Title: DG - Final - Launch the Alt Layer 1 index token (LAYER1)
Author: @JosephKnecht (Index Coop, MoonRock)
Gov Review: @sixtykeys
Discussions to: DG1 post
Created: 3rd March 2022
We propose launching LAYER1, an index token of alternative Layer 1 protocols.
The rise of alternative Layer 1 (L1) protocols has been one of the most exciting recent investment themes. The meteoric rise of alt L1 protocols has been driven by the fact that all blockchains face a fundamental trade-off between decentralization, scalability, and security, the so-called ‘blockchain trilemma’. By providing users different trade-offs, alternative L1 protocols can address different user preferences. For example, some users may be willing to trade-off decentralization for scalability or vice versa. The LAYER1 index token will capture the growth of these alternative L1 protocols. LAYER 1 can be implemented as a simple set with no additional engineering effort.
An L1 Index token was one of the most-requested products in the Index Coop’s last two primary market research surveys. Additionally, we are receiving more requests for deployment on non-Ethereum chains, which reflects the rise of these alternative protocols. The rapid developer growth on alt L1s suggest that these platforms will only gain in importance.
Constructing an alternative L1 protocol is made possible by the increase in alts being bridged to Ethereum mainnet by protocols such as Wrapped, Wormhole, pTokens, Ren, and others. Additionally, the index benefits from the extensive research on bridged L1s completed for the MCAP index token.
Feedback from the community included the following points:
- ‘Manage the risk of using bridged tokens’
We acknowledge that there is an exploit risk due to the use of bridged tokens. There is no clear way to avoid this risk so we will clearly disclose this risk in the investor communication. Also, we would look to rebalance into mainnet native-launched tokens if/when they become available.
- ‘Move MATIC to LAYER2 and remove wBNB’.
MATIC was moved to the LAYER2 product due to its disproportionate allocation and its stronger alignment with layer 2 in spite of it arguably being a L1 sidechain. wBNB was removed due to its very low liquidity relative to market-cap which gave it an artificially low allocation.
LAYER1 consists of a basket of ERC-20 tokens which represent the largest alt L1 protocols by market cap. The tokens are ERC-20-native as well as bridged.
Other Layer 1 index tokens on the market include SOLUNAVAX from GalleonDAO and ALT from Indexed Finance. SOLUNAVAX is on Optimism and consists of SOL, LUNA, and AVAX. ALT is on Polygon and contains SOLUNAVAX plus ONE and FTM.
Example composition as of 02 March 2022.
The trading depth is the aggregated depth on 0x including the LP fee. GNO was the only token affected by the capped weighting. The Overallocation Factor is the ratio between the allocation for a hypothetical $1M AUM and the trading depth. According to the Liquidity Manifesto, OA Factors greater than 1 for >5% positions suggest a heavy allocation relative to the available underlying liquidity. These OA factors are slight overestimates as we have included the LP fee in the trading depth figure. GNO was included as it is taking over from STAKE as the governance token for the xDAI sidechain following their merger.
Backtest results for the period 01 Jan 2021 to 28 Feb 2022. For the test period LAYER1 would have returned 3,407% vs 256% for ETH. Note that layer 1 tokens underwent explosive growth in 2021 and these results are unlikely to be predictive.
We predict total AUMs of $3M, $30M, and $100M at 3, 12, and 24 months respectively post launch. The starting AUM is based on the size of past recent composite product launches and the high demand for a layer 1 index according to Index Coop primary market research. The 10x growth to month 12 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.
- Ethereum-native users looking for exposure to alt L1 protocols
- Alt L1 users looking for exposure to the protocols they know and use
According to Index Coop’s market survey of 20 Dec 2021, 10% of respondents asked for an L1 index product, making it the fourth-most requested product after metaverse, gaming, and NFT index products.
Susan: ‘As an experienced alt L1 investor, I’m looking for an index product like LAYER1 that gives me broad exposure to the protocols I know and use regularly.’
Jo: ‘As an Ethereum mainnet investor, I’m looking for exposure to the alt L1 space even though I still do most of my trading on Ethereum. LAYER1 lets me benefit from the growth of the alt L1 ecosystem even if I haven’t taken the leap yet myself.’
We estimate monthly revenue of $7,375 and rebalancing costs of $500 for a gross profit margin of 95%. This is based on a $3M AUM, 100 bps aggregated trade size for rebalancing, 2 trades on average to manage the allocation cap, $250 gas cost, and a 2.95% streaming fee.
LAYER1 Profit Model
Assumption: add/remove token every 6 months.
Selection criteria for tokens
- Tokens of alternative L1 blockchain and sidechain protocols.
- Market cap > $300M
- Trading depth > $10k aggregated @ 100 bps including LP fees
- ERC-20 standard including wrapped/bridged tokens
The weighting is 75% square-root market cap and 25% liquidity. Liquidity is defined as the aggregated trading depth at 100 bps including LP fees. In order to prevent tokens with very high liquidity from distorting the allocation, allocations were capped at 2x the pure market cap weighting.
See composition above.
The index will only be rebalanced to maintain the 25% allocation cap. Otherwise the index will not be rebalanced. In order to avoid rebalancing simply to fit volatility we will use the 30-day weighted-average allocation.
On a quarterly basis we will evaluate new tokens for potential inclusion or removal. Such tokens will be phased in or out gradually. The allocation will not use the original index weighting formula. The AUM decay from recomposition is expected to be 0.3-0.5% per year and will be hard-capped at 5% per year following guidance from the Liquidity Pod.
LAYER1 will have a 2.95% management fee and a 1% mint/redeem fee.
The total cost to the customer will be disclosed including the actual and predicted annualized asset decay.
The fee split has been agreed as 100% to Index Coop with 3%, 5%, and 2% directed to the Product Designer, Quantitative Analyst, and Product Pod respectively.
Metagovernance will be enabled.
Intrinsic productivity will be enabled when it becomes available at Index Coop.
|Target Access Cost %||2.00%|
|Gas Price||65 gwei|
|Exchange Issuance Gas Required||1,930,000 wei|
|Exchange Issuance Gas Cost||$376|
|Total Baseline Liquidity||$3,982,181|
|Concentration - Lower Bound||-50%|
|Concentration - Upper Bound||100%|
|Total USD Required||$1,166,354|
The index will be provided white-label to Index Coop for marketing and promotion. The Product Designer will be available as needed for marketing support.
03 Mar 2022 - Initial DG post
Copyright and related rights waived via CC0.