IIP Number: [to be assigned]
Title: Launch the ETH:BTC Ratio Index
Status: [WIP, Proposed]
Author(s): @sidhemraj, @anthonyb.eth
Reviewed by: @afromac @allan.g @MrMadila
Discussions-to: N/A
Created: Feb 16, 2023
1.0 Simple Summary
Index Coop proposes launching the ETH-BTC trading product, providing exposure to the ETH-BTC ratio. It is not specifically targeting the “flippening” narrative but could benefit those betting on this outcome.
2.0 Abstract
The ETH-BTC ratio is a valuable metric for understanding the relative strength of Ethereum and Bitcoin. This product provides exposure to 2x ETH and -1x wBTC through supplying wETH to Aave’s V3 Market, borrowing wBTC, selling it for wETH, and supplying it as collateral back to Aave V3.
2.1 Motivation
The ETH-BTC ratio is important for traders and investors to track relative value and market sentiment. It is highly likely that this ratio will continue to be important for a long time. Despite its importance, the ratio is relatively difficult and expensive to gain exposure to on-chain.
2.2 Rationale
By introducing a liquid token with automated leverage management on a battle-tested infrastructure, users can get on-chain exposure to the ETH-BTC ratio without needing to create and manage expensive and tedious positions in lending markets.
This higher-risk strategy has historically outperformed both dsETH and icETH strategies over a long-term time horizon. Tokenizing the ETH-BTC ratio allows investors to enjoy exposure to both ETH and the relative performance of ETH and BTC, allowing them to increase their ETH-denominated holdings.
ETH-BTC delivers value to customers by…
- Offering exposure to the ETH-BTC ratio in a low-risk fashion
- Abstracting the management of collateral and debt balances
- Socializing gas costs associated with maintenance
ETH-BTC delivers value to the Index Coop by…
- Diversifying our product offerings
- Expanding the ETH-denominated returns category of our portfolio
2.3 Differentiation
Traders can gain exposure to the ETH-BTC ratio by manually taking positions on lending markets such as Aave, Compound, and Euler, as well as on-chain perpetual markets, centralized exchanges, and synthetics; however, there are currently no liquid tokens providing exposure to the ETH-BTC ratio.
3.0 Overview
ETH-BTC will utilize Index Protocol’s battle-tested leverage token infrastructure on Ethereum main net and integrate with Aave V3 for managing collateral and debt positions. wETH will be deposited to Aave V3 and enabled as collateral, allowing wBTC to be borrowed and subsequently swapped for more wETH; this new wETH will be added to the index’s collateral balance in Aave V3, allowing for additional wBTC to be borrowed and swapped for additional wETH. The index will target a leverage ratio of 2.0x and will require minimal rebalancing because of the relatively high correlation between the collateral and debt assets. Emergency deleveraging will be enabled with incentivized ripcord functionality to prevent liquidation during extremely high volatility events.
3.1 Example Composition
At the target leverage ratio of 2.0x, the composition will be ~67% wETH (collateral) and ~33% wBTC (debt). The exact composition may vary due to volatility. Automated rebalancing will recenter the index to the target leverage ratio according to predefined parameters.
3.3 Backtest Results
A backtest of the ETH-BTC was conducted, and the results showed that the product produced high returns over a 3-year period, outperforming both ETH and BTC individually.
Backtest Result 1
The above chart compares ETH vs ETH-BTC ratio returns denominated in ETH over a 3-year period. Over the period, hypothetical ETH-BTC holders who started with 1 ETH ended with 1.97 ETH after the said period.
Backtest Result 2
The above chart compares returns of ETH, ETH2x-FLI, and ETH-BTC in USD terms over a three-year period. ETH-BTC comprehensively outperforms ETH and ETH2x-FLI over 1y/2y/3y periods.
Past returns are not indicative of future performance.
4.0 Size of Opportunity
Our analysis reveals that at least $70 million is invested in this strategy on Aave, Compound, and Euler. We believe the potential market size is much bigger due to the fact that many people prefer not to manage their own leverage and resort to using centralized exchanges.
5.0 Market & Customer Research
A Twitter poll conducted by Index Coop on January 20, 2023, showed that 76.5% of respondents said “Yes” to the question: “Do you want @indexcoop ETH-BTC ratio product?” The poll had 153 respondents.
5.1 Target Customers
The target audience for ETH-BTC includes on-chain Ethereum investors and traders that believe ETH-BTC outperformance is likely to continue. This strategy has been popular with Ethereum-centric podcasts such as Bankless, where host David Hoffman has explicitly spoken of his long-term plan to deploy manual strategies like this one. Additionally, the large DAO, Gnosis, is deploying this strategy on Aave, demonstrating potential effects beyond the target audience.
5.2 User Stories
- As a retail user, I want to bet on the ETH-BTC ratio, but leverage management is too complex and risky
- As a retail user, I want to bet on the ETH-BTC ratio, but the gas costs are prohibitive
5.3 Product Economics
We predict monthly revenue of $16,250 and rebalancing costs of ~$2,500 for a gross profit margin of effectively 85%. This is based on a $10m AUM, 1.95% streaming fee, and rebalancing frequency consistent with the 3-yr backtest.
6.0 Methodology
6.1 Initial Composition & Token Inclusion Criteria
The composition would include Aave Supplied ETH and Aave Borrowed BTC.
6.2 Weightings
The weight of the index would be adjusted to have a 2-1 ratio of Aave Supplied ETH to Aave Borrowed wBTC to meet the 2.0 leverage ratio at launch.
6.3 On-Chain Liquidity Analysis of Underlying Tokens
The index will execute rebalance trades primarily on the WBTC/WETH 0.05% Fee pool on Uniswap V3, which has a TVL of $120M, and attracts 80% of the WBTC<->ETH trade volume on Uniswap V3.
6.4 Maintenance / Rebalancing Frequency
Asset and strategy parameters
Collateral Asset : wETH
Debt Asset : wBTC
DeFi Lending Protocol : Aave V3
Target Leverage Ratio : 2.0
Maximum Leverage Ratio : 2.3
Minimum Leverage Ratio : 1.5
Initial Supply Cap 1,000,000 Tokens
Token Value at Inception(TBD) 100 USDC or close to 1WETH in USD value
Rebalance Parameters
Rebalance Interval 3 months or when LR<1.5 or LR>2.3
Recentering Speed 2.5%
Slippage Tolerance 0.2%
Ripcord Parameters
Ripcord Leverage Ratio 2.5
Ripcord Slippage Tolerance 5%
Initial Liquidity
Pair : wETH / wBTC
DEX : Uniswap v3
7.0 Costs
7.1 Costs to Customer
Holders will be charged a 1.95% streaming fee, and 0.15% mint and redeem fee.
7.2 Costs Transparency
There are implicit costs associated with this strategy (though they are excluded from the effective yield communicated in this proposal):
-
Borrow costs from BTC debt balance in Aave v2/v3
-
Slippage incurred during rebalancing
The debt balance the product will carry within Aave v3 is subject to a variable interest rate. While that interest rate is currently and historically very low (0.64% for WBTC), a very large increase in utilization or a very large decrease in supply could drive the variable borrow rate higher and thus reduce the NAV.
NAV decay due to slippage is expected to be negligible due to the very infrequent rebalancing to maintain the target leverage ratio as well as the deep, concentrated WBTC/WETH liquidity on Uniswap 0.05% Fee pool.
7.3 Fee Split
All fees accrued will go 100% to Index Coop treasury.
8.0 Intrinsic Productivity
Token holders stand to benefit from the change in ratio of ETH to BTC price.
There are no metagovernance rights available with this product as it holds supplied ETH and BTC debt.
9.0 Liquidity
This product will require approximately $73,000 in seed liquidity at launch in order to provide a target access cost of 1% based on the assumptions below which are subject to market conditions. It is highly likely that this product will naturally attract LPs, given that ETH-BTC and ETH will not diverge in price quickly.
| Target Access Cost | 1.00% |
|---|---|
| ETH/USD Price | $1,550 |
| Gas Price | 20 gwei |
| Issuance Cost | 526,000 wei |
| Issuance Cost | .011 ETH |
| Exchange Equilibrium | 1.052 ETH |
| Concentration - Lower Bound | -16.7% |
| Concentration - Upper Bound | 20.0% |
| Total USD Required | $73,263 |
10.0 Author Background and Commitment
Index Coop’s product team is responsible for designing, developing, and deploying index products for the Index Coop, as well as managing and maintaining products post-launch.
Core team members have also been supporting, operating, and refining Set Protocol v2 and Index Protocol’s leverage token infrastructure for over a year.
11.0 Marketing Support / Distribution / Partnerships
As an internally-produced product for the Index Coop, there will be a joint effort amongst Product, Marketing, and Partnerships to market, distribute, and maximize composability for this product.
If you want to work with us to support ETH-BTC on your application or platform, please reach out on our discord.
12.0 Option to Extend
If approved by Index Coop governance, this suite proposal can be extended to other products that adhere to the same methodology (ex. BTCETH).
13.0 Contingency for Depreciation
If this product should be deprecated post-launch, it will be given 60 days notice following an IIP and will be rebalanced entirely into ETH which will make it easy for holders to redeem their assets.
is countered by the lack of liqudiity pair with wBTC.