IIP-XX: Launch a LINK2x Leveraged Product

title: IIP-XX: Launch a LINK2x Leveraged Product

status: proposed

author(s): Automated Indices Pod (@allan.g, @afromac, @Mringz, @emault , @tgreco, @sidhemraj)

Summary:

The Automated Indices Pod would like to propose that the Index Coop launch and manage a LINK2x leveraged product.

This product will use a new methodology that features a stable leverage ratio for consistent exposure to LINK. It will also automate the entire process of creating and managing leveraged positions for token holders. The index will be issued as an ERC-20 token on Ethereum main net using Set Protocol.

Abstract :

The Index Coop should launch a LINK2x product with a fixed leverage ratio on Ethereum main net using a new methodology developed by the Automated Indices Pod.

Motivation:

Based on an analysis of trading volumes and pertinent token supplies, LINK is the most promising ERC-20 token for the first fixed leverage ratio product (more details in the Size of the Opportunity section below). A LINK2x token will enable holders to get twice the exposure to LINK without having to manually manage or monitor collateral balances and debt positions.

By holding LINK2x, token holders would not have to worry about:

  • Monitoring their leveraged loan 24/7 and procuring stablecoins if deleveraging is necessary
  • Coping with costly gas fees, transaction latency, or unresponsive protocol UIs during times of high volatility
  • Being liquidated and having to pay penalties as a result

There are several key advantages over legacy LINK leveraged products:

  • Fully transferable and tradeable as an ERC-20 token
  • Zero slippage via composable entry and exit.
  • Emergency deleveraging during Black Swan events for additional safety

Size of Opportunity

The most relevant metric for gauging market demand for a leveraged trading instrument like LINK2x is 24hr Trading Volume / Market Cap. Plainly stated, this metric allows us to measure the share of total token value that is actively traded within the last 24 hours. The higher the number, the better!

At time of writing, the 24hr Trading Volume for LINK was $1,059,239,408 and the Market Cap was $10,848,274,291, which yields an outcome of 9.76% for 24hr Trading Volume / Market Cap. Comparatively, the 24hr Trading Volume / Market Cap for ETH and wBTC is 8.30% and 3.42%, respectively.

Additionally, leveraged LINK products offered by centralized competitors are among the most popular products in their respective portfolios. Products like $LINKUP by Binance and $LINKBULL by FTX are often the top traded leveraged products on their exchanges. Compared to these products, decentralization, portability, and lower management fees are the key differentiators for LINK2x products.

Differentiation

The LINK2x token will be the first fixed-leverage product for the Index Coop, and it assures consistent returns for token holders regardless of market conditions.

On-chain Liquidity Analysis

The LINK2x token will use Aave v2 as the borrowing / lending protocol

  • LINK Supply: $499M
  • USDC Supply: $5.97B

A combination of different DEXs will be traded against to ensure sufficient liquidity during rebalancing, with preference shown to pools with the lowest slippage and price impact. A multi-hop swap (LINK <> ETH <> USDC) is recommended for both Uniswap v2 and Sushiswap so the relevant pools are listed below.

  • Uniswap v3 LINK/USDC Pool: $256K (0.3% Pool)
  • Uniswap v2:
    • LINK/ETH Pool: $60.4M
    • ETH/USDC Pool: $305.1M
  • Sushiswap LINK/USDC Pool:
    • LINK/ETH Pool: $126.8M
    • ETH/USDC Pool: $435.2M

Methodology:

Objective

Offer a safe, easy-to-use index for users who want leveraged exposure to LINK on Ethereum main net.

Parameters

  • Underlying Asset: LINK
  • Borrow Asset: USDC
  • Fixed Leverage Ratio: 2.0
  • Rebalance Interval: 12 hours
    • Currently backtesting 12 hour intervals and 24 hour intervals, so this parameter may be updated in the future
  • Recentering Speed: 100%
  • DeFi Lending Protocol: Aave v2
    • borrowing / lending rewards (stAave v2) will accrue to the relevant contract that manages the product’s leveraged position; the ultimate destination of these rewards will be determined by the community (see more in FAQs section below)
  • Decentralized Exchange(s): Uniswap v3, Uniswap v2, Sushiswap
    • Trade Splitter and Trade Router will be employed to optimize rebalancing outcomes
  • Max Trade Size (targeted price impact <0.6%):
    • Uniswap v3: 24,000 LINK ($587K)
    • Uniswap v2: 5,000 LINK ($121K) LINK > ETH >USDC
    • Sushiswap: 7,500 LINK ($183K) LINK > ETH >USDC
    • Tradesplitter (combined Uni V2 & Sushi): 12,500 LINK ($304K)
  • Slippage Tolerance: 2%
  • Supply Cap: 100,000 LINK2x tokens
  • Ripcord Parameters (to be employed during emergency deleveraging):
    • Leverage Ratio Trigger: 2.7
    • Ripcord Max Trade Size
      • (Uni V3): 50,000 LINK
      • (Uni V2 & Sushi Combined): 50,000 LINK
    • Ripcord Slippage Tolerance: 5%

Fee split

LINK2x will have a streaming fee of 1.95% (195 basis points) and a 0.1% mint / redeem fee (10 basis points). The revenue generated from this product will go entirely to Index Coop and the product’s share of the methodologist bounty will also be directed to the community treasury.

Additional Context

Please see the following forum posts for broader context on the Index Coop’s leveraged products:

Author background and commitment

The Automated Indices Pod (formerly known as the Leveraged Indices Pod) is comprised of Index Coop community contributors who are dedicated to the support, maintenance, and growth of automated products since May 2021.

Support:

  • Supported AWG in the design and creation of FLI Dune Dashboards as well as profitability metrics for all Index Coop products
  • Monitored and engaged in #fli-discussion channel, including addressing technical questions about the products
  • Managed the FLI portion of the Community Handbook by creating new pages and refreshing outdated pages
  • Developed a discord bot and a twitter bot for automated parameter reporting
  • Developed a web app for estimating FLI returns, volatility decay included

Maintenance:

Growth:

FAQs

  • You’re going to have a snappier name for this product, right?
    • Yes, we are working on better branding for this product and will update this proposal once we’ve got something worth sharing!
  • Why are we using Aave v2 over Compound for the borrowing lending protocol?
    • Compound does not currently support LINK as collateral, and even when they do, the collateral factor (aka LTV ratio) is expected to be 50%. Aave v2 currently supports LINK as collateral and has an LTV ratio of 70%, which is a safer ratio for a 2x product.
    • Borrow rates for USDC are more favorable on Aave v2 than Compound
      • Aave v2’s utilization rate (78%) is currently higher than Compound’s (66%), yet there is still a preferable rate
      • Aave v2’s USDC liquidity: $6.0B vs Compound’s USDC liquidity: $5.1B
  • How will borrowing / lending rewards be handled?
    • This is to be decided by the community. Previous leveraged products were designed to swap protocol rewards for the underlying asset and add those new assets to the product’s AUM in order to offset volatility drift. However, this capability was not fully developed and the community has expressed interest in alternative uses for protocol rewards that we would like to consider.
  • When would a fixed leverage ratio work well? When would it work poorly?
    • A fixed leverage ratio will perform more predictably during a strong market move to the upside or downside.
    • It will perform less predictably during choppy and sideways markets.
  • How is this product different from the FLI products?
    • This product is designed to have a fixed leverage ratio of 2x with a hard rebalance every 12 hours so that token holders get consistent exposure to LINK and its price movements. In practice, this means that token holders can expect twice the gains when the market is up and twice the losses when the market is down. The FLI - or Flexible Leverage Index - products use a flexible leverage ratio that can range anywhere from 1.7x - 2.3x depending on market conditions; rebalancing for FLI products is dictated by a unique formula developed by DeFi Pulse. In practice however, when the market is up for the underlying asset, the leverage ratio trends toward the lower end of the range (1.7x), delivering less gains to token holders; when the market is down for the underlying asset, the leverage ratio trends towards the higher end of the range (2.3x), exacerbating losses for token holders.

Please see the “How are these products different from the current FLI products?” section of this forum post for more details.

20 Likes

@Pepperoni_Joe hello sir - would you mind assigning an IIP # to this proposal?

Just highlighting that I have raised some points against *EDIT, immediately * going ahead with IIP’s in this post here

Thanks

2 Likes

Hey @MrMadila - responded to your original comment in the other post you linked, sharing a link to my response here.

To reiterate though, we do not intend to move this product to snapshot or to DG1 until the community has had time to build context around the broader leveraged products conversation and its implications to the Coop. Apologies if the IIP # request made it seem like we were trying to rush the process!

2 Likes

Great post, @allan.g. leveraged LINK sounds like a great next addition to the product suite.

Why does the hard re-balance take place every 12 hours instead of 24 hours? Given so many look to 1-day returns, a twice-a-day reset with a leveraged product would - as you know - tend to distort the returns versus the underlying (sometimes making leveraged performance look better than 2x for a given day, while other times worse). I’m sure there is a reason that I’m just not aware of, and perhaps the rest of the community would be interested in that nuance, too.

4 Likes

Hey Mike.

We are currently back-testing both 12 and 24 hour strategies. The trade-off between the two is that the shorter period between rebalances will be more susceptible to volatility decay over longer time periods, but may do a better job of tracking the price of the underlying during shorter price movements.

As you mentioned above, this may differ from the kind of daily returns that customers would normally expect. Our thinking is that crypto is a more volatile asset class, so it is worth considering strategies that might be better adapted to that environment - if LINK moves 10% in a day, a single rebalance may fail to capture that. We have seen this issue frustrate some customers, and have considered this as an option to try mitigate that issue.

Ultimately, we will present the methodology that we know is both safe and attractive to customers based on the evidence.

Thanks for asking this question. It highlights an important consideration we are working on.

8 Likes

Hi @afromac

If we back extrapolate the ~150 days ETH2x-FLI has been live. Do you have the implied gas costs for comparison? IE if they had been running in parallel would there be any meaningful increase or decrease in this expense?

Thanks

Hey @MrMadila - we are indeed considering gas costs for either interval, and while we don’t have results to report out right now, I think it’s safe to assume a couple things…

  1. A routine, hard rebalance back to a fixed leverage ratio may incur additional gas costs because the payload per transaction will likely be larger on average than the FLI rebalancing transactions that don’t have a hard rebalance; the volatility of the underlying asset plays a significant role in this though.

  2. A 12-hr rebalance interval would likely generate additional gas costs compared to a 24-hr rebalance interval, but more frequent rebalancing may be a necessary tradeoff if the underlying asset is volatile; we wouldn’t want to risk dislocation from the fixed leverage ratio

  3. Last thing to bear in mind is that while rebalancing costs may be more significant for this product, the Coop will receive 100% of the revenue which these costs will be netted out against. We’re excited about the corresponding MATIC2x product because deploying on Polygon will largely eliminate these costs from the equation and lead to higher profitability for the Coop!

We plan to share out our findings along with our recommendations as soon as we’re able to!

4 Likes

Any news on these findings @allan.g @afromac ?

Also, can anything be done to make the 12h or 24h rebal less targetable and inefficiency incurring? Example: a 1h window at 12h marker with randomized trade execution target minute. And, if theoretically possible, would this deliver much value or ROI?

Currently, these products sound attractive to launch, pending a bit more data (which will help community members compare them against DeFi Pulse’s - and thus add more context to the fees impasse too).

Thank you.

1 Like

Hey @DevOnDeFi

We have a bit more time to focus on the product side of things this week, so we will begin to compile some of our learnings and provide to the community soon :pray:.

I have thought about this too. Seems like a great way to reduce some risks, but might be tricky to model.

I will need to check with Set as well, about how this might affect the smart contracts. Our ability to get these products to market quickly is completely contingent upon using the existing Set infrastructure with no modifications. So trying to focus on what we can do right now will guide our decisions.

That said, it’s a great question, so I will look into it.

I’m happy that you like the sound of the products. I completely agree that we need to get data in front of these people. In the background, we have been evaluating what the different tradeoffs are between different strategies (which underlying asset, how often to rebalance, L1 vs L2 etc) and have narrowed down to some strong ideas. The goal now is to get that in front of people and let them make their own minds up.

1 Like