IIP-100: Launch LINK2X-FLI

Governance Proposal
1

IIP: 100
Title: Launch LINK 2x Flexible Leverage Index (LINK2X-FLI)
Status: Proposed
Author(s): Pulse Inc
Created: 29-Oct-2021
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Summary

Pulse Inc proposes that the Index Coop manages a new index that provides two times the return of Chainlink’s LINK token, using the FLI strategy that was proposed in IIP-13.

Abstract

‌LINK2X-FLI is based on V0.1 of the FLI methodology that is also used for ETH2X-FLI and BTC2X-FLI.

Motivation

Manually maintaining a leverage position requires continuous monitoring of the health of the position in order to avoid liquidation and incurs high gas fees when the position is frequently rebalanced.

Rationale

Flexible Leverage Indices (FLIs) solve this problem by wrapping a collateralized debt position in a single token that can be bought and sold on an exchange and by socializing implementation costs. Furthermore, FLI’s unique index algorithm reduces rebalancing needs by an order of magnitude. Emergency deleveraging is possible during Black Swan events for additional safety.

Specification

Overview

At inception the following parameters are proposed for LINK2X-FLI:

Asset and strategy parameters
Underlying Asset LINK
Borrow Asset USDC
DeFi Lending Protocol Aave v2
Target Leverage Ratio 2
Maximum Leverage Ratio 2.3
Minimum Leverage Ratio 1.7
Initial Supply Cap 250,000 tokens
Token value at inception USDC 100
Rebalance parameters
Rebalance Interval Daily / 24 hours
Recentering Speed 5%
Slippage Tolerance 2%
Ripcord parameters
Ripcord Leverage Ratio 2.7
Ripcord Slippage Tolerance 5%
Initial liquidity
Pair LINK2X-FLI / LINK
DEX Sushiswap

More detailed rebalance parameters to be discussed after DG1.

Size of opportunity

While LINK has a market cap similar to WBTC, it has significantly higher trading volumes and volatility indicating demand and opportunity for a LINK2X-FLI product. Chainlink is one of the most widely used protocols in the Ethereum ecosystem that has gathered a strong community behind it. On Aave v2, LINK is the most supplied non-stable coin after BTC and ETH.
Demand for a 2X-FLI product is therefore expected to be stronger than for WBTC.

Market & Customer Research

Target Customers

  1. LINK holders who use the minting of a FLI token as a USDC loan while keeping their long LINK exposure and who cannot afford gas fees caused by the frequent rebalancing that is needed to maintain the debt position. In addition, some of these holders may act as LPs in a LINK2X-FLI / LINK pool resulting in a 1.5x leveraged LINK position that also earns LP fees with limited impermanent loss.
  2. Traders who are taking short term bets on LINK price movement.

Methodology

Objective

Flexible Leverage Indices enable market participants to take on leverage while minimizing the transaction costs and risks associated with maintaining collateralized debt.

Definitions

  • Borrow Rate — the cost to borrow the asset at the DeFi Lending Protocol over the most recent epoch.
  • Epoch Length — the time between rebalances.
  • Target Leverage Ratio (TLR) — the long term target for the value of the assets held by the index divided by the value of the debt held by the index.
  • Current Leverage Ratio (CLR) — the value of the asset currently held by the index divided by the current value of the debt held by the index.
  • Maximum Leverage Ratio (MAXLR) — the highest leverage ratio the index will ever have after a rebalance.
  • Minimum Leverage Ratio (MINLR) — the lowest leverage ratio the index will ever have after a rebalance.
  • Re-centering Speed (RS) — the rate at which the Current Leverage Ratio is adjusted each period to return to the Target Leverage Ratio, when the index is not being adjusted back to the Maximum Leverage Ratio or the Minimum Leverage Ratio.

Index value:

FLIt = FLIt-1 * (1 + ((Pricet / Pricet-1–1) * CLRt-1 - (BorrowRatet * (CLRt-1 - 1) / CLRt-1)))

Calculation of the new Current Lever Ratio for the period:

CLRt+1 = max(MINLR, min(MAXLR, CLRt * (1 — RS) + TLR * RS))

Costs

Cost to customer
Implicitly the customer earns the LINK deposit rate on the collateral while paying the USDC borrow rate on the debt position. In addition a 1.95% streaming fee is deducted from the index performance.

Cost to mint / redeem
There will be mint and redeem fees of 0.10%.

Fee split
Flexible Leverage Index will have a streaming fee of 1.95% (195 basis points) and a 0.1% mint / redeem fee. The revenue generated from the fees, after subtracting gas fees, will be split 40% to DeFi Pulse and 60% to Index Coop on a monthly basis.

Liquidity

Pulse Inc suggests a LINK2X-FLI / LINK pool on Sushiswap for initial on-chain liquidity based on observing BTC2X-FLI / WBTC as the corresponding most liquid pool for BTC2X-FLI. We expect self sustaining liquidity driven by FLI traders as well as LINK holders that provide liquidity to achieve a net 1.5 times leveraged position that earns trading fees. Being part of Sushi’s reward program should further incentivize LPs initially.

Author Background

DeFi Pulse and the Pulse Inc are committed to maintaining and creating indices as well as driving the continued growth of the Index Coop.

DeFi Pulse is the leading website for the latest analytics and rankings of DeFi protocols. DeFi Pulse’s rankings track the total value locked into the smart contracts of popular DeFi applications and protocols and provides key insights and educational content to help more newcomers go from zero to DeFi.

Marketing support / distribution / partnerships

DeFi Pulse and Pulse Inc will support the launch of this product through all their channels (websites, blog, twitter) and are open to joint marketing efforts with the Index Coop.

Copyright

Copyright and related rights waived via CC0.

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Excited to get this product to market!

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Huge thanks to everyone across multiple team to make this happen! Excited to get back to launching products :fist:

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Jeez, it’s been a slog to get here - full of tears, fears, new understandings, etc - but let’s just launch some bloody products and build the franchise.

Thanks for suggesting this @ChrisG and Pulse Inc.

Thanks for quick, solid support @afromac @allan.g.

Thanks to frickin’ everyone for their patience.

I am strongly FOR this.

Launch asap please. Let’s go - and let’s GROW.

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Fantastic to see the next launch lining up for the FLI suite, and thrilled to see the conversation between Index and DFP flowing smoothly :rocket:

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Hi @ChrisG,

Great to see Index Coop back building more leverage products :slight_smile:

I have a quick clarification and with that I want to play back how I interpreted the snippet above to make sure I understand correctly. The key clarification is around the “deposit rate” and “borrow rate” and if this includes the liquidity mining incentives.

As we know on Aave V2, there are interest for lending and borrowing capital, as well as Liquidity mining incentives on LINK and on USDC. Reading the above, I interpret the following capital flows to occur within the LINK2x-FLI product.

  • Interest from depositing LINK
  • Cost of borrowing USDC

May I confirm that is the correct interpretation of “deposit rate” and “borrow rate” ?

If so the question then becomes, what are our current thoughts on the liquidity mining incentives highlighted below ?

  • stkAAVE from depositing LINK
  • stkAAVEand from borrowing USDC

There is a natural tradeoff here which I am highlighting for those less familiar with this product offering:

  • Profitability is enhance with distributing these stkAAVE tokens out to Index Coop and DeFi Pulse.
  • Converting stkAAVE >> AAVE >> LINK >> aLINK enables the product to partially offset the ~8% net borrowing cost.

My personal view, is the stkAAVE is distributed out to Index Coop and/or DeFi Pulse. The 8% net borrowing cost to me is perfectly fine and acceptable given the nature of the product and its primary use case as a trading product.

Tagging the relevant folks for the next question: @Cavalier_Eth, @afromac and / or @edwardk

Apologies in advance, but I feel this is an important conversation to have and at the very least, we can all have the same interpretation / understanding of the path forward.

The long term profitability, NPV, etc… of the product from an Index Coop & DeFi Pulse perspective is significantly improved if we socialise the on chain gas costs across the product holders. Noting the above snippet, my question is how soon can we roll gas costs into the product ?

Whilst gas is pre-revenue split we have a direct incentive to socialise these gas costs among product holders. I also note, that I am assuming the on-chain gas costs are going to be paid by Index Coop (not Set Labs) at launch and for the duration of the product life and then reimbursed from the product generated revenue. There is a little bit of opportunity cost in this approach as asset prices could diverge between when costs are incurred and when reimbursement is received.

I also note, if this product is to be launched with Set Labs incurring the gas cost, that would be great for Index Coop. However, I won’t be supporting any proposal to reimburse Set Labs for any past gas costs, especially any relating to this product after flagging this. We need to get the incentives around the product correct at launch and if not, then Set Labs is incentivised to upgrade the product to prevent incurring future gas costs. That is a nice and simple way on handling it all.

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Hi Matt. You did not tag me in relation to this point, but I just want to point out that I completely agree with this particular suggestion - sktAAVE should accrue to IC and DFP, and the interest/cost of borrowing should accrue to customer.

The primary use case of the product is for customers who want to go long LINK and socialize the transaction costs of managing a leveraged position across a pool of traders with similar goals. The economic model you have described is appropriate to that use case.

Completely agree with this point. I would defer to Ed on the complexity of implementing this feature, but it seems like an essential feature.

However the question I would ask you is are you prioritizing revenue or growth in your thinking? If the opportunity cost of implementing this feature is further delays to the proposed leveraged product suite, is that a good strategic move at this time?

This is also an important point that deserves attention. As the revenue accrues in the proposed token itself, - and as the product is leveraged by nature - it is vulnerable to a mean reversion. This can often lead to a situation where the realized price when used to pay for gas costs is well below the price of the revenue when it accrued / was accounted for. Conversely, the opposite can also be true but it does add a risk element to holding revenue in the asset itself that should be considered seriously for all FLI. I would be happy to work with EWG and FN on developing a strategy/workflow that minimizes this risk to the coop. Caveat: If this cost is borne by IC like you mentioned above.

Why not? Set is our most important service provider and has invested heavily in developing the technology these products are dependent on, provided constant aftercare and support, and yet has no direct revenue stream from the products. They only upside from the products that accrues to Set Labs is from the increased value of the Index Token itself. Surely that creates a strong incentive to perfect the economic model of the products over time?

The latest data on ETH2x FLI shows that IC has generated over a million dollars of revenue (post-split with DFP), while Set Labs have paid out over $140K in gas costs to rebalance. I’m not sure why it would be such a sticking point to reimburse a partner for covering the cost of a successful product early in its life cycle.

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I’m not so much trying to disagree here, as I am trying to understand your reasoning for having this perspective. Do you feel that if IC and DFP assumes historical and future gas costs for these products that Set will refuse to update the economic model to socialize gas costs in the future?

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Hey @ChrisG - excited to see this product launch! I know I gave this feedback on the draft, but figured I would put it here for more visibility.

I think we should be launching this product on a Uniswap v3 concentrated liquidity pool. For a variety of reasons:

  • both current FLI products have naturally built as much (BTC2x) or much more (ETH2x) liquidity on concentrated pools after launching on non-concentrated pools
  • the liquidity of previous FLI products provides strong evidence that incentives are not needed to build deep liquidity - so why are incentives a consideration?
  • if giving passive LPs an opportunity to get into the 1.5 times leveraged position that earns fees - that can be achieved much better by launching a Visor vault on top of the concentrated pool
  • but to the point above, I would argue that servicing passive LPs should not be a high priority of FLI products (or really any of our products) - sophisticated LPs on concentrated pools serve the Coop so much better
  • seed liquidity will go much farther (to the tune of ~4x) at providing launch liquidity on a concentrated pool - also, if those providing seed liquidity are wary of v3, let’s launch a Visor vault and put the seed liquidity there for Visor to manage
  • current FLI products both have fractured liquidity, which overall decreases the capital efficiency of the liquidity being provided across pools - by launching on a concentrated pool (where FLI products naturally migrate) we likely keep liquidity in one place - this serves the product and the users much better

It feels like we are chasing short-term incentives with no apparent need or strong reasoning to do so. It feels, imo, that all the evidence points to FLI products thriving on concentrated pools.

In general, I think we need to rid ourselves of incentive mindsets at the Coop, especially when there are clear, strong alternatives to take. I would like to see us launch this product on a concentrated pool and reap the benefits of concentrated liquidity from the get go.

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Hi @afromac,

I don’t want to side track this conversation, I do want to share my thoughts and I believe this resonates with a lot of folks at Index Coop.

  • Set Labs chose to implement this design feature.
  • Many months have passed and there has been ample opportunity to correct this design flaw.
  • Set Labs gets 28% ownership of Index Coop - something we will revisit as part of Index 2.0.
  • Set Labs is monetising technology built for Index Coop without paying any royalty or providing any kick back - surely this offsets the gas costs.
  • If the Intellectual Property was protected like Uniswap V3, for a couple years, either by gentleman’s agreement or legally binding like Uniswap V3, then I’d have more empathy.
  • Index Coop is the sole source of >80% Set Labs TVL. How much would others pay for this privilege.

Index Coop does so much for Set Labs indirectly that we are not given credit for.

I am not advocating to delay the product in any way. I’m just sharing my thoughts up front so I can reference them later and so we can all be on the same page.

Here is Set Labs announcing they offer competing retail leverage products…

https://twitter.com/SetProtocol/status/1443689129032749058?s=20

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Hey @Matthew_Graham, @afromac
Lets move the gas reimbursement topic to a new thread as many in the community have very strong feelings on this already and as Matt rightly pointed out let’s keep this thread on topic as it could quickly unravel given the highly contentious nature of this particular subject.

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Hi @Matthew_Graham, yes, that is what I meant, the rewards accrued are not credited to the product but added to the top line revenue.

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Hi @jdcook , thank you for the feedback, these are all very good points. I will make sure we consider them during the upcoming discussions regarding the final launch parameters.

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Excited to see a new leveraged product proposal! The Work Team has conducted a preliminary analysis prior to DG1. This was our first time doing a hybrid work team assessment involving the “og work team” (myself, @Metfanmike , @jdcook ) and pod leadership (@afromac , @allan.g ), which we plan to continue moving forward. Providing this product moves past DG1, we will also complete a “final” work team assessment with a more thorough forum post analysis before DG2.

The full version is linked here and notes are below: LINK2x-FLI_Product Scoring Chart - Google Sheets

Overall score: 2.08, right below DPI (2.13) and above MVI (1.92).

Notes:

  • Market Opportunity, the highest-weighted section, scored 3.5. The team was torn on whether the research supports the potential of a large market for this product. The Leveraged Indices pod noted that LINK products are very heavily traded (data in post above), though the team was split on whether trading volume is the best indicator of a large market. Though leveraged products were originally designed to be frequently traded, less than 10% of users actually trade these frequently (5x or more over 2 month timeframe). The concept of easily gaining leverage for a particular token seems to resonate more in user interviews, and we don’t currently have data on how often LINK is used for leverage across Aave/compound/etc.

  • Revenue structured scored highly (4.75/5) with the new post-gas fee split

  • Methodologist Impact has varied over the past few DFP products that we’ve scored, so wanted to highlight that it scored a 3/5 for this round. The methodologist did not score a point for marketing support or brand reputation, as a recent survey found that less than 10% of users associate FLI products with the DFP brand.

  • On the costs side, financial and technical both scored a 1 – this is the lowest (and best) possible score, as we now have the capability to easily launch standard leverage products!

cc @ChrisG , @afromac , @allan.g , @Metfanmike , @jdcook

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Really excited to welcome the next FLI product into the Index Coop Family of products! Like BTC2xFLI launch because LINK2xFLI is part of the FLI suite of products that uses the same methodology a community call won’t be needed. If there is no dispute with that I would like to see this be queued for DG1 vote next week.

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@mel.eth @sixtykeys could you please assign an IIP # to this proposal?

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Hey @allan.g I handle the IIP process for products. Will assign an IIP number and queue the product for a vote.

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GovOps question :nerd_face: is this really IIP-101?

It seems we jumped for 99 to 101, though I am no longer sure where the record of truth is.

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Apologies for the confusion. IIP-XX - Joint Marketing and LM incentives with Kyber’s DMM This post was previously assigned IIP-100 then retracted. Thanks for picking that up.

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Link2x-FLI snags the coveted IIP-100 slot! good omen for a launch I’m already excited about.

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@Mringz can you please queue up IIP-100 Launch LINK2x-FLI for DG1 vote to begin on Monday, 11/8?

cc: @mel.eth @sixtykeys for visibility / support

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