IIP: 145
Title: Launch the Layer 2 Index (LAYER2)
Status: Proposed
Authors: @JosephKnecht (Index Coop, MoonRock), Advisor: Piotr Szlachciak (L2BEAT)
Reviewed by: @DocHabanero
Gov Review: @asira
Created: 29th March 2022
Notification: @GovNest
1.0 Abstract
We propose launching LAYER2, an index token of the Layer 2 ecosystem. The product is advised by and will receive data from L2BEAT, the leading analytics and research platform for Ethereum layer two (L2) scaling solutions.
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 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 being developed while being advised by L2BEAT, the leading L2 analytics dashboard and educational resource.
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.
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.
2.0 Market information
2.1 Target customer segments & user stories
- Layer-1 investors looking for exposure to the L2 market but have not yet migrated to L2.
- Layer 2-native 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.
‘As an experienced L2 investor, I’m looking for an index product like LAYER 2 that gives me broad exposure to the protocols I know and use regularly.’
‘As an L1-native investor, I’m looking for exposure to the L2 space even though I still do most of my trading on L1. 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.’
‘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 fellow protocols in the L2 ecosystem.’
2.2 Market research
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 Index Coop does not currently offer or have under development. Only a gaming index and an alt L1 index ranked higher.
2.3 Size of opportunity
We predict total AUMs of $3M, $9M, and $100M at 6, 12, and 24 months respectively post launch. The growth in months 6 to 12 is approximately 1.5x growth in share price and 2x in supply.
2.4 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.
2.5 Marketing support / distribution / partnerships
L2BEAT will serve as advisors to the project. They will provide technology consultancy, data delivery, branding and marketing.
2.6 Marketing risks and weaknesses
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The composition has few tokens and a very heavy allocation towards ETH and MATIC. This could reduce the product’s attractiveness. One mitigation is to explain that the ETH and MATIC reserves will be used to acquire future index components. LAYER2 token holders will vote on which tokens to include which could create war demand for the product.
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Many top L2 protocols are missing due to the lack of a token, in particular Arbitrum and Optimism. The reserves described above can be used to purchase these tokens if/when they come to market. One mitigation is to position the index as a passive way to acquire new L2 tokens without having to constantly monitor the market.
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The underlying liquidity is low, which will increase the price-NAV deviation. The index will not rebalance and so there’s no effect of the low liquidity on gas costs or asset decay.
3.0 Financials
3.1 Revenue
The streaming fee will be 2.95% and the mint/redeem fees 0.5%. The streaming fee is justified by the novelty of the product and the effort to manage the Governance Council.
3.2 Fee splits
Post-gas, fee income and protocol rewards will go 20% to L2BEAT, 70% to Index Coop and 10% to the Index Coop Product Pod according to the framework for internally-produced products.
3.3 Product economics
We estimate monthly revenue of $7,375 and no rebalancing costs for a gross profit margin of 100%. This is based on a $3M AUM, a 2.95% streaming fee, and no rebalancing.
3.4 Financial forecast
4.0 Specification
4.1 Product design
Methodology
LAYER2 will be a simple set built on TokenSets. The tokens will include the top L2 projects by Total Value Locked (TVL) according to L2BEAT.
Engineering lift
No additional adaptors or customizations are required.
Deployments and bridges
LAYER2 will be deployed to mainnet. Based on the success of the product we will consider deployments on Polygon, Optimism, and Arbitrum.
Token inclusion/exclusion criteria [if applicable]
Selection criteria for tokens
- Tokens in the L2 ecosystem incl L1 sidechains sparingly
- TVL > $50M
- Trading depth > $10 ETH aggregated @ 100 bps including LP fees
- ERC-20 standard
Tokens with <10 ETH trading depth will be included with a 2% allocation cap.
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 heavy investment in L2s. Including ETH and MATIC serves to improve the overall liquidity of the product and provides a reserve for adding additional L2 tokens as they launch.
Index weight calculation
The weighting is 90% square-root market cap and 10% liquidity. Liquidity is defined as the aggregated trading depth at 100 bps including LP fees. We note that certain pools can be used for issuance which are not available on 0x Matcha as required by TokenSets. We use these issuance pools to measure the underlying liquidity since the index will not be rebalancing and hence the post launch liquidity is less relevant.
ETH and MATIC will each be initially capped at a 15% allocation.
Rebalancing approach
The index will be rebalanced only to maintain a 30% allocation cap. Otherwise the index will not be rebalanced.
Recomposition approach
Tokens will be added or removed from the index based on a vote of LAYER2 token holder. The voting options will be delineated by the LAYER2 governance council.
Intrinsic productivity
Intrinsic productivity will be enabled if and where available.
Governance
Management of the protocol will be governed by the LAYER2 Governance Council (L2GC). The Council will consist of 5 members: 3 appointed by Index Coop and 2 members voted in by LAYER2 token holders. The L2GC will serve to direct votes to LAYER2 or Index Coop token holders depending on the topic and to delineate the votes for LAYER2 token holders.
4.2 Example composition
The trading depth is defined as the aggregated trade size that would induce 100 bps slippage including LP fees. For issuance, we use the dex’s with the deepest liquidity (eg, PMMs on 1inch) and 0x Matcha-supported dex’s for maintenance post-launch. The overallocation (OA) factor is the ratio between the component allocation for a hypothetical $1M AUM and the aggregated trading depth at 100 bps. OA factors > 1 for allocations >5% suggest a heavy allocation relative to the underlying liquidity. BOBA was subject to a 2% allocation cap due to its low liquidity.
4.3 On-Chain liquidity analysis of underlying tokens
See the underlying liquidity above under Composition.
4.4 Backtest results
The tokens are too recent to provide meaningful backtest results.
5.0 Product liquidity
LAYER2 is expected to require $430,000 in seed liquidity which would currently support a 2% Target Access Cost. The trading pair will be LAYER2:ETH and will be seeded in a Uniswap V3 30bps pool with a range of -29% : +40%.
This pool is not likely to be immediately self-sustaining for a long-period of time and we should expect Protocol Owned Liquidity to be required for at least 3 months. There will be no liquidity mining incentives.
The Liquidity Pod will explore the possibility of launching this product directly to zkSync on the ZigZag exchange using a Chainlink Price Feed. This would eliminate the need for an L1 liquidity pool which exposes Index Coop to impermanent loss risk as well as price risk. An L2-only launch would require $200K which is exposed only to the price risk of $100K in LAYER2. This pool would be a LAYER2:USDC Pool. Large buyers such as DAOs would still be able to mint and redeem on Mainnet. This option is highly unlikely however due to METIS, DVF, and BOBA not having Chainlink price feeds.
| Target Access Cost % | 2.00% |
|---|---|
| ETH/USD Price | $3,300 |
| Gas Price | 55 gwei |
| Exchange Issuance Gas Required | 1410000 wei |
| Swap Cost | $22 |
| Exchange Issuance Gas Cost | $256 |
| Exchange Equilibrium | $12,796 |
| Total Baseline Liquidity | $2,776,041 |
| Concentration - Lower Bound | -29% |
| Concentration - Upper Bound | 40% |
| ETH Required | 65.13 |
| Tokens Required | 2,149.29 |
| Total USD Required | $429,858 |
6.0 Author Background
JosephKnecht is a product designer and quantitative analyst at IndexCoop and Founder of MoonRock.
Piotr Szlachciak is a Co-Founder of L2BEAT, the leading analytics and research portal about Ethereum layer two (L2) scaling.
Copyright
Copyright and related rights waived via CC0.