Hey Jo. Great to see we are all in agreement that the best path forward is rapidly launching more leveraged products.
Before we commit to this next phase of leveraged products, there are a number of outstanding issues regarding the FLI suite that need to be addressed - both in terms of performance and licensing fee.
Performance Issues
In terms of performance, we have some open questions on how the FLI products behave. The image below shows the relative performance that ETH-FLI has compared to a simple 2x strategy where the product rebalances to a set leverage ratio every 24 hours.
The data that we have points towards the fact that the flexible leverage methodology underperforms a simple leveraged strategy in all markets. As is clear from the data above, holding a simple leveraged position, such as that used by FTX ETHBULL would be both more effective in a bull and in a bear market.
In fact it appears that a FLI methodology will consistently underperform a simple leveraged strategy over time.
This noted underperformance is reflected in the feedback we have gotten from numerous customers over the last few months. If you were to spend a few minutes scrolling through the #fli-discussion channel, you would see this is the prevailing sentiment.
Two takeaways:
- Our customers are sophisticated investors, and want to understand the product and monitor its performance - this includes the flexible leverage ratio.
- It has become widely known that the flexible leverage ratio, as it operates today, is ineffective and many of our customers are aware of this.
This leaves me with a number of questions also:
- How much research and testing was actually done to decide on a flexible leverage ratio?
- Can you share some of these results with us?
- We are still operating on V.0 of the FLI methodology. When can we expect V.1 and what will be the improvements?
- The FLI products have found strong market fit and been profitable for Defi Pulse and the Index Coop. Would it make more sense to use that as an opportunity to refine the methodology before launching more products that will create the same issue for our customers?
With regards to this performance issue, it seems that a more practical approach would be for the Index Coop to begin launching our own line of leveraged products. This way we can provide that product option to our customers while DeFi Pulse continues to refine the FLI methodology. When V.1 is ready, we can implement it on the existing FLI products and decide whether to begin rolling out the FLI suite based on the (assumed) evidence of it’s improved performance.
Licensing Fee Issues
An outstanding issue that has yet to be addressed is the high gas costs associated with managing these products, and the asymmetric risk that creates for Index Coop relative to DeFi Pulse. Quickly looking at Uniswap, it is clear that all of the suggested assets for inclusion as FLI tokens, have significantly less trade volume than BTC.
| Asset | Trade Volume |
|---|---|
| ETH | $1.02B |
| WBTC | $58.7M |
| UNI | $14.5M |
| LINK | $13.6M |
| MATIC | $8.9M |
| DPI | $689.9K |
This is concerning because BTC2x-FLI has struggled as an asset, and has placed a significant burden on the coop in managing related gas costs.
The BTC-FLI product is still operating at a loss.
We know from historical data that during periods of high volatility, the gas costs of rebalancing the product can be upwards of 1000% of daily revenue. If markets were to suddenly collapse and remain depressed for an extended period, it could take upwards of three years for a FLI product to become profitable again.
My worry stems from the fact that all of the suggested products could plausibly trade at significantly lower volume than BTC2x-FLI but would require similar gas expenses to rebalance during neutral/positive market conditions. There is no guarantee they would be profitable for the Coop to operate.
In the event of a major downturn, IC could be in a position where it has to manage multiple products that are underwater - while still paying a 40% fee to DeFi Pulse before expenses are accounted for. This is not a hypothetical situation. This is exactly the situation we have been in with BTC2x-FLI since launch.
Summary:
Index Coop is now positioned to rapidly deploy a range of leveraged products that will give our customers a broad ecosystem of assets to trade. The opportunity is great, but so are the risks. In order to advance this plan, we need to address the outstanding issues relating to licensing fees that we have been discussing for over a week. These are valid concerns, and we would appreciate a constructive response from DFP.
Similarly, it has emerged that there are deficiencies in the actual performance of the methodology. We appreciate that the products were brought to market quickly and currently exist in a V.0 state; however it would be irresponsible to launch a third, fourth, fifth, and sixth FLI product knowing what we know now about the flexible leverage underperformance. Before we can proceed in good faith, it’s important for the community to know what is being done to address these issues and how DFP intends to improve the methodology. In the meantime, it makes more sense for the Index Coop to launch these products ourselves as we can do so more profitably, and deliver more for our customers.