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.
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.
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.
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.
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.
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.
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.
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).
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.
- 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.
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.’
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.
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.
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.
See composition above. More detailed liquidity analysis to follow for DG2.
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.
To be determined after DG1.
We anticipate MCAP having a 1.9% management fee.
The total cost to the customer will be disclosed including the actual and predicted annual NAV decay.
Every few months depending on the tracking error.
We anticipate turnover of 20% at each rebalance.
To be determined after DG1.
Metagovernance will be enabled.
Intrinsic productivity will be enabled when it becomes available at Index Coop.
To be described in DG2.
MoonRock is developing the next generation of crypto index strategies.
The methodologist will promote the token/s through the MoonRock brand. The methodologist will also be available for AMAs and interviews.
22 Dec 2021 - Original version
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