Title: Launch the FIXED Suite
Author(s): @allan.g , @JosephKnecht (Index Coop, MoonRock)
Reviewed By: @afromac, @dochabanero, @twoodward (Notional)
Gov Review: @sixtykeys
Created: 7th March 2022
The Product Pod would like to propose that the Index Coop launch a suite of fixed-rate yield products, starting with DAI-FIXED. This will be the first fixed-rate yield token to give token holders passive exposure to high, fixed interest rates.
The advent of fixed-rate lending brought about by Notional has laid the foundation for crypto-native fixed income products and the infrastructure required for creating and managing a fixed-rate yield index has been enabled by Set. As a result, the Product Pod would like to launch a suite of decentralized, fixed rate yield tokens that give investors high, market-neutral yield, starting with a DAI-denominated index, DAI-FIXED.
Establishing a fixed-rate lending position today requires a certain degree of expertise and users are often forced to choose between earning a higher yield or keeping their assets liquid. By abstracting the complexity of managing this position and creating a secondary market for the index token to be traded, both of these pain points can be addressed. Holders also benefit from matured assets being rolled forward for them, as opposed to manually initiating new lending positions after maturity and dealing with high gas fees and taxable events.
In traditional finance, a typical portfolio is balanced between stocks and bonds, with 60% stocks / 40% bonds being the most prominent. However, in decentralized finance today, there are very few options for anchoring a crypto portfolio in the same way that bonds secure a traditional portfolio; available options also require a certain level of sophistication that average crypto investors may not have. While crypto markets are known for their volatility, there is an opportunity to offer the stability that a well-balanced crypto portfolio requires.
Additionally, most Index Coop products today are built for bull markets. In a bear market, holders of existing products may seek to de-risk their portfolios and sell into stables, creating a net outflow of capital for the Coop. With a market-neutral product earning stable, dollar-denominated yield, investors can cycle into lower-risk positions and the Index Coop can retain accumulated capital.
FIXED tokens deliver value to customers by…
- filling a hole in a well-balanced portfolio where bonds would traditionally fit
- offering a safe haven during bear markets or heightened volatility
- offering a predictable, high yield that is unavailable in the leading lending markets
- offering capital preservation and preventing loss of value within a portfolio
- shielding holders from early withdrawal penalties by creating secondary market liquidity
- abstracting the management and rolling of fixed-rate lending positions
- socializing gas costs associated with maintenance
FIXED tokens deliver value to the Index Coop by…
- diversifying our product offering
- positioning us as a one-stop-shop for any investor’s needs
- retaining accumulated capital if customers want to rotate out of existing products
- expanding the yield-bearing category of index products
The first index we propose launching within the suite is a DAI-denominated product. The underlying assets will be sourced and stored within Notional v2 and utilize Set’s battle-tested asset management infrastructure. The core allocation will be spread amongst the highest-yielding fDAI maturities with a preference for longer-dated maturities in order to minimize the rolling frequency. As fDAI positions reach maturity quarterly and automatically convert to cDAI, funds will be rolled forward into new maturities (akin to rebalancing).
Not only is this the first fixed-rate yield product for the Index Coop, but it is also the first fixed-rate yield token in DeFi. The most explicit difference from other proposed yield products is that holders receive a stable, predictable return on their assets. The interest earned on fixed-rate maturities has been substantially, consistently higher in DeFi compared to the variable rates available on Compound and Aave, and DAI-FIXED gives token holders access to those rates while also providing a secondary market for seamless exchange and instant liquidity.
An example composition and expected return at launch for DAI-FIXED are provided below:
|fDAI 3mo (core allocation)||25.00%||7.53%||Fixed|
|fDAI 6mo (core allocation)||75.00%||8.56%||Fixed|
It is worth noting that as AUM grows and new fDAI maturities are added to the index, marginal fixed rates will decline if the borrow side of the Notional market remains constant.
DAI-FIXED will have a core allocation of fDAI 3mo and 6mo maturities (also known as “tenors”) at launch. To provide some background, fCash positions vary depending on date of maturity (3, 6, or 12 months) and each tenor may have a different fixed rate depending on prevailing market conditions at time of origination. The index’s core allocation will be distributed amongst 3mo and 6mo fDAI positions, with preference shown to the highest-yielding, longest-dated maturities. The core allocation is not constrained by a specific average maturity/duration target, but there is an upper limit to the allocation percentage a single fDAI maturity can have (75%). In the event that yield curve for fDAI inverts, 3mo maturities may be included in the core allocation to maximize effective yield.
The expected annual return for this particular composition would be 7.79%, matching the tables within the “Differentiation” section above. Note that for the above allocation the index will alternate every 3 months between having 1 and 2 tokens. This is because the 6mo and 3mo tenors will have the same expiry date when the 3mo tenor rolls over. The effective annualized yield for the index will be influenced by prevailing rates during quarterly rolls and the inherent interest rate decay resulting from rolling forward large notional amounts of capital.
Forward simulations were conducted instead of backtesting because the fCash ERC20s are novel and hence price history is not available. The forward simulation incorporated the slippage due to the rotation of the 3mo and 6mo tenors. The asymmetric price action around NAV is due to there being a redeem fee but no mint fee. Assumptions: $2M AUM; Price-NAV drift = 0, corresponding to neutral buy-sell pressure; Price volatility = 0.2/day; Resolution: Daily; Reference currency: DAI.
In traditional finance, the outstanding value of global bond markets was over $123 trillion 1 in 2020, which is ~17% larger than the global equities market the same year. Since their inception in 2002, bond ETFs have been the fastest growing category of fixed income products; in the last year alone, global bond ETF AUM has increased by over +50% 2. There are a variety of bond and fixed income instruments besides bond ETFs - like bond mutual funds or index funds - but they typically require active management because of their complex compositions and/or limited automation opportunities. Additionally, YTD returns for US Bond ETFs have been negative which could drive institutional investors to crypto to seek above average returns compared to traditional financial products 3.
However, because of the programmable nature of digital assets, there is a compelling opportunity to create an automated bond-like product that minimizes costs and maximizes value for customers. In DeFi today, there are no fixed rate yield ERC-20 tokens, though there are several protocols that enable fixed rate lending through a variety of mechanisms. The TVL for the three largest fixed rate lending protocols on Ethereum at time of writing are as follows:
- Notional: $473m
- Element: $170m
- Ondo: $56m
It is worth noting that in late November 2021, the collective TVL across the three protocols listed above exceeded $1.25B. Additionally, Notional v2 launched in November 2021 (less than 3 months ago) and amassed nearly $1B in AUM before more recent market corrections. We estimate the AUM to reach $2m in the first month, $25m in the sixth month, and $50m in the twelfth month; these approximations are derived from DAO treasury research.
This suite of products is targeted towards DAO treasuries and retail users who want high, predictable returns on their assets. Within the largest protocols like Aave or Compound, lenders are subject to variable rates that can fluctuate wildly and have also gradually decreased over time; this forces users to take their tokens elsewhere in pursuit of higher yields and incur gas fees while doing so.
Additionally, within the leading fixed rate protocols, investors must manage their own lending positions and manually roll forward anything that matures, which also costs additional gas and may create a taxable event to be managed. Lenders are subject to high redemption penalties if they choose to close positions before maturity, creating a lock-in effect that limits user’s access to liquidity. Certain fixed rate lending protocols can also require a certain level of expertise and financial fluency to understand and operate, which is a hurdle for a large number of less sophisticated actors.
Simply stated, this suite of products enables DAO treasuries and retail users to get immediate and predictable exposure to fixed rates without the friction and fees associated with managing fixed rate lending positions. It’s as simple as buying a token!
As a DAO, I want to diversify my treasury so that I can reduce risk during downward markets.
As a DAO, I want to earn high fixed yields on my stablecoins so that I can predictably cover operational costs.
As a retail user, I want predictable yield on my stable coins so that I can have more stability in my portfolio and not have to worry about variable rates.
As a retail user, I want access to higher fixed rate lending yields without forfeiting immediate access to my assets or subjecting myself to high, early redemption fees.
As a retail user, I want my fixed rate lending position to automatically roll after maturity so that I don’t have to worry about doing it manually and paying fees.
As an institution, I want to earn above average interest compared to the traditional finance options.
For the first year, we estimate average monthly revenue of $1,250 and rebalancing costs of $78 for a gross profit margin of 94%. This is based on $2m AUM and recomposition every 3 months from rolling over the 3mo and 6mo tenors. This calculation does not include the redeem fee.
Note: The above cashflow does not include the provision and removal of protocol-owned liquidity (POL).
In order to be included in a FIXED product, a token must meet the following criteria:
- the token must be native to Ethereum main net
- the token must be issued by Notional v2
- there must always be an active, tradeable market within Notional for the token
DAI-fixed will initially be composed of fDAI 3mo and fDAI 6mo positions. Eligible assets in the future include different fDAI maturities, like fDAI 12mo, once a solution is in place for idiosyncratic fCash.
In order to avoid unnecessary re-balancing on main net, the core allocation will not be prescriptive when weighting different maturities. As maturities expire or new capital flows in, new fCash positions will be minted and added to the index according to 1) the highest available fixed rate and 2) the longest-dated maturity. An upper limit of 75% will be set for one maturity’s share of the core allocation.
For example, if fDAI 3mo is paying 7% and fDAI 6mo is paying 8%, then capital will be allocated to fDAI 6mo up to a point where the marginal yield on a new 6mo falls below the yield of the 3mo or the constituent cap of 75% kicks in (at which point we would allocate to fDAI 3mo). In the event that yields on different maturities are identical, the longer maturity is preferred. This same strategy will apply to new constituents that meet the inclusion criteria.
DAI-FIXED constituents will be sourced from the Notional AMM, which exclusively supports fCash markets.
Price Impact for a $1m exchange issuance trade: 0.234%
FIXED tokens will rebalance on a quarterly basis as underlying fCash positions expire and must be rolled forward into new positions. It is worth noting that this will function more as a recomposition (adding new fCash tokens) than a traditional rebalance (adjusting the weighting of existing tokens). Rolling into new fCash positions will be optimized to avoid any significant slippage based on Notional’s AMM and will factor in interest rate decay resulting from roll volumes. Core team members from the Product Nest will be responsible for executing rebalances on a quarterly basis.
Holders will pay a 0.75% streaming fee. There will be no mint fee and a redeem fee of 0.30%.
Quarterly, or every three months.
Gas fees for routine rebalancing will be paid by the Index Coop from the streaming fee.
Token holders stand to benefit from the intrinsic productivity enabled by the underlying, interest-bearing fCash tokens issued by and held within Notional v2.
There are no metagovernance rights available with this product as it holds stable coins and stablecoin equivalents.
Post-gas, fee income will go 100% to Index Coop with 10% of that directed to the Product Pod.
Product Pod’s share of the fees will be distributed according to the framework for internally produced products here.
For DAI-FIXED, the primary pair on secondary markets will be DAI-FIXED / DAI. It is worth noting that LPs would have limited impermanent loss because of the stable nature of the product and more certainty around potential profitability brought about by trading fees.
Seed liquidity will be provided by the Index Coop per budgetary allocations defined for 2022 and deployed on Uniswap v3 (main net).
|Target Access Cost %||1.00%|
|Gas Price||65 gwei|
|Exchange Issuance Gas Required||920,000 wei|
|Exchange Issuance Gas Cost||$179|
|Total Baseline Liquidity||$8,209,771|
|Concentration - Lower Bound||-2%|
|Concentration - Upper Bound||2%|
|Total USD Required||$80,886|
The Product Pod is responsible for designing, developing, and deploying index products for the Index Coop, as well as managing and maintaining products post-launch.
As the first internally-produced product for the Index Coop, there will be a joint effort amongst Product, BD, and Growth to market, distribute, and maximize composability for FIXED products.
If approved by Index Coop governance, this suite proposal can be extended to other products that adhere to the same methodology (ex. USDC-FIXED, FEI-FIXED, etc).
Describe any modifications to this proposal since the original post on the forum
Copyright and related rights waived via CC0.