IIP: 89
Title: Polygon Diversified Index (PDI)
Status: Proposed
Authors: Hamzah Khan (Head of DeFi, Polygon Foundation), @AsifKhan (DeFi Team, Polygon Foundation), @Mringz, @Ahuja
Created: 2021-09-20
Simple Summary
The Polygon Foundation and members of Index Coop would like to re-propose the Polygon Diversified Index (PDI). The index will showcase the top-performing projects built on Polygon based on a new risk-adjusted methodology that provides exposure to the polygon network eco-system. The index will serve to give holders exposure to the leading protocols deployed on Polygon.
Abstract
After the initial feedback from the original Polygon 10 Index proposal. The Polygon Foundation team and contributors from Index Coop decided to re-propose a new Polygon Index that gives investors better and safer exposure to the Polygon network ecosystem.
After considering initial feedback and conducting further due diligence on the underlying projects in the first P10 proposal the authors decided to develop a new methodology that optimizes the index allocation based on return/volatility factor which will be described in further detail below.
We envision this Index to be a moderate Set deployment based on the need to migrate Set/IC features from mainnet to Polygon. The initial technical requirements have been outlined below.
Motivation
The launch of this index will mark the first scaling solution native product from Index Coop, both showcasing the innovative culture at Index Coop and marking the beginning of Index Coop’s expansion to other chains. If launched this will be the first native Index token on the Polygon network.
Specification
Overview
This product will contain a collection of ERC-20 (POS) tokens that will be created and managed on Set Protocols’ recent Polygon deployment. The Index will capture broad exposure to the most influential Polygon network projects.
Product Differentiation
Polygon is able to provide blockchain developers an ultra low-fee environment which has led to the development of entirely new classes of dapps. We believe that the Polygon Diversified Index (PDI) has the potential to capture the best of these projects as well as offer a holistic, sector agnostic snapshot of the innovations occurring in the Polygon ecosystem. Ethereum needs to continue to scale in order to reach the average consumer, and scaling solutions such as Polygon will play a critical role in helping usher in that vision.
As of this post, no native sector Index product exists on Polygon. This will be the first cross-chain sector index supported by Index Coop. This will also be the first Index that gives exposure to a blockchains’ network eco-system of projects and protocols.
Index Composition
| Token | Allocation % |
|---|---|
| WMATIC | 15.0 |
| AAVE | 15.0 |
| SUSHI | 15.0 |
| LINK | 15.0 |
| BAL | 6.0 |
| QUICK | 5.0 |
| KNC | 5.0 |
| SAND | 5.0 |
| MANA | 5.0 |
| SX | 5.0 |
| DG | 3.0 |
| GHST | 3.0 |
| DFYN | 1.0 |
| QI | 1.0 |
| MUST | 1.0 |
Back-test Data
- Daily return % for the index for the past 100 days (limited to start since the launch of token with the shortest history - QI)
- Daily Return % - Zoom-in to the first 20 days
- Cumulative Return % for the index for the past 100 days (since the launch of token with the shortest history QI)
Size of opportunity
Polygon has seen large amounts of liquidity and trade volume and has established itself as the undisputed leader in scaling infrastructure. According to Nansen AI, Polygon boasts 1,300,000 daily active addresses, processes around 6,200,000 daily transactions (~62.5 tps). The large size of the daily active addresses and the recent spike in the number indicate an engaged user base and an ecosystem that is building on its momentum.
Another way to think about the potential market size is the following - Polygon, on Twitter, boasts approximately 700K followers. Followers of Polygon are highly engaged crypto enthusiasts. They provide for a potential pool of investors that are interested in following the progress of the Polygon ecosystem. PDI will provide a great entry point for these Polygon supporters to engage, track and benefit from the Polygon ecosystem and its future development.
As an example, a 10% penetration of this twitter pool base translates to 70K unique holders. At a $1000 average investment per user, the AUM can potentially exceed $70M. A similar penetration of the daily active addresses will yield a potential AUM double this number. While the numbers are estimates, this goes to show that Polygon is a thriving ecosystem that deserves an Index product (with low frictional costs) that should track the development and success of the important projects within the ecosystem.
Market & Customer Research
Target Customer
This product will be targeted to users of the Polygon ecosystem and holders of the MATIC token. To date, no other native Polygon Index tokens exist. This Index will also be the first Index product in the cryptocurrency eco-system that uses a risk-adjusted methodology to produce superior returns.
Methodology
Token Inclusion Criteria
The Polygon Diversified Index (PDI) is a diversified digital assets index that is designed to capture the growth and performance of major themes in the polygon ecosystem.
The selection of the components of the Polygon Index is based upon the following criteria:
- The token must be available on the Polygon blockchain.
- The token must belong to one of the following categories
- Project that is associated with dominant themes within the decentralized finance space
- Dominant projects or projects gaining traction within the NFT, entertainment, virtual Reality, augmented Reality, and music space. To belong to this category, the project must be contributing to the advances in the virtual shared space or Metaverse
- The protocol must have organic network activity or usage. On-chain transaction volume, Total Value Locked (TVL), and/or revenue paid to service providers are all examples of metrics that can be used to demonstrate organic network activity.
Token’s Trading Liquidity and Supply Characteristics
- Fully diluted market valuation of the token must be greater $100m
- The token must have greater than 90 days of price and liquidity history
- The token should ideally be listed on multiple DEXs. The token must have reasonable and consistent trading liquidity on the DEXs on Polygon
- The ownership profile of the token should not be overly concentrated in a small number of wallets. Such a token may suffer from a liquidity crisis and a significant price downdraft when the majority of owners reduce or eliminate their ownership.
- The tokenomics must not have locking, minting, or other features that would significantly harm or disadvantage passive holders
Project’s Descriptive Characteristics
- The project should have been in existence for more than 180 days
- The project must be widely considered to have a useful product or protocol.
- The project should have a significant number of existing users or must exhibit significant growth in its user base.
- Security professionals must have reviewed the protocol to determine that security best practices have been followed to maintain user assets safe under different circumstances. Alternatively, the protocol must have been operating long enough to create a consensus about its safety within the decentralized finance community.
Allocation Constraints
- No project or token can make up > 15% of the index
- Tokens are then tested against the following two criteria to determine the allowed range of allocation range.
- Fully Diluted Market Capitalization > $ 300 m
- Token Price History > 6 months
| Theme | Market Cap > $300 mil | Token History > 6 months | Max Allocation % | Min Allocation % |
|---|---|---|---|---|
| DeFi | Y | Y | 0.15 | 0.05 |
| DeFi | Y | N | 0.08 | 0.05 |
| Metaverse | Y | Y | 0.05 | 0.02 |
| Metaverse | Y | N | 0.03 | 0.01 |
| DeFi/Metaverse | N | Y/N | 0.03 | 0.01 |
The above tests are applied to the following list of tokens belonging to the DeFi and
Metaverse/NFT theme within the Polygon ecosystem based on fully diluted market capitalization on Sep 18th 2021. The resulting allocation ranges are noted below.
| Token | Maximum Allowed Allocation % | Minimum Allowed Allocation % | Theme |
|---|---|---|---|
| WMATIC | 0.15 | 0.05 | DeFi |
| AAVE | 0.15 | 0.05 | DeFi |
| SUSHI | 0.15 | 0.05 | DeFi |
| BAL | 0.15 | 0.05 | DeFi |
| QUICK | 0.15 | 0.05 | DeFi |
| LINK | 0.15 | 0.05 | DeFi/Infrastructure |
| KNC | 0.08 | 0.05 | DeFi |
| DFYN | 0.03 | 0.01 | DeFi |
| QI | 0.03 | 0.01 | DeFi |
| SAND | 0.05 | 0.02 | Metaverse |
| MANA | 0.05 | 0.02 | Metaverse |
| SX | 0.05 | 0.02 | Metaverse |
| DG | 0.03 | 0.01 | Metaverse |
| MUST | 0.03 | 0.01 | Metaverse |
| GHST | 0.03 | 0.01 | NFT/Metaverse |
Initial Composition
The initial composition of the index is derived based on optimizing for volatility-adjusted return. The components are considered together and the correlation of returns exercises influences the resulting composition.
The correlation of returns for the various component tokens is shown above. Daily returns while noisier than monthly returns provide a longer data set to study correlation characteristics. Note that price history data for such an analysis is limited by the token with the smallest history (QI - start date 6-4-2021 to present date).
Here are a few takeaways
- Metaverse projects such as DG, SX, SAND are largely uncorrelated with most of the remaining tokens belonging to the DeFi theme in the time period under study.
- LINK, BAL, AAVE show a strong correlation in daily returns.
The above plot shows the efficient frontier for portfolio allocation consisting of the 15 selected tokens with constraints that limit the maximum allocation to 15%. The data uses price history since the origin of (shortest lived token) QI. The efficient frontier is defined as the allocation that provides the highest return (shown on x-axis) for the volatility level (shown on x-axis). All performance numbers are annualized %.
To highlight the efficient frontier, expected performance is shown for 300 random portfolios with random allocations of the constituent assets. The random allocations follow the same constraints as outlined above and in the table in the previous section.
For the index, we choose the allocation marked with a “red dot” in the plot above. This allocation corresponds to a specific allocation % for all the individual 15 tokens that make up the index.
On-Chain Liquidity Analysis
We study the adequacy of on-chain liquidity by looking at the liquidity offered by the major DEXs for Polygon. They are Quickswap and Sushiswap. Looking at the large allocations WMATIC, AAVE, SUSHI, and LINK, SUSHI has the smallest LP size at ~ $2.4M. Now, consider a sample AUM size of $50M. At that size, SUSHI token will account for 750K. In the unlikely event of a 10% redemption or minting that occurs clustered together, the demand for liquidity is ~ 75K. This compares to the $2.4M liquidity or approximately 3% of total liquidity. For constant product AMM, this corresponds to a small price slippage of < 5% If such redemption or minting events occur spaced in time or the implementation splits the trade into smaller trades, the LP behavior will be much better and price slippage will be negligible.
Looking at the other end for the lowest liquid tokens in the index such as DG or MUST. These tokens take a small portion of the index. The smallest LP is for DG at a little less than $1M. With a similar analysis, we determine that liquidity demand for DG (for 10% redemption events) to be 150K which is approximately 15% of the LP. In this scenario, it is expected that smaller chunks will need to be executed over time to limit the price slippage to a manageable number below 5%.
Index Maintenance
The PDI Index rebalances will be methodologist initiated and rebalanced quarterly with the goal to migrate to monthly re-balancing.
The rebalancing process will occur in two phases:
- Determination Phase: During the determination phase, the tokens being added and deleted from the index calculation are determined during the final week of the quarter and published before quarterly rebalancing.
- Rebalancing Phase: Following the publication of the determination phase outcome, the index composition will change to the new weights during the first week of the following quarter.
We acknowledge current limitations in the TokenSets Polygon deployment currently limit the ability to rebalance and for that reason, we are selecting a quarterly rebalance, however, once sufficient development and testing have been conducted, we intend to rebalance monthly.
Costs
Fees
A more detailed fee structure will be determined before the DG2 vote and subsequent product launch. However, Polygon’s methodologist portion of the fees generated by the PDI will be streamed directly to the Polygon Ecosystem Development Fund, to support the continued growth of the Polygon Ecosystem. We also hope to direct a portion of the methodologist INDEX rewards earned from the PDI to a bounty program to encourage the further development of Index Coop and TokenSets technology on Polygon.
Streaming fee
The index will charge a 0.95% (95 basis points) annual streaming fee.
Mint & Redeem fees
The index will charge a mint fee of 0.10% (10 basis points) and a redeem fee of 0.20% (20 basis points).
Rebalance Frequency
As mentioned above the index will be initially balanced quarterly with the goal to transition to monthly rebalances. Due to the low-fee nature of the Polygon network, we believe Gas costs from rebalancing will be negligible.
Technical Requirements
Based on brief initial consultations with the Set team, members of the Engineering working group & Product working group. The Index will require the following deployments in order to be supported by the Index Coop:
- Creating and managing an IC multisig on Polygon.
- Recreating the backend system of keeper bots to manage rebalances on Polygon.
- Updating the Admin UI to manage products on Polygon.
- Re-vamp of front-end website to support Polygon.
Author Background and Commitment
Polygon Foundation
Polygon (formerly known as Matic) is a protocol and a framework for building and connecting Ethereum-compatible blockchain networks. Polygon’s open-source technology provides developers with the tools to readily deploy a stand-alone network or to a secure sidechain, such as MATIC, that leverages the security of the Ethereum network via smart contracts. Polygon maintains its security from Ethereum, however, it uses a Proof-of-Stake consensus layer to allow for up to 7,000 transactions per second, helping bring much-needed scaling to the Ethereum ecosystem.
Polygon is committed to making DeFi, NFTs, Dapps, and all kinds of blockchain-based technology accessible to everyone. This mission is deeply aligned with the Index Coop’s strong desire to make crypto investing safe, easy, and accessible for all.
Michael Mtenga and Ahuja are the internal methodologists for Index Cooperative.
Michael Mtenga
Michael Mtenga has been consistently contributing to the Index Coop since February 2021, contributions that have led to him being awarded Gold Owl within the DAO. His contributions include initiatives with PoolTogether, Perpetual Protocol & Rabbithole. Furthermore, he has been a key member within the business development working group (BDWG) creating and leading the DeFi Partnerships vertical. He also serves as the protocol ambassador for Maker DAO.
Ahuja
Ahuja is a member of the Index Coop Treasury Working Group and the FLI Pod within the Product Working Group. He has been making contributions to the TWG since July 2021 and FLI Pod since August 2021. He has a CFA and a strong background in quantitative & statistical analysis.
The Polygon Network Index was jointly developed by core members of the Polygon Team and BDWG, and is hopefully the first of many collaborations between the Coop and external methodologists.
Revision history
- First revision from initial proposal: **[Under Revision]** - Creation of Polygon 10 Index (P10)
-
Altered methodology from market-cap-weighted to risk-adjusted
-
Change Index name from Polygon 10 Index (P10) to Polygon Diversified Index (PDI)
-
Added the following projects based on Methodology:
- WMATIC
- SUSHI
- AAVE
- BAL
- LINK
- KNC
- MANA
- SAND
-
Removed the following projects after further due diligence and liquidity analysis:
- TEL
- ADDY
- UFT
-
Added new Index Coop contributor as Methodologist
Copyright
Copyright and related rights waived via CC0.
