non-arbed pools. We take the definition from the Liquidity Manifesto that a pool is said to be arbitrageable if more than 50% of the trading volume is not on the most liquid Dex.
The allocation for the top component is capped at 25%.
Defining liquidity in terms of trading depth instead of total liquidity value has several advantages including better reflection of the actual price impact, harmonization of the liquidity definition across unconcentrated and concentrated pools, and accounting for LP fees.
6.3 On-Chain liquidity analysis of underlying tokens
The liquidity for each token is shown in the Example Composition section. For a $2M AUM, the index can be composed using 53 total trades and 1.3% net slippage. This complies with the recommendation from the Liquidity Pod that the cost of acquisition should be <2%.
6.4 Index maintenance
6.4.1 Rebalancing
The index will not be rebalanced. We will only rebalance to enforce a time-weighted average 25% cap on the top component if needed on a quarterly basis.
6.4.2 Recomposition
On a quarterly basis we will evaluate new tokens for potential inclusion or exclusion. Such tokens will be phased in or out gradually. The allocation will not use the original index weighting formula. To minimize AUM decay and gas costs, new positions will preferably be paid for from the ETH reserves. The AUM decay from recomposition is expected to be 0.3-0.5% per year and will be hard-capped at 5% per year following guidance from the Liquidity Pod.
6.5 Go-to-Market: Risk communication
The JPG token has certain risks which are not present in other Index Coop products. Accordingly, the go-to-market plan will include disclaimers and education to raise customer awareness on these risks. These messages will be communicated in the JPG product page and regularly on platforms including Twitter and Discord.
Risk 1: The token price may deviate substantially from the underlying net asset value (NAV) price.
Due to the low underlying liquidity, the spot price could deviate considerably from the NAV price. The deviation would occur if the NAV grows faster than the underlying liquidity, resulting in a large price impact for minting and redeeming. Consequently, a larger margin between spot and NAV would be needed for profitable arbitrage.
We believe the market would accept a large spot-NAV deviation due to the high market demand, the fact that the underlying NFTs are difficult to value, and since NFT curation DAOs currently trade at very large premiums to NAV, i.e., 10-80% premium.
It is important to emphasize that the price-NAV deviation would not affect the price impact customers experience when trading since that’s only affected by the liquidity in the index token and not the underlying liquidity. Also, the low underlying liquidity would not affect AUM decay since there’s no rebalancing and new components will be added very gradually.
Steps to mitigate the large price-NAV deviation include maintaining an allocation in ETH, moderating the growth through reduced marketing and reduced LMI rewards, liquidity management, and incentivizing communities to add underlying liquidity through inclusion in the index. The spot-NAV deviation will be actively monitored and communicated. At this stage it’s impossible to predict the size of the future spot-NAV deviation since that would require predicting how fast the underlying liquidity would grow relative to the NAV growth.
Risk 2: In the event of a successful auction of a fractional vault the swap price and/or NAV may not be accurate.
JPG currently contains five tokens from fractional vaults: DOG and NFD managed by PleasrDAO on the Fractional protocol, and uJENNY managed by the Jenny Metaverse DAO on the Unicly protocol. In the event that any of these vaults go to auction the price action would be very volatile and LP owners would likely pull the liquidity in order to avoid interference with the auction bidding. As a result, the price feeds for the token would stop which would temporarily impact the index token spot price until the auction proceeds are claimed. The temporary price disruption would cause customer confusion since it would appear like the price collapsed due to a rug pull. To mitigate this confusion we will communicate the auction process and consequences in advance and reiterate that communication in the event of an auction.
At the end of a successful auction, it would be necessary to manually claim the ETH proceeds. The proceeds would then be reallocated according to the original allocation rules. There is no time limit to claiming the auctions proceeds although it would be preferable to claim them as soon as possible to minimize the price confusion. The pre-existing ETH position in JPG would condition customers that part of the index allocation is in ETH.
7.0 Costs
7.1 Costs to customer
The cost to mint and redeem will be 0.5%.
The streaming fee will be 5.95%. The fee is justified by the very high customer demand, the lack of any competing products on the market, the high effort needed to maintain the product, the large governance role for curation decisions in the DAO components, the abstraction of auction claiming, and the engineering innovation, ie, novel dex and auction claiming.
As cited in the Differentiation section, the closest product is Bitwise’s NFT centralized index fund which charges a 3% management fee but has several severe restrictions and weaknesses and has not been launched yet. JPG’s relatively high fee will also help moderate trading volume which will be helpful in light of the low underlying liquidity.
7.2 Cost transparency
The total cost to the customer will be disclosed including the actual and predicted annual asset decay.
7.3 Manual rebalance magnitude
Not applicable as there will be no rebalancing. New components will be added gradually and not according to the original weight formula.
7.4 Fee split
The fee split has been agreed as 70% to Index Coop and 30% to the Product Designer and Quant post gas costs.
7.5 Meta / intrinsic productivity
Metagovernance will be controlled by JPG holders since most of the governance decisions relate to curation. Decisions unrelated to curation will be delegated upwards to the Index Coop.
Intrinsic productivity is not required at launch. However, several tokens offer single-sided staking on the native protocols and so it would be highly desirable to enable staking in the future.
8.0 Liquidity
Liquidity in JPG:ETH will be provided on Uniswap v3 through a Visor liquidity pool. Visor has committed to providing $25k of liquidity mining incentives. The Liquidity Pod at Index Coop will perform an analysis and provide appropriate seed liquidity for launch. We will provide liquidity and price ranges to give a 1 ETH trading depth at 100 bps.
9.0 Author Background and Commitment
@JosephKnecht is a Product Designer and Quantitative Anayst at Index Coop and Founder of MoonRock
MoonRock is committed to developing the next generation of crypto index strategies.
10.0 Marketing support / distribution / partnerships
The Product Designer will actively promote the token through social media and conventional channels. The Product Designer will actively engage in AMAs and interviews to promote the token. If the liquidity can sustain further AUM growth, the Product Designer will evaluate engaging a crypto marketing agency for additional promotion.
11.0 Disclaimers
Disclaimer: This content is for informational purposes only and should not be construed as legal, tax, investment, financial, or other advice. Each purchaser of an Index Coop product should consult with his or her own investment, legal and tax adviser/s before purchasing.
Disclaimer: Index Coop token products are not marketed or offered to persons or entities who: are citizens of, reside in, are located in, are incorporated in, or operate a registered office in the United States of America (collectively defined as ‘U.S. persons’). If you are a U.S. person, do not use Index Coop token products. Our website restricts trading of these tokens by U.S. persons. All website users, including U.S. Persons, must read our Terms of Service and List of Restricted Tokens. U.S. person(s) must comply with our Terms of Service and not use Index Coop tokens.
Revision history
07 Feb 2022 - Initial DG2 post
Copyright
Copyright and related rights waived via CC0.
