The goal of this document is to outline the fundamental principles and contextual sources that can be used to frame economic discussions of Index Coop product and methodologist relationships. This piece complements JDCook’s “Request for Discussion: The Coop & Methodologists” and some of the discussions re: the FLI Fee Split - and doesn’t touch upon concepts such as permissioning, grand-fathered agreements, or the specifics for actual negotiations.
- Index Coop aims to work with the best Methodologists to deliver and market innovative and desired products to the market.
- Methodologists are important actors in the Index Coop ecosystem and it is important to build fruitful relationships w/ methodologists
- Similar to how Blackrock works with 3rd parties (e.g. S&P, MSCI) and has home-grown in-house products, Index Coop intends to work with 3rd party methodologists as well as build its own home-grown products.
- That said, Index Coop prefers to work with partners who bring ingenuity, brand, and distribution to the table.
Index Coop aims to provide the best incentive structures to attract and retain the best methodologists. When we determine economic structures, we hope to generate outcomes that are:
Fair: We believe there needs to be a clear, objective and measurable set of criteria for determining fairness (without which, the conversation devolves into arbitrary and emotional discussions). This measurable criteria should be based on the relative work required by each party to create, maintain, and grow the product in question. Some burden categories and questions include:
- Flexible: When a product is launched, we often do not have full information about the profitability, economics, or work required to grow / maintain the product. We recognize that in crypto, things change (e.g. airdrops happen, new ideas re: intrinsic productivity are formed, costs are higher than originally imagined), and we have to make adjustments (especially since we’re all learning). We will often-times never get arrangements perfect, and thus it is beneficial for both parties to be open to revisiting arrangements when new situations arise.
- Sustainable: Arrangements should be long-term sustainable for the Index Coop, in that Index Coop should not be unprofitable running a product (unless done strategically) - and it should not be receiving less compensation if it is doing a significant portion of the work.
If arrangements do not meet the above criteria, the Index Coop may choose not to maintain the product or to not launch products w/ a particular methodologist.
Comparable Fee Arrangements
When we think about fee-split arrangements, we look at historical and existing examples to inform us on potential structures:
- Licensing Deal (music, manufacturing, media etc.): There are a number of approaches one could take, but the most common rule of thumb for licensor take-rate is the 25% of income (revenue less costs). Typically, this arrangement requires a clear understanding of the product’s revenue and costs. That said, fair market royalty rates of an invention is typically based on: uniqueness of invention, profit margins, risk, strength of IP protection, exclusivity rights, and availability of competing technologies.
Yearn Relationship w/ Methodologists: Yearn charges a 2% management fee and a 20% performance fee for its vaults. From YIP-52, strategists earn 50% of ONLY the performance fee. Yearn does not split the management fee as: “There are a lot of constant costs on the protocol side. Operations, Development, maintenance, and R&D. These require a stable source of funding and should not be affected by Strategists.”
That said, strategists are expected to cover their own development, testing, gas, and monitoring costs. Note that development costs are one of the most rare / expensive commodities in this industry.
SPDR S&P 500 Index License Deal: When looking at the SPDR S&P 500 agreement, S&P Global receives an annual fee of $600k + 0.03% of AUM for the right to “use the S&P500 name and duplicate the index with its ETF”. In this case, SPDR’s take-rate is 0.065% - in which the total fee is 0.095% (awfully similar to one of our existing arrangements with the DeFi Pulse Index!).
S&P does not need to do any of the heavy lifting, which includes fund management, marketing, and other expenses.
Analyzing Existing Products
If we were to apply an analysis of our existing products through the lens of the above frameworks / insights, we have the following insights:
|Product||Arrangement / Analysis|
Revenue Fee split where 70% goes to Index Coop and 30% to methodologist
IC Contributions: Gas costs are ~$10-20k per rebalance monthly; Moderate continued development cost; Index Coop bears BD, marketing, and liquidity-mining costs
Methodologist Contributions: Monthly rebalance weights, marketing / BD support
|-This fee split and burden-sharing mirrors that of the SPDR S&P to the tee.
-That said, it only currently charges a streaming fee, but there is a chance that intrinsic productivity can be enabled - which offers new revenue streams.
Discussion Points: For Index Products, the existing fee split does not warrant future discussions, but intrinsic productivity (if activated) may be separately negotiated since it may be the case that engineering and maintenance required may explode
Leverage Index Products
Revenue Fee split where 60% goes to Index Coop and 40% to methodologists. Fee is charged on streaming AND entry / exit
IC Contributions: L1 gas costs are high and spike significantly during times of increased market volatility; On-going development costs require extensive engineering resources and slow down other product launches; Index Coop bears parameter update and safety costs - as well as marketing / BD
Methodologist Contributions: Ongoing monitoring, marketing / BD support -The goal of Index Coop is to launch a suite of leverage indices products vs. a single product - in which we believe there is significant benefit to all parties
|-In this case, we have a product that succeeds when there is significant volume and has multiple revenue streams (streaming and entry/exit fees
-If we were to use a similar product example, we can look at Yearn fee splits - as there are ongoing gas and development costs for this product. A more equitable split may be that the streaming fee is entirely taken by Index Coop, while the entry / exit fee is split 60 / 40 with Index Coop / Methodologist
-Note that even though there are COMP rewards to off-set gas costs, they do not represent a long-term or sustainable source of fees
-Note that if we build a L2 ETH2x-FLI, the gas cost component will need to be revisited
-Note that we are not entertaining having customers bear the gas costs - as the gas costs are reflected in their fees already
Discussion Points: For future FLI products, an arrangement that takes into account the ongoing costs (gas, development, etc.) is important for ensuring a deal is fair and sustainable (whether it is a yearn-style fee split or an income-derived split).
We believe it is critical to have a fruitful and trust-based relationship between Index Coop and methodologists. Our goal is to create fair, flexible, and long-term sustainable arrangements between all parties. While these negotiations may seem complex, there is a long history of similar fees splits in traditional industries. Many other companies have built long-term sustainable business models around fee-split models. We can look at these deals to gain insight into the types of arrangements that have worked for other organizations in the past.