IIP-57: Launching iETH-FLI - The Ethereum Inverse Flexible Index

Governance Proposal
1

IIP: 57
Title: Launching iETH-FLI
Status: Proposed
Author: Pulse Inc
Created: 30-Jun-2021

Summary

Pulse Inc would like to propose that the Index Coop manages a new set using the FLI strategy proposed in IIP-13.

With the successful maintenance and stress testing done through the launch of ETH2x-FLI and BTC2x-FLI , we think it is time for the first Inverse FLI to be born!

We propose the launch of iETH-FLI which is a short position on ETH with 1x exposure to the downside

Abstract

This new set, if launched, would be based on V0.1 of the FLI (same as both ETH2x-FLI and BTC2x-FLI) methodology and would be the first Inverse Flexible Leverage Index and would be called the Ethereum Inverse Flexible Index

Initial parameters for The Ethereum Inverse Flexible Leverage Index:

  • Underlying Asset: USDC
  • Target Leverage Ratio: 1
  • DeFi Lending Protocol: Compound
  • Maximum Leverage Ratio: 1.15
  • Minimum Leverage Ratio: .85
  • Recentering Speed: 5%

We are proposing that iETH-FLI utilize Circle’s USDCoin (USDC) based on the liquidity & utilization metrics on Compound. This may be changed in the future if other stablecoins present sufficient liquidity and utilization in Compound or supported lending protocol.

Inverse FLIs function the same way FLIs do in the sense that your deposited asset is locked in a money market and used as collateral to borrow more of the underlying asset.

A key distinction between the two is that Inverse FLIs have much lower volatility decay since the APY on stablecoins is significantly higher than the borrowed asset (being ETH in the case of iETH-FLI)

Motivation

Flexible Leverage Index makes leverage effortless.

The User would not have to worry about:

  • Monitoring his leveraged loan 24/7, having to always be ready to act.
  • High fees, transactions not being included fast enough or the relative UIs being unresponsive during times of high volatility.
  • Paying for overpriced stablecoins to deleverage on time or panic trading to save his positions.

FLI has several key advantages over Legacy Leveraged Tokens:

  • Zero slippage via composable entry and exit.
  • The unique index algorithm reduces rebalancing needs by an order of magnitude.
  • Emergency deleveraging possible during Black Swan events for additional fund safety.

Size of opportunity

Lending protocols are currently leading the Decentralized Finance space, having multiple Billions in Total Value Locked. There is certainly no shortage in interest for collateralized debt positions, one can simply visit DeFi Pulse and look at lending protocols rank and TVL to get a sense of the magnitude of opportunity this new kind of index can potentially present.

Differentiation

FLI being very dissimilar to any existing or proposed Index opens up a new category of leverage based Indexes.

With this initial Inverse FLI, we are addressing the second part of the market that would like to speculate on any potential downside on the price of the underlying asset

On-chain liquidity analysis

USDC is the most supplied stablecoin on Compound, with over $3,532,39M in total supply from 218,222 suppliers.

At the time of writing the pool has a utilisation of ~56% meaning $1,555M USDC is left unborrowed.

Methodology

Objective

Flexible Leverage Index enables market participants to take on leverage while minimizing the transaction costs and risks associated with maintaining collateralized debt.

Definitions

  • Borrow Rate — the cost to borrow the asset at the DeFi Lending Protocol over the most recent epoch.
  • Epoch Length — the time between rebalances.
  • Target Leverage Ratio (TLR) — the long term target for the value of the assets held by the index divided by the value of the debt held by the index.
  • Current Leverage Ratio (CLR) — the value of the asset currently held by the index divided by the current value of the debt held by the index.
  • Maximum Leverage Ratio (MAXLR) — the highest leverage ratio the index will ever have after a rebalance.
  • Minimum Leverage Ratio (MINLR) — the lowest leverage ratio the index will ever have after a rebalance.
  • Re-centering Speed (RS) — the rate at which the Current Leverage Ratio is adjusted each period to return to the Target Leverage Ratio, when the index is not being adjusted back to the Maximum Leverage Ratio or the Minimum Leverage Ratio.

Index Price:

FLIt = FLIt-1 * (1 + ((Pricet/Pricet-1–1) * CLRt-1 — (BorrowRatet * (CLRt-1 -1)/CLRt-1)))

Calculation of the new Current Lever Ratio for the period:

CLRt+1 = max(MINLR, min(MAXLR, TLR * (1 — RS) + CLRt * RS))

Fee split

Flexible Leverage Index will have a streaming fee of 1.95% (195 basis points) and a 0.1% minting /redeeming fee. The revenue generated from the streaming fee will be split 40% to DeFi Pulse and 60% to Index Coop.

Author background and commitment

DeFi Pulse and the Pulse Inc brand are committed to maintaining and creating indices. As well as driving the continued growth of the Index Coop.

DeFi Pulse is the leading website for the latest analytics and rankings of DeFi protocols. DeFi Pulse’s rankings track the total value locked into the smart contracts of popular DeFi applications and protocols. Providing key insights and educational content to help more newcomers go from zero to DeFi.

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Strongly support this addition to the product line and look forward to it’s launch!

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More product! more AUM! Glad to see this getting moved forward!

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Delighted to see this and can’t wait to see it in action!

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Excited to see the first inverse FLI product come to life! I particularly appreciate the call out that the lend/borrow rates will be much more favorable for an inverse product compared to the long products - the ratio of interest earned / interest paid will definitely have a positive impact on volatility decay.

Would you mind validating my understanding of how we would create a leveraged short position like this (aka lever up)? I think it would be very helpful for the community to understand the steps taken behind the scenes for a product like this.

  1. Deposit USDC (underlying asset) to Compound as collateral
  2. Borrow ETH from Compound
  3. Swap ETH for USDC on Sushiswap / Uniswap v3
  4. Deposit new USDC to Compound as additional collateral
  5. Borrow more ETH from Compound (enough to reach the target leverage ratio of -1x)
  6. Swap additional ETH for USDC on Sushiswap / Uniswap v3
  7. Deposit new USDC to Compound as additional collateral

Eager to see this product launch!

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hey Allan, FLI products lever up through debt tokenization,
in the example of iETH-FLI, here are the steps that happen:

1- minter deposits cUSDC into the set contract
2- contract draws ETH debt against that collateral
3a- contract mints the iETH-FLI token which is a claim to the cUSDC deposited in step 1 (collateral) and the ETH debt drawn against it
3b- in addition to the FLI token, the contract returns the borrowed funds (ETH in this case) to the minter seperatly.

At this point the minter still has the same exposure they had before minting (since they carry the FLI token + the borrowed ETH)

To gain short exposure you would sell the borrowed ETH received from minting!

(i encourage you to mint any live FLI product to see exactly how this works)

For users and traders they can directly buy the FLI token from the secondary market and just gain a short position directly

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Hey @Jo_K - thanks for walking us through that process!

I realize now that my question was not specific enough - I was trying to think through the rebalancing process for AUM rather than the mint / redeem process for the tokens themselves. The process that you outlined is super helpful for investors though because those details apply to the user-facing interactions!

I’ll confer with the Set team to validate my understanding of the way AUM is managed by the FLI smart contracts behind the scenes - there’s a reason those nuances are abstracted away :grinning: !

Thanks again for the detailed explanation!

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Great proposal @Jo_K - many community members have been discussing the need for inverse leveraged products for a while now. We absolutely need to release this product and I believe it will find the same level of success as our other leveraged products.

However - I will be voting against this proposal based on the current Fee split. A 40% methodology fee does not make sense to me in the context of this product. Index Coop will be shouldering the engineering lift, product support, and maintenance costs. Outside of the methodology work designing this proposal and providing initial specifications- it seems to me that the vast majority of the cost to build, release and maintain this product falls on Index Coop. The fee split should more clearly reflect this.

DeFi Pulse is an incredible supporter of our community and helps design awesome indexes- I want Index Coop to continue to release as many products as possible with DFP and hope our partnership extends far into the future. But we need clarity around the role of methodologists specifically around our exchange traded products. If we think of methodologists as primarily data providers - what data is being being provided to these products outside of the initial specifications?

We need to have a further discussion around the true cost of supporting our indexes. Off the top of my head here are a few major line items.

  • we have a FLI-pod of subject matter experts working essentially full time on maintaining FLI

  • Rebalancing and maintenance gas costs

  • The extremely dedicated community members who support these products in various capacities

Each of these functions costs money from Index Coop to support. The success of our protocol over the last 8 months is a definitive statement to the value add of Index Coop. We need to recognize this and take it into account with our methodologist partners when discussing fee splits around our products.

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Great product and excited to see this come to market. :rocket:

From a TWG perspective it will help balance out revenue from other FLI products making the FLI offering a great earner in all market conditions. This will add stability to our revenue stream which is great for the longevity of Index Coop.

Can we please discuss what happens to any COMP tokens here and who pays for the rebalancing costs of the product.

IMHO - I believe the rebalancing costs should be built into the product itself with the user covering the cost for rebalancing. I think it makes sense for this to be built into existing FLI products. Doing so would dramatically improve the Gross Margin of the product. The gas costs are also considerably less per unit of product compared to being a portion of the fees generated.

COMP tokens with other FLI products have not yet been discussed, but this conversation looms. It would be great if that conversation can be had early with the Index Coop.

Super excited for this product and glad to see the lessons from previous products being discussed openly.

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Hi @Matthew_Graham there is a standing policy for COMP tokens from FLI.

Per documentation:

Currently, there is an implementation to do the following with COMP rewards:

  1. Claim COMP rewards.
  2. Trade them to the base asset (ETH in the case of ETH2x-FLI).
  3. Wrap the base asset into Compound (cETH)

This deposits the cETH into the SetToken and returns the COMP rewards back to the FLI holders. When a leverage rebalance is submitted, the excess cETH is turned into a position.

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Hi @Jo_K, great work again. Another pioneering product!

I must agree with @BigSky7’s sentiment. The FLI suit has been a huge success but as Simon points out the operational burden for the Coop has become higher than originally envisioned. I would be really interested to hear your thought’s on the 40/60 justification for a product that requires seemingly less ongoing maintenance from a methodologist standpoint than DPI at 30/70?

Thank you

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I think it would be great if we can route those COMP rewards to Index Coop to help offset the maintenance costs. I think we can revisit this in light of the streaming fee discussion. Seems like a nice way to improve the revenue stream from the product without increasing the streaming fee. Just an idea for discussion.

I would be a bit surprised if any FLI holder considers the COMP tokens as significant in determining if they would purchase the product or not. However, I think it would be very significant to either DeFi Pulse or Index Coop.

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Hey Matthew - really appreciate your point of view on product profitability and how we ought to handle costs. Couple things I’d like to mention that may be helpful for the conversation:

  • COMP rewards are indeed exchanged for the underlying asset and redeposited to our collateral position, which adds to AUM. This approach aligns with the broader product strategy of returning rewards / airdrops to token holders rather than claiming them on behalf of the Coop. Technically, as we collect streaming fees, we indirectly receive a fraction of the liquidated COMP as a share of total AUM. I’m sure the amount of indirect COMP rewards drawn from AUM is a lesser number than the total COMP rewards captured our collateral and debt positions in Compound, but I still think it’s worth mentioning

  • Today, all of the gas costs incurred during FLI rebalancing are realized by Set and not by the Coop. At some point in the future, rebalancing costs may be realized by the Coop as eng / technical operations responsibilities are transitioned from Set to the community, but we would need input from Set and the right WG leads for direction or a timeline there (if one even exists). Overall product profitability is what is most important to us though, so we’re totaling all gas costs regardless of who realizes them in this particular dashboard. I’m all for minimizing operational and maintenance costs though, and acknowledging who realizes which costs is not a blocker for pursuing profitability!

  • Outside of gas and Set eng costs, there are operational costs that the Coop is realizing (ex. contributor rewards for the Leverage Indices Pod, formerly known as the FLI Team) that ought to be considered also.

I agree though that the discussion around streaming fee split will have a big impact on how we offset all operational and maintenance costs, and I hope this provides some additional context for the discussion.

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Hey @bigsky7 thank you for the feedback provided in the message above.

Since there’s a lot to unpack, I’d like to start by going over a few metrics and data points regarding FLI products, before addressing your points:

Fee structure:

  • The FLI products current fee structure includes streaming fees and mint/redeem fees. These fees are split 60% to the Index Coop and 40% to DeFi Pulse.

Unique value proposition:

  • FLI products are unique in the space since they are the only onchain leveraged product that is transferable.

Revenue: (Source: @jdcook’s dashboard)

  • FLI products revenue account for over 50% of the coop’s daily revenue .

  • FLI products aggregate revenue for the past three months is over 350,000$

|249x113.17618966399462

I’d also like to highlight that the outstanding growth, and revenue of hundreds of thousands of dollars generated by the FLI products has happened organically, i.e.,with ZERO liquidity mining incentives from the coop.

Now let’s address the points you made in your message above:

1. The FLI-pod of subject matter experts working full time on maintaining FLI assets

This is super exciting. It’s made me very happy to see so much enthusiasm from the Leverage pod and I value the content they’ve been producing. It really shows that the Coop is thinking long term and, having the DAO as a partner for these assets, is the right way to go.

It is crucial to note that these are diminishing costs, meaning that, with every additional FLI product launched, the associated costs will not scale linearly.

I understand your point and realize that this set of experts could be driving a high cost to the coop today. But I do not doubt that, over time, the cost margin will diminish dramatically as more FLI products are launched and managed by the pod.

2. Rebalancing and maintenance gas costs

All the rebalancing and maintenance costs are paid for by Set, as far as I understand. Their engineering team has been excellent at building these contracts and has demonstrated resilience even through recent challenging market conditions. FLI products are thriving.

I’m personally very happy that Set has a significant stake in the coop and is well incentivized to keep doing outstanding work in the future.

To wrap up, I’d like to point out that, so far, more than 95% of the Index Coop’s revenues have been driven by Pulse.inc. We’re committed to continue the same path and help the coop maintain its market leadership in the space.

Considering the extended context, we believe that a 40% split for Pulse.inc for this product is appropriate to maintain the right incentives for the coop to continue its sustained growth.

Happy to elaborate further on any of the points above!

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@Jo_K thank you for the extended context here. My comment was not meant to question the value that DFP brings to Index Coop or the revenue generated by those products. I agree with all the points you laid out.

However, I am not sure if your post addresses my core question.

If we think of methodologists as primarily data providers - what data is being provided to these products outside of the initial specifications?

The role of the methodologist is incredibly important for market-basket style indices such as $DPI. These indices rely on complex analysis from the DFP team on a monthly basis. On top of that, the strength of these methodologies really rests on the trust and reputation of the methodologist.

On the other hand, exchange-traded products fit a very different area. Outside of the initial specifications, the role of the methodologist is limited. The primary data input is the price of ETH, leverage ratio, and recentering speed. They require no further management on the methodologist side while costing a significant amount to be maintained on our end ( I am aware that Set currently bears the cost here - but it should be noted that after our recent Treasury Diversification that expense can and should be handled in house by Index Coop.)

Over the coming months, I anticipate continuing to launch a suite of these products (i.e. 2xYFI 2xUNI etc…). The specifications for these products are minimal, while the cost to maintain is very high. If we want to continue to launch these products with DFP, we need to make sure the economics make sense for Index Coop. DFP earning 40% of the revenue for all future leveraged tokens is simply not sustainable for Index Coop. Especially when these products require minimal specifications or design from the methodologist.

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To add to Simon’s points a bit, I think focusing on revenues is just half of the picture.

  • Liquidity mining for DPI has been and continues to be a significant cost to the Coop.

  • Development of FLI contracts started in December, which arguably prevented work on other products as well as additional revenue options like intrinsic productivity. FLI products continue to take up a lot of engineering resources, blocking our ability to pursue other products and diversify revenues.

  • The fact that rebalancing and maintenance costs are paid by Set doesn’t mean they shouldn’t be considered. The Coop will eventually take those on. FLI products are expensive to maintain and I look forward to seeing some data on the exact numbers here.

Certainly agree that these products have been very successful but that success came at significant financial and engineering cost which should be reflected in the fee split.

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Just want to signal my agreement with @BigSky7 and @verto0912 on the fee split. I think they have articulated clearly the need to re-visit the fee split.

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Likewise, I agree with the comments from @verto0912 and @BigSky7.

While

While I would agree, that we should see costs vs AUM for the community contributors reduce for the Leveragesd product POD reduce as we launch more leveraged products, I think that there will be an even more rapid reduction in costs for Pulse.inc.

With regard to gas costs, my preference would be for all products to have gas costs taken from the streaming fee before the coop : methodologies split.

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Would support this going to DG1 while the fee split is discussed further.

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When was this discussed or decided? I don’t remember seeing this convo anywhere. From what I remember the COMP recycling decision was entirely made by Set/DFP without even notifying Coop until after product was launched.

For recentering gas fees I think they should be paid for by users. FLI is targeted at traders with advanced models, they are making a ton of money off trading FLI and can easily bear the cost increasing Coop profit on a not very (or at all) profitable product when factoring in all expenses to operate FLI including contributor payments.

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