IIP-126: DG1 Launch the Total Crypto Market Cap Index (MCAP)

IIP: 126
Title: Launch the Total Crypto Market Cap Index (MCAP)
Status: Proposed
Authors: @JosephKnecht (MoonRock), @MrMadila (Index Coop)

1.0 Simple Summary

We propose launching the Total Crypto Market Cap Index (MCAP), an index of the total cryptocurrency market capitalization. MCAP will be the first non-synthetic total crypto market cap token.

2.0 Abstract

MCAP is an index token that tracks the total crypto market capitalization. The token uses a sampling approach to represent the total market cap using a subset of large cap tokens. The product can be implemented as a Simple set with no additional engineering effort. The components are among the most liquid on the market so the NAV decay and gas costs will be minimal.

2.1 Motivation

Total market cap indices are the bedrock of passive investing. There is approximately $2B total AUM in centralized large cap crypto index funds. However, there are few decentralized total market index tokens and all of them are synthetic. Providing a total market cap index would address the largest segment of the index market and serve as a foundation for future diversified meta-index products.

2.2 Rationale

MCAP uses sampling replication to represent the total crypto market cap. In the sampling method, the weights are selected to maximally explain the total market variation. Sampling is a standard method in designing traditional equity index funds but we believe this is the first application to crypto. Advantages of sampling techniques over synthetic methods include full collateralization, no de-pegging risk, transparency, and ease of communication. The main weakness is the inability to capture variability which is outside of and uncorrelated with the sample.

3.0 Specification

3.1 Overview

The MCAP index is constructed using partial sampling. We take a subset of large cap tokens which best explain the variance of the total market cap. In traditional finance, total market ETFs and mutual funds solve this problem by using partial sampling and derivatives instead of direct replication. For example, VTI, the largest total market ETF, uses 85-95% partial sampling and the remainder in futures, option and swap contracts, as well as securities not in the underlying index. VTI’s target is to replicate the price performance of the underlying index and key characteristics including “industry weightings and market capitalization, as well as certain financial measures, such as price/earnings ratio and dividend yield.” Motivated by these sampling approaches, we aim to represent the total crypto market using a sampling approach.

3.2 Differentiation

Total crypto market index token on the market include the following:

  • Base Protocol (BASE, $1.2M fully-diluted market cap) uses a rebasing algorithm to implement tracking, has very large tracking error, and is not collateralized and so is always at risk of depegging.
  • Cryptex Finance’s Total Crypto Market Cap token (TCAP, $6.4M fully-diluted market cap) is an over-collateralized synthetic. As a synthetic, TCAP always has the risk of depegging. Cryptex’s CTX governance token can “…be used to compensate for black swan events that may leave TCAP vaults under-collateralized.” Gemini article
  • Alongside Finance is creating The Broad Market Crypto Index (AMKT) which “aims to be the most diversified way to invest in the crypto market for the long term. Alongside is the first to create a cross-chain index allowing a single purchase to buy all the top assets in the space. This index optimizes for capturing broad exposure, without focusing on a specific theme, and instead captures the most adopted projects across all of the crypto ecosystem.” Little information is available about AMKT’s methodology except that it will have 50+ components and quarterly rebalancing.
  • Centralized large cap indices include BITW, GDLC, DLCX, SPCBLC, and others.

3.3 Example composition

Example composition for the period November 1-30, 2021. This composition has the lowest predicted tracking error for the following December month.

This composition explains 99.3% of the market cap variance for Nov 2021 and so there’s little benefit in adding additional tokens.

3.4 Performance

The price history and tracking error for MCAP and TCAP for the test period 01 September 2021 to 30 November 2021 are shown below.

To benchmark the tracking error we consider that the standard deviation of the total crypto market cap is 2.56% across Chainlink oracles and 2.97% across major portals (i.e., CoinGecko, CoinMarketCap, TradingView, Nomic, and Chainlink Oracle).

4.0 Size of Opportunity

We predict total AUMs of $3M, $50M, and $200M at 0, 12, and 24 months respectively post launch. The starting AUM of $3M is benchmarked off of the $6M market cap for the closest competitor TCAP.

5.0 Market & Customer Research

5.1 Target Customers

  • Retail investors from TradFi looking for a product analogous to a total stock market ETF or mutual fund.
  • Crypto-native investors looking to track the overall market.
  • Treasuries looking to diversify into a broad portfolio and increase their Risk-Free Value.

According to Index Coop’s market survey, 2-3 out of 59 respondents asked for a large cap index product or a variant. For example, customers asked for a “Top 30 Market Cap Index”, “S&P500 equivalent”, and a “Market-cap-weighted L1 Index”. For reference, 7 customers requested an NFT index, 4 for a social token index, and 2 for automated yield.

5.2 User stories

Susan: ‘As an experienced passive equity investor getting into crypto, I’m looking for a product similar to a total market ETF like VTI or SPY that will allow me to maximize my risk-adjusted returns. I don’t have the time, interest, or risk-appetite to purchase individual tokens. MCAP gives me a “set it and forget it” approach where I know I’m tracking the overall market.’

Jo: ‘As a crypto-native investor, I’m looking for a core position that I can then complement with smaller thesis-driven investments. I like the fact that I get indirect exposure to a diverse basket of blue-chip tokens.’

John: ‘As the Chair of the Magnificent DAO Treasury Committee, I’m looking to diversify our treasury in order to increase its Risk-Free Value. I like MCAP due to the diversification, relatively low risk, and lack of overlap with our treasury holdings.’

5.3 Product economics

We estimate monthly revenue of $4,750 and rebalancing costs of $2,000 for a gross profit margin of 58%. This is based on a $3M AUM, 100 bps trade size for rebalancing, 10% average monthly turnover, $141k weighted-average trade depth (excluding wBTC and ETH), $250 gas cost, and a 1.9% streaming fee.

6.0 Methodology

6.1 Initial Composition & Token Inclusion Criteria

Selection criteria for tokens

  • Top 50 market cap according to CoinGecko or CoinMarketCap.
  • ERC-20 standard
  • ERC-20-wrapped versions of the above, e.g., wBTC, renBTC, renDoge, Wrapped Terra, etc.
  • No staked tokens, e.g., no STETH, CETH, etc.
  • '>$25k trading depth at 100 bps without order aggregation
  • The top 15-20 tokens by market-cap are selected from the above list.

6.2 Weightings

Full replication of the total crypto market cap is impossible because of the sheer number of tokens required. Instead, we use a sampling approach to find the allocations which best represent the total market cap based on the previous month’s price history.

The objective function is the total daily root-mean-square error plus a prior for the previous month’s weights. The weights are solved for using the interior point method and bootstrapping. The interior point method is a linear programming technique for solving least-squares problems with inequality constraints. The prior incorporating the previous month’s weights serves to reduce turnover and hence reduce NAV decay and transaction costs. The prior will be set to keep the average monthly turnover below 10%.

The total crypto market cap history will be taken from the Total Marketcap Chainlink oracle also used by BASE and TCAP. In the example above, the total marketcap data were taken from TradingView.

The sampling method used here can also be generalized to other indices where either the tokens are unavailable, a certain profile is desired, or the universe of tokens is prohibitively large.

6.3 On-Chain liquidity analysis of underlying tokens

See composition above. More detailed liquidity analysis to follow for DG2.

6. 4 Maintenance

The index will be rebalanced when the 20-day time-weighted correlation falls below r<0.97. We estimate this will entail rebalancing every 2-4 months.

7.0 Costs

7.1 Cost to customer

To be determined after DG1.

We anticipate MCAP having a 1.9% management fee.

7.2 Cost transparency

The total cost to the customer will be disclosed including the actual and predicted annual NAV decay.

7.3 Rebalance frequency

Every few months depending on the tracking error.

7.4 Manual Rebalance magnitude

We anticipate turnover of 20% at each rebalance.

7.5 Fee split

To be determined after DG1.

8.0 Meta / intrinsic productivity

Metagovernance will be enabled.

Intrinsic productivity will be enabled when it becomes available at Index Coop.

9.0 Liquidity

To be described in DG2.

10.0 Author Background and Commitment

@JosephKnecht is a methodologist at Index Coop and Founder of MoonRock.

MoonRock is developing the next generation of crypto index strategies.

11.0 Marketing support / distribution / partnerships

The methodologist will promote the token/s through the MoonRock brand. The methodologist will also be available for AMAs and interviews.

Revision history

22 Dec 2021 - Original version

Copyright

Copyright and related rights waived via CC0.

13 Likes

Passive investments are 80% of my port, and this is a must have for an org called “index”. How did you arrive at the 1.9% management fee?

1 Like

Thanks JZ. I’m glad to hear your interest. I agree that a total crypto market index is overdue.

The final fee is TBD but the 1.9% figure is benchmarked off other Index Coop products which have a 0.95%-1.95% fee.

Got it. I ask about the fee because in Tradfi, as you know, funds like VTI are well-known for the low ERs, due to their passive nature, so investors may expect that value prop to be mirrored here as well? It would be cool to see target risk indices develop out of this, with nested sets consisting of MCAP and a yield-bearing index, at different ratios (60/40 etc…).

3 Likes

Yes I expect fees will come down over time as the products scale and offset the fixed gas costs, and more products enter the space. That said, the off-chain crypto index funds still have 2-3% fees and very poor tracking error.

I agree that there’s a lot of potential for risk-class indices. On that note, you may be interested in another proposal for a Target Retirement Index series.

2 Likes

Guys,

Thanks for posting.

So the portfolio would look something like this as of right now?

If so, do you think the crypto market has enough balance to make a total market cap index work? I mean huge BTC dominance still.

I’m wondering if there isn’t much AUM or TVL in other similar products for a reason!?

According to Index Coop’s market survey, 2-3 out of 59 respondents asked for a large cap index product or a variant. For example, customers asked for a “Top 30 Market Cap Index”, “S&P500 equivalent”, and a “Market-cap-weighted L1 Index”. For reference, 7 customers requested an NFT index, 4 for a social token index, and 2 for automated yield.

Do these customers really want to buy and long term hold a product which is mostly BTC and ETH for 1.9% annual holding fee?

5 Likes

A big part of the MCAP appeal to Susan is “set it and forget” - she wouldn’t have to pay attention to crypto and manually rebalance her holdings (taking a tax hit each time) to maintain her broad exposure.

If she decided to replicate the MCAP herself, she would have to take an active role that she isn’t particularly keen on. She would have to counterintuitively buy BTC/ETH in the ratio of 63% BTC/27% ETH. If one day BTC is no longer the dominant coin, she would have to stay informed and adjust her weights accordingly.

The appeal of MCAP is that Susan could buy and hodl MCAP on the timeframe of years while in the background the Coop rebalances MCAP to weights that she blissfully is unaware about. I think that’s expertise that could be compensated for in a holding fee, but whether it’s worth 1.9% is a good question.

2 Likes

Thanks for these good questions. Your first question is what’s the advantage of a total market cap index if one can replicate it closely using just BTC and ETH. Firstly, BTC and ETH poorly reflect the total market cap because a lot of the growth and price action is outside of these 2 tokens. Here’s a comparison of a market-cap weighted portfolio of BTC and ETH vs the total market cap for 2021.


I expect that divergence to increase as BTC dominance declines and other L1s challenge ETH.

Secondly, BTC dominance is declining (from 72% to 40% in 2021) while ETH dominance is flat. Continuing to hold BTC wouldn’t prepare you for the multi-flippening. As a passive investment, MCAP will automatically rotate into whichever tokens best explain the total market cap.

The second question is about the fee. In general, we don’t have good guides for setting fees. If MCAP passes DG1, I would suggest GWG do willingness-to-pay market research to determine what the appropriate fee is. It would be good to have that research for all of our future products. The fact that off-chain large cap crypto index funds can charge 2-3% fees despite poor tracking errors and questionable compositions, suggests that there’s market support for that fee range but I will defer to the WTP research.

2 Likes

Hi Joseph, I value your insight and knowledge when it comes to methodology.

However, in your response to @DevOnDeFi it seems to me that while the Market Cap is higher it looks to clearly track in line with BTC ETH, indicating BTC and ETH (still) very closely reflect the total market cap. At least that’s my understanding based on the time shown.

Noob question also about the overlap in tokens here between MCAP and existing products. I understand we can’t create products that are 100 unique just wondering is there a standard around how much we differentiate between Index products (token inclusion) or is that a non-issue?

1 Like

Hi Lee,

Thanks for the nice feedback. There are no noob questions.

Year to date, a total market cap index would have returned 289% vs 212% for BTC+ETH with the same volatility of 4.8%. The two tend to move in and out of correlation. Here’s a plot of the 10-day correlation over 2021.

As you can see the correlation can vary considerably from ~0.6-1.0. It’s precisely the periods of de-correlation which drive the excess returns. We would expect the correlation to slowly decrease in 2022+ for the reasons mentioned above, i.e., continued decline in BTC dominance.

On your question about overlap, our products need to have differentiated narratives but it’s perfectly fine for the tokens to overlap. This is particularly important as we move to use tokens with higher liquidity in order to reduce gas costs and value decay. As a result, the list of available tokens has shrunk considerably. Another benefit of token overlap is building on our partnerships and meta-governance of the underlying tokens. MCAP’s narrative is completely differentiated from existing IC products so it’s a non-issue.

2 Likes

Learned something here ^^^
Thanks for the insight!

I also like the user stories and that you have a well-identified target market. How big is this opportunity at this point in time in terms of

  • population size (US &/or Global)
  • target market size in terms of # of people
  • target market size in terms of % of the market population (capture)
  • estimate average purchase amount

@JosephKnecht What do you see driving the Year One 1566.67% growth in assets under management? Is this primarily a function of the expected growth of the assets + an increase in the % of the market captured &/or something else?

1 Like

I hesitate to speculate on the specific market make-up but I would expect the demographic and purchase sizes to be similar to DPI. It might have broader appeal because of the similarity to tradfi total market funds and off-chain large cap indices as well as the much deeper liquidity for minting.

The predicted 15x growth is roughly 3x in share price and 5x in supply. The 3x figure is based on last year’s market cap performance and the 5x is based on the average annualized supply growth for all the IC products launched in 2021.

Have a wonderful Xmas and a Happy New Year and we’ll chat more in 2022! :christmas_tree::santa: :gift: :tada:

2 Likes

If you think about the 50+ investor segment, they’ve had substantial time in tradfi markets to accumulate handsomely. But they’re of an age where they can still remember excite and netscape - Web 1 unicorns that disrupted everything, then disappeared. As these folks approach retirement, they can’t risk their wealth trying to pick Web3 winners (BTC, ETH…). But they know that Web3 is the way forward, so a total market fund is the ideal vehicle.

The main question I’d have around the “Retail investors from TradFi…” target is, when will they start transacting with DeFi in force? Whenever that happens, I could see MCAP being their first and last stop, if positioned/messaged right.

MCAP would be an ideal core holding in any lazy portfolio.

Happy holidays y’all!

I like this! Also @JosephKnecht I took a look at your other work w/ MoonRock and I’m impressed! I think it would make sense to include this as a “Lazy Portfolio” addition. The liquidity would come in just from the pure logic of this index. Who wouldn’t want to invest in this type of index?

Question: Would rebalancing also include switching Tokens when one overtakes another?

Thanks for the kind words and the good question. Yes, the index would add and remove tokens if they met or no longer met the eligibility criteria, i.e. top 50 market cap and >$25k depth @ 100 bps. This is one of the reasons against having a minimum allocation as most of the recomposition would happen at the bottom of the allocation, creating additional turnover. In general, recompositions are very expensive because of the gas costs and slippage for entering and unwinding positions, particularly since the smaller tokens tend to be less liquid and available on fewer exchanges for arbitrage.

The more impactful scenario is needing to add a new wrapped or mapped large non-ERC-20 token (e.g., wrapped Cardano) which would require entering a large position. We are considering adding more wrapped/mapped non-ERC-20 tokens to the starting composition to pre-empt that, i.e., wAVAX, wBNB, renDOGE, stkATOM, SOL, wXRP. To @DevOnDeFi’s earlier point, this would also reduce the BTC dominance.

We’ve added support for wAVAX, wBNB, renDOGE, stkATOM, SOL, and wXRP and implemented a minimum 0.5% allocation. Tokens with low liquidity have also been capped at 2%. The allocation for Dec 2021 is …

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5 Likes

Hi all, new to the discussion. I came across this looking for the SPY of crypto. I 100% agree this product is needed and should come from a protocol called $INDEX.

Another competitor is also cyrpto20.com though with a much different methodology. How quickly can you execute on this idea? I think it will be about the product differentiation and marketing.

Given fee will be one main attraction / deterrent, I suggest lower fees and assume that scale will come. 1%
Or can you write into the contract that fees will decline as AUM increases? Step functions of sliding scale.

Besides fees, and still in terms of product differentiation, is there a way to show a road map to include more than just the top 50? Again, why not have it increase with AUM? Top 100 once you get to 100 for example. Or could it start with more tokens but rebalance less often so that gas fees don’t consume returns. For example create a rule that you rebalance if new top 50 and gas fee relative to rebalance is less than 1% of transaction cost?

I agree it’s important to capture the smaller market cap tokens so that MCAP can capture the big moves of the next SOL. Warren Buffet said that if it weren’t for a handful of stocks, his lifetime returns would have been subpar. Most of the returns come from a small handful. I was just listening to The Psychology of Money. Good read.

Another part of product differentiation - liquidity. How will liquidity providers in MCAP be incentivized such that market depth isn’t the roadblock to rapid growth. Crypto20 - C20 - has very low liquidity - 7d volume of $250k for 85mm AUM. MCAP would need to have better liquidity to scale. Could I be an initial funder of initial creation of MCAP and stake in Uni for $INDEX incentives?

Marketing - What’s the plan? Besides leveraging social media. Did using Bankless Podcast have material impact of BED? Or use Grayscale to scale with a parallel off-chain version despite the downfalls of Grayscale equity listings. I like the idea of marketing to treasuries. And why wouldn’t MCAP be a better decentralized currency to own than OHM and TIME.

If done right, why couldn’t this be billions or tens of billions. ETFs in equities has been a growing theme. Maturation of crypto will naturally lead to more dollars being allocated to ETF style vehicles.

I’m interested in the product. Curious about what I could contribute that might be valuable enough to be rewarded given the core idea has already been proposed.

And have you considered other tickers besides MCAP?
ALLC, CETF (Coin ETF - because people like me will search for “ETF”), BETF (Blockchain ETF), ABTF (All Blockchain Traded Fund), or what about all INDEX products end in X? ALLX

Kevin

1 Like

Hi Kevin, Warm welcome to the forum. Thanks for your questions.

Yes, C20 wasn’t mentioned in our original post but you’ll find them described in the community call slides.

We haven’t set a timeline yet but assuming it passes the decision gates and no technical hurdles I think late Q2 is realistic.

We could include more tokens over time. The tradeoff is worse price-NAV deviation due to lower underlying liquidity and, counterintuitively, higher tracking error due to the minimum allocation.

The liquidity strategy is key. It’s usually presented later in the process at Decision Gate 2. We’re using several wrapping/mapping protocols (ie, Wormhole, Wrapped, pTokens, Ren) that might want to partner with us to incentivize the liquidity.

This is also presented later at DG2.

Let’s go for it.

We’re always looking for talented contributors. Find a group that best matches your skills (eg, Product, Growth, Engineering, Biz Dev, etc) and show up at a meeting. It’s that easy.

I’m glad you brought that up. I’m not committed to the name MCAP and I’m very open to suggestions, eg, ALL, ENTIRE, etc. I’d avoid the term ETF because of the securities connotation.

1 Like

I like / want to love this “who” but, Defi / I.C. investing is not easy yet. The gap between buying BTC/ETH on a Coinbase or buying a traditional ETF product and buying a IC product is big. Is Susan really going to figure out fiat onramps, virtual wallets, and DEXs to buy this, or is she going to stop at Coinbase? I am thinking the bigger target here may be family offices? We don’t have to eliminate Susan as a target, but commercialization targeted at family offices first - and reuse the commercialization for the advanced retail investor.

1 Like

I agree that the DeFi on-ramp and UX are horrible and are the biggest barriers to adoption. Yes, ‘Susans’ would primarily be targeted by RIAs, asset managers, etc. We have an Institutional Business function dedicated to that.