Gas costs for Index Coop product launches & product maintenance are currently primarily paid for by Set, who will not be able to pay for them forever. Currently, gas costs are not considered by IC or Methodologists, obscuring the true performance of our products, and misaligning incentives.
This post outlines:
- A breakdown of the current costs incurred for product launch & maintenance
- The work in progress to solve the current issues across the Coop, Set and methodologists
- A plan and IIP to reimburse Set for future-looking product launch & maintenance costs
- Suggested future work that may help mitigate maintenance costs
The goal of this post is to share the process under way on this important issue, and the plan to resolve it. The proposed framework of forum post + IIP has been shared the with the WG leads.
During the early months of Index Coop, there was no clear agreement on who would be liable for gas costs, and as the performers of rebalances and in the spirit of a startup, Set Labs bore those costs. In the months since, AUM and product maintenance costs have grown considerably, and Set is no longer able to responsibly bear the cost of rebalances.
The cost of rebalances is not currently considered, or paid for, by methodologists or Index Coop, and so is currently unaccounted for in profitability assessments of our products. For Index Coop to launch and maintain profitable products, the true costs need to be known, transparent, and shared with methodologists.
Over the lifetime of a product, contract deployments should comprise a relatively small piece of costs. Every product that the Index Coop launches requires a minimum number of contract deployments on mainnet. If a product uses sufficiently novel functionality, a series of contracts may also need to be deployed on test nets and mainnet for thorough testing & review.
For a single standard product launch with no novel functionality, contract deployment costs are somewhere between 2 to 4 ETH (8,000 to 16,000 USD) depending on the gas environment.
After contract deployment costs, automated Indices like ETH2x-FLI and BTC2x-FLI have maintenance costs from daily rebalancing events and emergency deleveraging events.
Our current automated index products (ETH2x-FLI & BTC2x-FLI) define a rebalance interval of 24 hours. This means that the product will, at minimum, rebalance the amount of collateral posted/borrowed on Compound on a daily basis. These daily rebalances cost anywhere from 400 USD to 800 USD per day depending on the gas environment.
Emergency deleveraging events are required during periods of extreme price volatility. Periods of extreme price volatility typically coincide with high gas volatility, so costs can be extremely difficult to predict. Transactions have been submitted with up to 2000 gwei in gas fees in the past. High gas costs must be tolerated because if these products fail to rebalance, they face risk of liquidation.
When emergency deleveraging is needed, rebalance bots will submit several rebalance transactions in succession. In extraordinary cases, a ripcord must be pulled to prevent imminent liquidation. May 19th 2021 was the first and last time Ripcord was pulled for ETH2x-FLI. Set Labs spent more than 50k USD rebalancing ETH2x-FLI and BTC2x-FLI that day.
In contrast to Automated Indices, Composite Indices (DPI, MVI, BED, DATA) have maintenance costs more severely affected by component token DEX liquidity than price volatility. The primary metric that drives Composite Index rebalancing costs is the total number of trades required to rebalance the product over a given period of time. Three factors primarily drive rebalance trade counts:
This is by far the biggest risk for rebalancing composite indices, the source of greatest stress at Set, and an area for Index Coop to level up it’s understanding and become true experts. Set’s current rebalancing system is architected to support Kyber, Balancer V1, Uniswap V2/V3 and Sushiswap. If a component’s liquidity moves to another DEX we do not support, it can become extremely costly to rebalance a component token. Liquidity moving to a Layer 2 or side chain is even more difficult, as arbing against L1 DEXs becomes much more risky without the ability to use flash loans. There are long term ways we can mitigate this, but being able to track and anticipate liquidity movement risk must be an essential competency of the Coop.
Any time a token is added or removed from a Composite Index there is a high likelihood of a large number of trades being required to rebalance the product. Most components in a composite index only rebalance their allocation slightly month to month. Adding or removing a token requires trading in to or out of a 0% allocation which likely consists of a higher delta in asset allocation than otherwise.
As an aside, any new token additions also represent an ongoing & compounded risk of “DEX Liquidity Moving” from above. For a Composite Index composed of 100 different tokens, the risk of DEX liquidity moving on any one of them presents a risk to the maintenance cost & profitability of the entire product.
Simply put, products that rebalance more often will typically have higher maintenance costs. DPI, MVI, and BED rebalance on a monthly basis whereas DATA only rebalances on a quarterly basis. DATA’s single quarterly rebalance may require a larger number of trades than any single DPI or MVI rebalance but in total we expect it’s rebalance costs to be significantly lower.
A single MVI or DPI rebalance typically requires 100 - 200 trades costing 20,000 to 40,000 USD in ETH. In total, automated & composite index rebalances have cost more than $350k over the past 12 months with the trend continuing upwards.
For Index Coop to build a 100 year organization, the products we launch, their maintenance cost risks, and their paths to profitability need to be well understood. This will require concerted effort across Index Coop Working Groups, Methodologists, and Set.
EWG and Wizards have created a tool to better understand token liquidity profiles for composite indices. This is under active development and will be used by PWG, Methodologists and Set to better understand how liquidity profiles are changing leading up to and on the day of a rebalance.
AWG is working on setting up analytics to track product revenue relative to product maintenance costs over time to get an accurate picture of the path towards true product profitability.
PWG is working with methodologists to share data and tools on rebalancing costs, shifting liquidity profiles, and providing continual feedback on projected costs of token additions, removals, or significant reweightings. They are also exploring ways product methodologies can be updated to help reduce product maintenance costs.
Any new fee split agreements will be post-gas, so that incentives are aligned, and the split is of the “gross profit” of the product. It’s worth noting that IC pays for all gas costs until products are breakeven.
PWG is taking the lead role in rebalance discussions with methodologists rather than Set. It will also be conducting product performance reviews using data gathered from AWG and Set.
PWG has at its disposal a handful of levers that can impact Composite Index rebalance trade count outside of DEX liquidity conditions and methodologist target asset allocations. It is actively working on better understanding the relationship between product performance and profitability with these levers. Those are:
- Slippage tolerance on rebalance trades
- This has been historically set to 50 bps, but was increased to 100 bps or more for the October rebalance.
- Maximum gas price on rebalance trades
- This has been historically set to 100 Gwei, but was increased to 150 Gwei for parts of the October rebalance.
- Rebalance kickoff date and target duration
- This has been historically the first business day of the month, but was extended for parts of the October rebalance.
As an aside, there’s a conversation to be had here about what liberties PWG can take when implementing methodologies to save on costs while faithfully reproducing a defined methodology for our customers. There is also an open question on whether or not that discretion lies solely with PWG or with Methodologists. To date, these decisions have been made by both parties together.
Set is providing historical rebalance data to Index Coop teams to compile and learn from. Set is also continuing to improve existing rebalancing infrastructure to increase the flexibility of rebalance parameters, and improve monitoring, so that rebalances can be performed over longer periods of time with less manual oversight required.
EWG is not yet in the position to consider in-housing rebalancing due to the complexities of the process and the expertise & organizational maturity needed to react to unexpected black swan events (e.g. May 19th). However, in the long term it is essential that EWG owns the product rebalancing process. This has been raised in the Set → Index responsibility transition.
For the time being Set will take only an operational role in executing rebalances with slippage tolerances and max gas prices being decided by PWG.
Finance Nest is working with Set to design a product launch & maintenance reimbursement model for the existing rebalancing system. This system of reporting & reimbursement will be public so any member of the Index Coop can audit gas costs independently.
An IIP is in the works to propose reimbursing Set for rebalancing gas costs each month from December onwards. The IIP can be expected in the week beginning Nov 15th.
Some longer range options are available to help mitigate product maintenance costs across the board. These include:
1. Moving to an Auction Based Rebalance System for Composite Indices: Moving to an auction based system may significantly reduce the amount gas costs required to rebalance a product, potentially at the detriment of product performance. In this scenario, arbitrageurs are incentivized to build integration to new DEX protocols & impact of the current gas fee environment is also baked into bids.
2. Funding Leveraged Indices via COMP or AAVE Rewards: For Leveraged Indices, gas costs could be socialized by claiming COMP or AAVE rewards gained from each product’s utilization of lending protocols, or increasing fees.
3. Moving existing products to post-gas fee splits: Launching any product without a post-gas fee split agreement is sure to produce conflicting incentives. For products that are already live, shifting to a post-gas fee split will better align incentives. Methodologist and Index Coop’s vision of what constitutes a profitable and sustainable product should converge with the adoption of post-gas fee splits across the board.
This week we’ll be working on the IIP and invite you to share any commentary and feedback