IIP: 127
Title: Launch the Layer 2 Index (LAYER2)
Status: Proposed
Author: @JosephKnecht (MoonRock), Advisor: Piotr Szlachciak (L2BEAT)
Created: 07 Jan 2021
1.0 Simple Summary
We propose launching the LAYER2 Index, an index token of the Layer 2 ecosystem. The product is receiving data from and being advised by L2BEAT, the leading analytics and research platform for Ethereum layer two (L2) scaling.
2.0 Abstract
Layer 2 (L2) blockchains are a ground-breaking innovation in cryptocurrency. L2 chains provide transactions which are orders of magnitude faster, less expensive, and higher throughput than their L1 counterparts. The extremely high performance of L2 chains will be instrumental in onboarding the next generation of mainstream users to crypto. Additionally, the dramatically faster speed and lower transaction costs enable a wide range of applications not currently possible on decentralized L1 chains such as real-time gaming, high-frequency trading, micro-trading, perpetuals, and central limit order books. It is anticipated that most applications will eventually move to L2 with L1 serving as a settlement layer.
The LAYER2 index token will capture the leading protocols in the L2 revolution. The protocols include infrastructure, scaling, and application tokens. The index is receiving data from and being advised by L2BEAT, the leading L2 analytics dashboard and educational resource.
2.1 Motivation
L2 protocols represent one of the most dynamic and promising segments of the cryptocurrency market. In the Index Coop’s most recent market research surveys, an L2 index token featured as one of the most requested products. The LAYER2 token can address that market demand. Strategically, an L2 index would also help the Coop build partnerships and visibility with L2 protocols and users ahead of the industry-wide migration to L2.
2.2 Rationale
LAYER2 will be deployed on Ethereum L1 due to the low underlying liquidity and fragmentation of the native L2 platforms. L1 side-chain tokens are included sparingly. The allocation will include scaling protocols as well as L2 application tokens.
3.0 Specification
3.1 Overview
LAYER2 includes the L2 protocols with the highest market cap and liquidity. Additionally, the allocation will have high liquidity weighting and no rebalancing with the exception of a 20% allocation cap and new additions and removals. As most of the liquidity is still on L1 the token will be deployed natively on L1 and then bridged to other L2 chains such as Arbitrum and Optimism.
3.2 Differentiation
There are no L2 or scaling index tokens currently on the market. PieDAO has a proposal for a scaling index token SCALE which includes a number of roll-up and side-chain tokens. See the SCALE Risk Analysis and Monitor. The project was first proposed in Feb 2021 but has not gone to governance vote yet.
3.3 Example composition
Example composition as of Jan 2022. It is anticipated that the composition will change substantially prior to launch as more L2 platforms launch native tokens and liquidity on L1 improves.
More than 30 tokens were excluded due to insufficient liquidity, most notably LRC, ZKS, OMG, CTSI, CELR, STAKE, LPT, and RDN. PERP was not included because it’s built on XDAI which is an L1 sidechain.
SKALE will likely need to be removed if there is no improvement in liquidity prior to the final composition. BOBA’s inclusion is tentative as they are currently in the process of adding liquidity on L1. Currently, there is insufficient liquidity and it will be removed if the liquidity is not added.
3.4 Performance
Back-testing will be performed for DG2.
4.0 Size of Opportunity
We predict total AUMs of $3M, $30M, and $100M at 0, 12, and 24 months respectively post launch. The starting AUM is based on typical fundraise sizes of Copper launch auctions. The 10x growth in year 1 is approximately 2x growth in share price and 5x in supply. The 2x share price growth is based on the historical share price growth for similar sized protocols.
5.0 Market & Customer Research
5.1 Target Customers
- Layer-1 investors looking for exposure to the L2 market but have not yet migrated to L2.
- Layer 2-pilled investors looking to track the overall L2 ecosystem.
- Treasuries of Layer 2 protocols looking to diversify into a broad portfolio, increase their Risk-Free Value, and support the Layer 2 ecosystem.
According to Index Coop’s market survey of 20 Dec 2021, 7% of respondents asked for an L2 index, making it the second-most requested product of the ones we do not currently offer or have under development. Only a gaming index and an L1 protocol index ranked higher. We are currently drafting an alt L1 index proposal and will post that next week.
5.2 User stories
Susan: ‘As an experienced L2 investor, I’m looking for an index product like LAYER2 that gives me broad exposure to the protocols I know and use regularly.’
Jo: ‘As an L1-native investor, I’m looking for exposure to the L2 space even though I still do most of my trading on Ethereum mainnet. LAYER2 lets me benefit from the growth of the L2 ecosystem even if I haven’t taken the leap yet myself. The token vetting by L2BEAT gives me added confidence in the methodology.’
John: ‘As the Chair of the Magnificent L2 DAO Treasury Committee, LAYER2 helps us diversify our treasury and increase its Risk-Free Value, as well as strategically support the fellow protocols in the L2 ecosystem.’
5.3 Product economics
We estimate monthly revenue of $7,375 and rebalancing costs of $1,000 for a gross profit margin of 86%. This is based on a $3M AUM, 100 bps non-aggregated trade size for rebalancing, 5% average monthly turnover, $250k weighted-average trade depth, $250 gas cost, and a 2.95% streaming fee.
6.0 Methodology
6.1 Initial Composition & Token Inclusion Criteria
Selection criteria for tokens
- Tokens in the L2 ecosystem incl L1 sidechains sparingly
- Market cap > $50M
- Trading depth > $15k non-aggregated @ 100 bps
- ERC-20 standard
ETH is included as a proxy for Optimism and Arbitrum. MATIC is technically not an L2 protocol but rather an L1 sidechain due to its dependence on external validators. However, MATIC is still included due to its proximity to L2 and hence heavy investment in L2s. Including ETH and MATIC also serves to improve the overall liquidity of the product.
6.2 Weightings
The weighting is 50% square-root market cap and 50% liquidity. Liquidity is defined as the non-aggregated trading depth at 100 bps excluding LP fees. We note that there’s substantially more liquidity available using aggregated orders since a lot of the liquidity is fragmented and in Proactive Market Making (PMM) pools. For example, SKALE has $18k depth at 100 bps for non-aggregated orders and $910k depth for aggregated orders.
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 only to maintain the 20% cap. Otherwise the index will not be rebalanced.
7.0 Costs
7.1 Cost to customer
To be determined after DG1.
We anticipate LAYER2 having a 2.95% management fee.
7.2 Cost transparency
The total cost to the customer will be disclosed including the actual and predicted annualized asset decay.
7.3 Rebalance frequency
The index will be rebalanced quarterly only to enforce the 20% allocation cap. There will be no other rebalancing.
7.4 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
Preliminary liquidity figures are in the Example Composition.
The liquidity will be described in detail for DG2.
10.0 Authors and Advisors Background and Commitment
@JosephKnecht is a methodologist at Index Coop and Founder of MoonRock.
MoonRock is developing the next generation of crypto index strategies.
Piotr Szlachciak is a Co-Founder of L2BEAT, the leading analytics and research portal about Ethereum layer two (L2) scaling.
11.0 Marketing support / distribution / partnerships
The index will be provided white-label to IndexCoop for marketing and promotion. The Methodologist will be available as needed for marketing support.
Revision history
07 Jan 2022 - First version
Copyright
Copyright and related rights waived via CC0.
