IIP: 25
Title: Synthetix Debt Mirror Index ($SMI)
Status: Proposed
Author: David Goldberg and Andrew Trudel, Synthetix, overanalyser (@overanalyser), INDEXcoop
Created: 30th March 2021
Simple Summary
When staking Synthetix, the user takes on a share of the synthetic debt pool. This is comprised of all the circulating synths at their relative market capitalisations. As the majority of the synths have free-floating prices, the user is exposed to a future debt liability that is unknown. In order to hedge this market risk, users purchase equivalent assets so that they can enjoy staking rewards with some protection. The proposed index fund is intended to mimic the composition of the debt pool using 100% collateralised assets and so allow simple and robust hedging.
Abstract
A five-component index (wBTC, wETH, DAI, DPI, and LINK) will be created to mimic the composition of the debt pool* (less 10% in USD). The fund will be based on the Set Protocol V2 contracts (market cap structure) with weekly rebalances to follow the debt pool. The fund will be maintained by INDEXcoop with support from Synthetix.
The fund will be designed to be low cost for users and will incorporate intrinsic productivity to capture underlying yield for the benefit of Synthetix and INDEXcoop.
*The mirror fund will actually follow a modified debt pool; 10% of the total balance of the pool (as sUSD) will be removed before calculating the fund weights. This allows stakers to hedge their position by using only 90% of their minted sUSD to purchase SMI, enabling them to retain 10% of their minted sUSD for personal use.
Motivation
Synthetix has a desire to create an easy flow for SNX stakers to hedge their exposure to market moves. The index needs to contain non-synths because otherwise the problem of the underlying debt would not be fixed and the debt risk would be taken on by just another staker.
For Index Coop the proposed fund delivers a number of benefits:
- Substantial Increase in AUV and associated income.
- synthetixDAO would support liquidity mining and seed funding.
- Initial proof of concept for intrinsic productivity with a fund aimed at DeFi natives.
- Builds INDEXcoop reputation as a partner for other protocols.
Synthetix approached Index Coop as a partner to launch this product as they saw a need in offering a collateralised hedge for SNX stakers. They would like to integrate the buying of $SMI into the staking flow on synthetix.io and allow all Synthetix users to access this index fund for hedging
PROBLEM STATEMENT SUMMARY
If the total debt pool is $1,000,000 and an individual staker created $100,000 of synthetic assets using their staked SNX as collateral they would be responsible for 10% of the total debt in the system. To summarize the risk this poses to the staker let’s pretend in this scenario that the staker had all of their $100,000 in sUSD. If sETH and sBTC each made up 25% of the debt pool (50% total), then if the prices of ETH and BTC increase, the total amount of debt would also increase and the staker would have to either add more SNX as collateral or burn their issued synthetic assets in order to maintain their desired c-ratio (currently 500%). This exposes them to risk and if they can hedge their position by mirroring the debt pool they would remain unaffected by the changes to the debt pool caused by price movements in volatile synthetic assets. The reason that stakers are comfortable taking this risk now is that they are rewarded with SNX staking rewards. If stakers can have the ability to hedge their debt risk they can reap the benefits of the staking rewards while minimizing their risk of unfavorable debt pool movements that can cause losses without a proper hedging mechanism.
Size of opportunity
The total value of all synths is currently $760M. SynthetixDAO estimate market size for $SMI to be between $50M and $100M AUV. This is just a rough estimate and proven reliability of the index mechanism would make this much higher.
Liquidity commitment
As the intention is to build the acquisition of SMI into the SNX staking flow, reliance on issue/redemption contracts and/or exchange issuance is not considered practicable. As a result, the creation of a sizable secondary market (Uniswap or Sushiswap) is anticipated.
The size requirements and any liquidity mining for this secondary market will be agreed with the INDEXcoop work groups between DG1 and DG2.
Differentiation
The proposed fund comprising ETH, BTC, USD and DeFi tokens has some overlap with existing funds on the market (BCP from PieDAO PieDAO Pool Management ) and funds proposed by members of INDEXcoop for future products (ICP Product proposal - Index Crypto portfolio (ICP) and BED IIP-22 Bankless BED Index ). So there will need to be some differentiation between this product and others / potential others.
However, the use of the Synthetix debt pool as the benchmark index is unique and it is unlikely that the market will create a suitable hedging fund without it being a specific target.
Statistics
Data used has been sourced from:
The debt pool behaves like a market cap index fund. The value of the fund and a staker’s liability are related to both the composition of the fund, and the price behaviour of each component. As we have no control over the prices, the key parameters are to monitor and track the composition of the pool, as well as the current debt ownership of each staker. Both of these values will be returned in the Synthetix utility smart contract that contains read only view functions. In order to calculate the composition of the pool, the Synthetix utility contract will return the net skew for each synth in the index pool. The net skew can be calculated by taking the total longs for a synth (sBTC, sETH, etc.) and subtracting both its corresponding inverse synths (represented as iBTC, iETH, etc.), and the shorts for that synth (sETH shorts, sBTC shorts, etc.).
Further details will be agreed with the Synthetix team and Coop work teams between DG1 and DG2.
Component Selection
Synthetic-monitoring lists 53 different tokens, with 40 of them having non zero market caps. However, the largest 12 tokens comprise 99% of the debt pool. With the remaining 28 being less than 0.25% each. sDOT and sTSLR have been omitted as there are no ERC 20 analogues.
The top 12 tokens are:
| Synth | Total number | USD | % of total | |
|---|---|---|---|---|
| 1 | sUSD | 268,417,567.95 | 268,417,568 | 36.64% |
| 2 | sETH | 121,266.18 | 216,724,723 | 29.58% |
| 3 | sBTC | 2,455.77 | 141,184,008 | 19.27% |
| 4 | sEUR | 22,087,309.87 | 26,401,514 | 3.60% |
| 5 | sLINK | 735,033.12 | 20,970,349 | 2.86% |
| 6 | iETH | 14,254.37 | 18,656,373 | 2.55% |
| 7 | sDEFI | 810.18 | 11,705,415 | 1.60% |
| 8 | sUNI | 228,791.50 | 7,424,284 | 1.01% |
| 9 | sDOT | 164,957.23 | 5,997,968 | 0.82% |
| 10 | sAAVE | 10,011.60 | 3,766,199 | 0.51% |
| 11 | sTSLA | 4,171.12 | 2,896,382 | 0.40% |
| 12 | iBTC | 83.61 | 1,945,128 | 0.27% |
| 99.1% |
Based on these observations and review of the correlations the fund structure can be rationalised by a number of steps:
- The balance of iETH can be subtracted from sETH, in addition, any shorts should be considered.
- BTC can be similarly treated and represented by wBTC
- sUSD will be represented by DAI.
- sUNI, sAAVE and sDeFi will be represented by DPI.
- sLink will be represented by LINK.
This results in a 5 component fund that represents 98% of the entire value of the debt pool.
In order to remove 10% of the total Mcap as USD, Some off chain calculations will be required (to be finalised between DG1 and DG2).
On-chain liquidity analysis
The v1 fund will comprise of:
- wETH
- wBTC
- DAI
- DPI
- Link
There is significant liquidity in all of these available on-chain.
Fee and Split
Fee: 0% Streaming Fee
Synthetix has requested that there be no streaming fee to optimize the $SMI for the use case of being a long-term debt hedge for SNX stakers against the Synthetix debt pool’s performance. Any costs associated with managing the $SMI will instead be covered through intrinsic productivity.
Intrinsic Productivity Fee Split: 70% INDEXcoop and 30% Synthetix
The Synthetix Core Contributors estimate that the revenue generated from the first year of intrinsic productivity could be within the range of 2-3 million USD. Since INDEXcoop is responsible for the implementation and management of intrinsic productivity, as well as the management and gas costs associated with rebalancing the $SMI, they will receive 70% of revenue generated from intrinsic productivity while Synthetix will receive the remaining 30% as a reward for incentivizing SNX stakers to manage their capital with $SMI.
There will be no issue and redemption fees for $SMI
Methodologist bonus
Methodologist Program: 100% Synthetix
The INDEXcoop has recommended that 100% of the methodologist program fee be given to the SynthetixDAO to secure the SynthetixDAO as a stakeholder invested in the INDEXcoop’s success.
Methodology
The methodology is to use the 5 components to follow the debt pool composition (less 10% fiat). This would require a utility contract from Synthetix. Components may be added or removed as part of the rebalancing.
The fund would be built using Set Protocol contracts which work on a market cap basis.
Rebalancing schedule
Rebalancing would be done on a weekly schedule. It is expected that the v1 methodology will use off-chain monitoring and management by Set Labs / INDEXcoop. This is the current process for $DPI and other funds with monthly rebalancing schedules.
However, the rebalancing may move to a market-driven technique based on changes to the debt pool composition.
Index Calculation
The value of $SMI will be calculated as the sum of the individual components and the weights at the last rebalance.
Intrinsic productivity
As a product intended for DeFi natives, inclusion of intrinsic productivity for the benefit of all (INDEXcoop, SMI holders and Synthetix) is planned for activation after launch. Details of the yield generation methods (Compound, AAVE) and destination of the yield will be agreed between INDEXcoop and Synthetix before implementation.
Methodologist commitments
INDEXcoop
- Smart contracts and rebalancing of fund
- Exchange issue contract for $SMI Exchange Issuance Bounty [December 2020] - IN PROGRESS
- Managing Intrinsic productivity - once agreed
- Backstop for Intrinsic productivity
SynthetixDAO
- Provide utility contract on debt pool
- Seed investment for SMI:sUSD pool and / or Liquidity rewards
Author background and commitment
Synthetix is a decentralized derivatives liquidity protocol that enables the issuance of synthetic assets on the Ethereum blockchain. Synthetix supports synthetic commodities, cryptocurrencies, equities, indices, and fiat currencies.
INDEXcoop is a decentralised organisation focused on the creation of structured products on the Ethereum block chain. This includes sector specific index funds (DPI, MVI), volatility adjusted sound money funds (CGI), and on chain Leveraged funds (FLI)
♂
Synthetix
Playing devil’s advocate for a second – do we still think this product is a real priority, given how many times it’s been pushed back? I’m not sure if there’s ever been a reversal back from something passed through DG2, but given all we’ve learned about the technical constraints, it may be worth considering.