IIP-127: Launch the Layer 2 Index (LAYER2)

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.

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Here are the details for the upcoming LAYER2 Community Call.

Thursday, January 13 · 1:00 – 2:00pm EST (18:00-19:00 UTC)
Google Meet joining info
Video call link: https://meet.google.com/gso-tqsq-ior
Or dial: ‪(US) +1 617-675-4444‬ PIN: ‪508 780 514 4320‬#
More phone numbers: https://tel.meet/gso-tqsq-ior?pin=5087805144320

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Sharing some notes from Work Team Analysis pre-DG1. Note that this is a lighter analysis than is typically posted pre-DG2 as many details of the product are still being discussed!

Link: LAYER2_Product Scoring Chart_DG1 - Google Sheets

Overall Score (prelim): 1.82

Market Opportunity: 3

  • This product earned a baseline point, a point for differentiation, and a point for nice-to-have product.
  • It did not earn points for a large market: the team was unsure about the long-term outlook for the L2 market, given the innovation happening on many L1s and very recent launch (and therefore lack of historical data) of many of these L2s. We’d love to see more research on the size of opportunity if we proceed to DG2. We did note that a Layer 2 focused product received 2 votes in the recent product survey, but did not feel comfortable giving a point for that low of a vote number.
  • It also did not earn a point for a must-have product due to the number of tokens that had to be excluded due to lack of underlying liquidity.

Revenue Structure: 4.17

  • The split has not yet been discussed so this is a very preliminary score, though we felt that the proposed 2.95% streaming fee merited a high score.
  • We did note that 2.95% is a much higher fee than IC has used before, and further research should be done to make sure it is viable in the market.

Methodologist Impact: 3.5

  • The methodologist has displayed very sound product competency and the methodology has undergone rigorous review.
  • Given the smaller social & industry footprint of L2Beat and Moonrock, the team was split on whether they earned a point for reputation. The methodologist did not earn a point for marketing support given their smaller profile compared to methodologists like Bankless.

Financial: 3

  • The product will require IC to seed a liquidity pool, though is not anticipated to use incentives

Operational: 2

  • The product will only require quarterly rebalances

Technical: 1

  • This is a simple index that does not require new engineering work
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Hi Catjam and WTA,

Thanks for the useful feedback. Let me give some brief replies here and we’ll then incorporate the feedback into the DG2 proposal (pending Snapshot+).

WIl do.

Bear in mind it was a tiny survey so even 2 votes meant it was the 5th most-requested product after gaming, metaverse, NFT, DAO and Layer 1 index products (tied), all of which are already in market or in progress. This perhaps suggests we need larger sample sizes in our market surveys or more market discovery if we plan to get a deeper pipeline.

Will do. I think there’s a lot of opportunity in setting our prices more aggressively.

The rebalancing will only be done to maintain the allocation cap so we only anticipate a few rebalances per year, if that. I’m trying to move our future products away from rebalancing considering how hideously expensive and value-destroying it is and how weak the justification is.

Thanks again for a thoughtful review – it’s helpful. Fingers and eyes crossed for the Snapshot vote.

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Glad this is useful @JosephKnecht , thanks as always for the depth of thought and expertise that you bring. Look forward to DG1 :slight_smile:

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Hi @Mringz, we’re ready to move forward with DG1 for LAYER2 , can you please help us schedule a snapshot? Thanks

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@Mringz If it’s not too much trouble, for the Snapshot vote could you please use the updated composition below? Cheers. JK

Ticker Allocation
ETH 20.0%
MATIC 20.0%
DYDX 17.3%
LRC 11.2%
IMX 8.2%
METIS 9.5%
BOBA 9.3%
DVF 4.5%
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The DG1 snapshot governance vote for IIP-127 DG1: Launch the Layer 2 Index (LAYER2) is live here: Snapshot

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