IIP-144: DG - Launch the Basis Trading product suite (BASIS-ETH et al)

IIP: 144
Title: Launch the Basis Trading product suite (BASIS-ETH et al)
Status: Proposed
Authors: @JosephKnecht (Index Coop, MoonRock), @afromac, Set Labs
Gov Review: @sixtykeys
Link: Proposal: Launch a Basis Trading Product Suite
Created: 15th March 2022

1.0 Simple Summary

We propose launching a suite of basis trading products beginning with BASIS-ETH. The basis trading suite will provide products with market-leading yield through a price-neutral basis trading strategy. This Decision Gate proposal is seeking blanket approval for all BASIS markets including, for example, Perpetual BTC.

The first product , BASIS-ETH, will use ETH:USD perpetuals from Perpetual Protocol and will be launched natively on Optimism.

2.0 Abstract

Basis trading, also known as cash and carry arbitrage, is an established strategy for achieving price-neutral profit by arbing the difference between an asset price on the spot and near-term futures markets. In defi, perpetual swaps – also called perpetuals or perps – can be used in lieu of futures. First implemented by BitMEX, perpetuals are futures with no settlement date. The yield is derived from a funding payment (also called a funding rate) paid periodically between long and short perpetuals in order to incentivize the peg to the spot index price. The spot index price is typically taken from a Chainlink oracle. The funding payment is executed by the perpetual market maker.

BASIS-ETH takes simultaneous long spot and short perpetual positions and derives yield from the funding rate. By taking a fully hedged position, the product has no net asset price exposure. BASIS-ETH will use a 1x long ETH spot position and a -1x short ETH perp settled in USD. The yield will be further enhanced by thrice-daily auto-compounding when the USD funding balance is positive. The yield is used to maintain a leverage position between -1x and -2x.

3.0 Motivation

Defi investors are continuously seeking higher yields. DAO treasuries in particular are eager for price-neutral yield in order to avoid correlation with their native token and to meet their operational costs irrespective of market cycle.

Basis trading represents one of the highest yielding, price-neutral investment strategies. To date, basis trading is only possible using manual execution on dedicated exchanges. BASIS-ETH will be the first product to offer a basis trading strategy through a single liquid ERC20 token. BASIS-ETH will be one of Index Coop’s suite of basis trading products which will use different token underlying settlement currencies.

3.1 Rationale

Basis trading is currently available on a number of centralized exchanges including Binance ($3B ETH:USD/T volume), FTX ($677M), Huobi ($280M), and Bybit ($221M). BASIS-ETH will be the first defi basis product available through a single ERC20 token.

Perpetual Protocol’s ETH-USD short perpetuals are battle-tested, have deep liquidity, and tend to have high APR. dYdX is built on its own roll-up and so is non-composable.

4.0 Specification

4.1 Overview

BASIS-ETH will consist of a 1x long ETH spot and a -1x short ETH perpetual. The product will use Optimistic ETH:USD perp settled in USD.The USD yield will be auto-compounded into the core position every 8 hours when the accrued USD funding is positive. Eight hours is the funding rate period on Perpetual. The yield is used to maintain a leverage ratio between -1x and -2x.

It is important to note that Perpetual Protocol is not available to residents of the United States and other restricted territories, so Index Coop’s minting interface for BASIS-ETH will need to be geofenced to exclude these regions. The geofencing code has already been completed.

4.2 Differentiation

The only two defi competitors are Lemma on Arbitrum and UXD on Solana. Advantages of BASIS-ETH over Lemma include higher yield, no need to stake, and a single liquid token. UXD is an algorithmic stable coin that is 100% collateralized by delta-neutral derivatives.

Differentiation from other planned Index Coop products is shown below.

Product Underlying Asset Composition Yield
icETH ETH Single 10-13%
PINT USDC, DAI, USDT Diversified 3-6%
PAY Stables Diversified 10-12%
FIXED Stables Single 7-9%
BASIS-ETH Various Assets Single 15-20%

4.3 Example composition

The token will consist of 50% 1x long spot ETH and 50% -1x short Optimistic ETH:USD perp.

4.4 Backtest data

Backtest results

Backtesting was performed for the period 28 Nov 2021 to 10 Feb 2022. Assumptions were:

Perp trading fee 0.10%
Perp price impact 0.05%
Spot trading fee 0.30%
Spot price impact 0.05%
Min leverage ratio -1
Max leverage ratio -2

The effective APY was 15.78% post asset decay. The APY could potentially be increased further by delivering to -2x instead of -1x. The backtesting calculations were performed by Set.

Past ETH:USD funding rate APRs for Perpetual can also be found on r72.fi

5.0 Size of Opportunity

We predict total AUMs of $3M, $6M, and $30M at 6, 12, and 24 months respectively post launch.

6.0 Market & Customer Research

6.1 Target Customers

  • Defi investors and DAO treasuries seeking price-neutral, high yield

Primary market research was conducted using a Twitter poll on 24 Feb 2022. The primary poll question had n=204 respondents for a ±6% margin of error. The secondary poll question had n=57 respondents for a ±13% margin of error.

The results showed that yield products had the highest demand and that respondents were indifferent to the source of the yield followed by delta-neutral hedging.

6.2 User stories

As a user, I want high returns (10-20%) from a variety of assets and different markets.

As a user, I want to be able to generate revenue from the cash and carry trade strategy, but I am unwilling to manage my own margin positions due to risk and complexity

As a DAO, I want stablecoin returns that are sustainable and not dependent on short-lived stablecoin farms.

As a DAO, I want to diversify my treasury into stablecoin denominated yields from different sources that avoid concentration of risk.

As an institution, I want access to DeFi protocols and products to earn above average interest compared to traditional financial markets

6.3 Product economics

We estimate monthly revenue of $2,375 and negligible rebalancing costs for a gross profit margin of effectively 100%. This is based on a $3M AUM and a 0.95% streaming fee.

6.4 Product financial forecast

7.0 Methodology

7.1 Initial Composition & Token Inclusion Criteria

Selection criteria for tokens

Long: Spot ETH

Short: -1x ETH perpetual with >10 ETH trading depth at 100 bps tradesize

Chain: L2 for low gas to enable flexible leverage and auto-compounding.

7.2 Weightings

The weighting is 50% 1x ETH spot and 50% -1x short ETH perpetual. There will be a transient USD holding from the funding rate.

7.3 On-Chain liquidity analysis of underlying tokens

Perpetual Protocol’s -1x short ETH:USD perpetual has 56 ETH depth at 100 bps.

7.4 Maintenance / Rebalancing frequency

  1. The core position consists of 50% spot ETH and 50% ETH perp short
  2. Accumulated USD yield is auto-compounded into the core position with the funding rate payment every 8 hours.
  3. When the leverage ratio (LR) > -1x, the set levers up by reinvesting in the core position.
  4. When LR < -2x, the set delevers perp and sells spot to return to LR = -2x.

8.0 Costs

8.1 Cost to customer

BASIS-ETH will have a 0.95% streaming fee, 0% mint fee, and 0.3% redeem fee. The 0% mint fee was chosen to avoid a buying fee for large mint orders.

8.2 Cost transparency

The total cost to the customer will be disclosed including the actual and predicted annualized asset decay.

8.3 Fee split

The 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.

8.4 Meta / intrinsic productivity

There are no opportunities for metagovernance or intrinsic productivity.

9.0 Liquidity

Exchange Issuance will not be available for this product. We anticipate $100K in seed liquidity in a Uniswap v3 pool on Optimism with concentration around +/- 5% which will allow for trades of $10K at a price impact of 1%. Larger buyers should go through direct issuance. This liquidity will likely be pulled from the pool at two weeks after launch or at the discretion of the Liquidity Pod.

10.0 Author Background and Commitment

@JosephKnecht is a Product Designer and Quantitative Analyst at Index Coop and Founder of MoonRock.

@afromac is a Product Manager and Technical Lead at Index Coop.

11.0 Marketing support / distribution / partnerships

BASIS-ETH will be marketed internally by Index Coop. There is no branding partner at this time.

12.0 Disclaimers

Disclaimer: This content is for informational purposes only and should not be construed as legal, tax, investment, financial, or other advice. Each purchaser of an Index Coop product should consult with his or her own investment, legal and tax adviser/s before purchasing.

Disclaimer: Index Coop token products are not marketed or offered to persons or entities who: are citizens of, reside in, are located in, are incorporated in, or operate a registered office in the United States of America (collectively defined as ‘U.S. persons’). If you are a U.S. person, do not use Index Coop token products. Our website restricts trading of these tokens by U.S. persons. All website users, including U.S. Persons, must read our Terms of Service and List of Restricted Tokens. U.S. person(s) must comply with our Terms of Service and not use Index Coop tokens.

Revision history

15 Mar 2022 - First version
16 Mar 2022 - Updated to reflect basis trading suite and not only BASIS-ETH
16 Mar 2022 - Updated Liquidity section 9.0


Copyright and related rights waived via CC0.


Hey @mel.eth and @Mringz

Please assign an IIP and schedule vote to begin on Monday 21st. The PRD has been shared privately with Governance Nest.


Hey @afromac , an IIP number (144) has been assigned, with a snapshot vote queued for Monday, 21st March 2022, 6PM UTC.
Snapshot here