Token Terminal Smart Beta Index

For the amended proposal see Updated index proposal - Token Terminal Smart Beta Index (TTI)

1. Summary

A price to sales ratio (P/S) weighted smart beta index by Token Terminal (TTI). Token Terminal wishes to contribute to the Index Coop product offering by proposing a fundamentals-weighted index to complement the current market cap-weighted index provided by DeFi Pulse (DPI). Given the Index Coop’s mission to expand its product offering, we feel that our proposed index product would be well-aligned with the overall goals of the Index Coop community.

*Figure 1. Backtested performance of the TTI. Token Terminal TTI dashboard

Token Terminal is a leading data analytics provider focused on the fundamentals of crypto protocols. We track metrics such as revenue and earnings to gauge the actual usage and performance of different crypto protocols. Over the past six months, we’ve witnessed increasing interest towards our chosen methodology and believe that a broadly available index product based on that same methodology could generate significant interest among the community.

Token Terminal could become a key member of the Index Coop community. The product roadmap for Token Terminal includes the addition of several new protocols and metrics, which means that over time, we would be able to provide indexes for several different products, should there exist demand for additional indexes.

2. Objective

Smart beta. In contrast to traditional market cap-based indexes, smart beta indexes employ alternative index construction rules with the aim of improving a portfolio’s risk-adjusted returns. These indexes seek to combine the benefits of passive investing and the advantages of active investing strategies.

Token Terminal smart beta index (TTI). The TTI uses a fundamentals-based ruleset for its index construction. Assets included in the TTI are chosen primarily based on their price to sales ratio.

The price to sales ratio compares a protocol’s market cap to its revenues. A low ratio could imply that the protocol is undervalued and vice versa. The price to sales ratio is an ideal valuation method especially for early-stage protocols, which often have little or no net income. Given the nascency of the crypto market, we believe that the price to sales ratio offers a highly accurate tool for relative analysis between different crypto protocols.

2.1 Size of opportunity

Our institutional clients have expressed an interest towards an index product that is easily understandable for investors coming from traditional finance. The value proposition of a P/S based index is that it optimizes for fairly valued and widely used protocols and thus lowers the threshold for institutional investors looking to gain exposure to decentralized finance (DeFi). We believe that the next cycle of crypto adoption will be driven more by fundamentals than the previous cycles.

2.2 Differentiation

Market cap-based indexes like the DPI offer a low-cost and easily accessible alternative for investors looking to diversify their cryptoasset exposure. We believe that the TTI could serve as a great fundamentals-based complement to the DPI and over time, especially as the crypto market and the asset universe expand, evolve to offer its investors differentiated exposure to revenue-generating and fairly valued crypto protocols.

*Figure 2. Backtested performance of the TTI and actual performance of the DPI. Token Terminal TTI dashboard

3. Methodology

3.1. Index calculations

TTI uses a forward price to sales ratio that is calculated based on a protocol’s past 30-day average revenue. Formula for the forward price to sales ratio: fully diluted market cap / annualized revenue (calculated as a simple 30 day moving average * 365).

3.2 Token inclusion criteria

Eligible tokens are those that meet the following technical, market and safety requirements:

3.2.1 Technical requirements

  • The token must be available on the Ethereum blockchain.
  • The token must be listed on Token Terminal.
  • The token must not be considered a security by the corresponding authorities across different jurisdictions.
  • The token must be the native token of a protocol.

3.2.2 Market requirements

  • The token must have a capped supply or it must be possible to reasonably predict the token’s supply over the next five years.
  • The token must have sufficient liquidity for initial inclusion and rebalances.
  • The token’s economics must not have locking, minting or other patterns that would significantly disadvantage passive holders.

3.2.3 Safety requirements

  • The protocol must have been launched at least 90 days before inclusion.
  • The protocol must be recognised as having a high-quality product and team.
  • The protocol must have sufficient resources for future development.
  • The protocol must be actively developed and must not be insolvent.
  • The protocol must have conducted sufficient security audits and/or security professionals must have reviewed the protocol to determine that security best practices have been followed.

4. Index maintenance

TTI would be maintained monthly in two phases:

i) Determination phase

The determination phase takes place during the last week of the month. It is the phase when the changes needed for the next reconstitution are determined.

  • Price to sales ratio determination: TTI references Token Terminal’s price to sales ratio. The price to sales ratio is determined during the last week of the month and published before the monthly reconstitution.
  • Additions and deletions: The tokens being added and deleted from the index calculation are determined during the last week of the month and published before the monthly reconstitution.

ii) Reconstitution phase

The index components are adjusted, added and deleted as per the instructions published after the end of the determination phase. New index weightings, additions and deletions are incorporated into the index during the monthly reconstitution, which will take place on the first business day of the month. As assets tracked by the index grow, the reconstitution window will expand to more than one day to lower the reconstitution’s market impact.

5. Author background and commitment

This proposal has been drafted by the founding team at Token Terminal. Token Terminal was launched at the end of 2019 with the aim to create institutional-grade analytics tools for cryptoasset investors.

Token Terminal wishes to contribute to the Index Coop in the role of a methodologist. The product roadmap for Token Terminal includes the addition of several new protocols and metrics, which means that over time, we would be able to provide indexes for several different products, should there exist demand for additional indexes. As a methodologist Token Terminal would:

  • Provide an initial but complete methodology for the proposed index.
  • Provide all necessary data for the maintenance of the proposed index.
  • Track and monitor the data provided for the maintenance of the proposed index.
  • Propose new assets to be added to the index product in accordance with the inclusion criteria.
  • Collaborate with the Index Coop in all aspects related to the proposed index.
  • Use its best efforts in marketing and distribution of the proposed index.
    • List the proposed index on Token Terminal’s website.
    • Update Token Terminal’s community (Twitter / Newsletter) on index products offered by the Index Coop.
    • Launch a dashboard (on Token Terminal’s new portal) that includes all index products offered by the Index Coop.

Token Terminal TTI dashboard (updated 17 Jan 2021)

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18 Likes

Thanks for this proposal!

And congrats to your current successes with TokenTerminal thus far. I like what you are doing with the P/S ratio.

There seems to be a lot of unfinished aspects around the token distributions of a methodologist.

In the initial document that talks about the token distribution (Index Methodology Bounty), I think we need to talk more about how we plan to distribute the tokens first rather than who we should initially allocate them.

Do we want to release ~$150k of tokens monthly to do this? Do we want to have any of those tokens vested to those addresses? Do we want the tokens to be accessible based off of KPIs (e.g. discounted off of market price to be bought with profits?).

This would mean we are dispersing about 41k tokens monthly. Not to say we don’t want to distribute tokens, but we should allocate them properly, and accordingly so the market doesn’t get tanked.

TLDR; need to have a discussion about how we want to distribute these tokens prior to who should become a methodologist.

2 Likes

There was really good discussion in that thread I linked to, but nothing was finalized there.

That is a biggg problem! It’s all suggestions, but nothing was set in stone, and that needs to be finalized. It is also a bit of an issue that this wasn’t fleshed out before the DAO was launched, but I guess that’s something that the DAO will need to structure on our own!

Best to protect ourselves so we don’t shoot ourselves in the foot in any scenario :smiley:

2 Likes

Hey ansteadm! Thanks for your comment.

We think that the distribution of INDEX tokens is something that should be discussed separately from this proposal.

If we were to be voted in as a methodologist, we would of course participate in the discussion re the token distribution — should it still be undecided at that time.

6 Likes

Ok understood! Thank you for that clarification.

Last thing I want is for a bad actor to come in with the intent of just filling pockets vs. aiming to grow an ecosystem, and definitely need to make sure we have everything covered on the coop’s side to protect against it.

Appreciate your feedback, and again, I really like your p/s ratio. Definitely solid!

1 Like

What a fantastic idea - thank you @TokenTerminal

3 Likes

Hey @TokenTerminal thanks for the post and welcome to the Index Coop community.

I have a couple of questions about your proposal, hoping you can expand on them. The price to sales approach is novel in DeFi indexes as far as I know which is great and gives it a unique selling point. The makeup of the index is quite similar to DPI however and will require careful thought and marketing so as not to split interest between the two DeFi indexes.

  • Do you have any thoughts/plans on how to communicate the difference between TTI and DPI to avoid cannibalisation? Given the indexes (as presented) share 8 tokens in common, to more casual defi users there may appear to be very little differentiation and I think marketing and education will be important for growing rather than splitting market share.
  • There is a line item for token inclusion ‘must be listed on Token Terminal’. Do you have a separate set of criteria for including tokens on your site outside of the specification presented here?

Other than that the backtested data looks decent (albeit over a short period!) and having another credible name onboard will surely benefit the Coop as a whole.

3 Likes

It’s good to see a third team creating indices what they want the coop to implement on chain.

I have many questions,:

  1. I’m assuming Set protocol contracts, so the $ of each allocation with drift with the relative prices between rebalances.
  2. Why 10 tokens? why a different number, or why not set a threshold of P/S? than if prices lag sales, more get included, but if prices take off, the fund becomes more focused on this producing most income.
  3. What fee structure do you propose (streaming, issue, redemption.
  4. How often would you expect to be adding / removing / swapping tokens?
  5. Who is the fund aimed at (crypto natives, retail, institutions, small holders, large holders).
  6. How much liquidity do you think we need on the secondary market. How do you propose to reach that (will we need liquidity mining).
  7. Do you foresee integration into other protocols (AAVE, Compound, Maker etc)

I think the main objection I have at the moment is the overlap with DPI. Any liquidity mining / marketing of one is likely to eat into the market share of the other so any coop resources spent on either are weakening the other. Obviously in the long term, both should be come self sustaining with the marketing being led by the methodologists so the coop becomes more neutral less involved in marketing individual products.

6 Likes

Thanks for the comments @darkforestcapital and @overanalyser. We compiled your questions and our answers into one post, and answered them with the role of the methodologist in mind:

1. Do you have any thoughts/plans on how to communicate the difference between TTI and DPI to avoid cannibalisation? Given the indexes (as presented) share 8 tokens in common, to more casual defi users there may appear to be very little differentiation and I think marketing and education will be important for growing rather than splitting market share.

In our view, the TTI (and the data analytics product of Token Terminal) are aimed primarily towards (a) existing institutional investors who are shifting their focus towards protocol fundamentals and (b) new institutional investors who are looking for a fundamentals-based solution for their cryptoasset exposure. As we list more assets to Token Terminal, it’s likely that the portfolio compositions between the TTI and DPI become more differentiated. Also, it’s worth noting that the core mission of Token Terminal is to educate (more casual) DeFi users about the importance of protocol fundamentals.

2. There is a line item for token inclusion ‘must be listed on Token Terminal’. Do you have a separate set of criteria for including tokens on your site outside of the specification presented here?

The qualitative criteria set out in section 3.2 guides our listing process for Token Terminal as well. Currently, the key differentiator between the TTI and Token Terminal is that TTI includes only Ethereum-based assets, whereas Token Terminal is chain-agnostic.

3. I’m assuming Set protocol contracts, so the $ of each allocation with drift with the relative prices between rebalances.

To our knowledge, this question is better answered by the Index Coop and Set Protocol, instead of the methodologist.

4. Why 10 tokens? why a different number, or why not set a threshold of P/S? than if prices lag sales, more get included, but if prices take off, the fund becomes more focused on this producing most income.

We want to emphasize that the proposed methodology reflects our view of the current state of the crypto market. As the market matures, it might become feasible to increase the amount of assets included in the index and/or limit the amount of sector-specific (e.g. exchange or lending) protocols that can be included. We are happy to iterate on this together with the Index Coop community.

5. What fee structure do you propose (streaming, issue, redemption)?

We feel that a streaming fee would be optimal for aligning the different stakeholder interests in the long-term. The size of the streaming fee and the revenue share between the methodologist and the Index Coop is something that we’re happy to discuss in more detail with the community.

6. How often would you expect to be adding / removing / swapping tokens?

Our proposal assumes a monthly rebalancing (subject to the criteria outlined in section 3.2) of the index portfolio.

7. Who is the fund aimed at (crypto natives, retail, institutions, small holders, large holders)?

See answer to question #1 above.

8. How much liquidity do you think we need on the secondary market. How do you propose to reach that (will we need liquidity mining)?

We think this should be discussed in more detail with the Index Coop. We suggest that a similar approach as for the DPI could be used here.

9. Do you foresee integration into other protocols (AAVE, Compound, Maker etc)?

We believe that this question should be decided by the Index Coop community, rather than the methodologist. Although, we don’t see a reason not to explore different integration alternatives.

10. I think the main objection I have at the moment is the overlap with DPI. Any liquidity mining / marketing of one is likely to eat into the market share of the other so any coop resources spent on either are weakening the other. Obviously in the long term, both should be come self sustaining with the marketing being led by the methodologists so the coop becomes more neutral less involved in marketing individual products.

As the crypto market continues to mature and more focus is given to protocol fundamentals, we believe that it’s a matter of time until a similar smart beta product is released, either from the Index Coop or some other actor. As we highlight in our proposal, we think that a smart beta product would be well-aligned with the long-term goals of the Index Coop.

Hopefully these answered your questions. We are more than happy to write down a more extensive DDQ document.

12 Likes

I like the overall idea and big fan of what you’re doing with Token Terminal !

I do have 2 questions / remarks :

  • Low P/S ratios in stocks usually mean that you’re holding mature companies stocks with little room for improvements - and sometimes, it also means that there aren’t any growth opportunities - How do you plan to prevent the Index to catch falling DeFi projects with this methodology ?
  • I know we are still early in DeFi and P/S ratios might help to better assess tokens value, but still : usually in Stocks, Dividends focused portfolio are actually cool because of…the dividends that you receive periodically, but the stock prices are not increasing a lot because there is not much room for the stock price to increase when dealing with mature companies on mature markets - As a consequence, a yield farming system should come with the Index to make sure people actually benefit from these low P/S ratios. Otherwise, it could end up like holding tokens with no future. Don’t you think ?

Thanks again for your proposal !

2 Likes

Thanks for your thoughtful proposal.

Couple comments:

  1. Cannibalisation concern has already been raised. I just wanted to reiterate that I think it might be a problem. DPI is already a blue chip DeFi index, I’m not sure if having a “fundamental blue chip DeFi” index makes sense.
  2. Using P/S as the only metric for index construction presents certain challenges. Similar to P/E in traditional finance, there are many reason why P/S might be low. One of them is the underperformance of a token, due to factors not captured by the P/S metric. Maker is one example as despite growth in its revenues from adding more collateral types and raising stability fees, there are known problems with the MKR token. Overall, P/S in itself is just a number. Without context it holds little value. Is there room to use multiple fundamental metrics for this index?
  3. Another issue I see is that P/S will invariably exclude high growth projects due to lower revenue/higher price. This is similar to the traditional finance where many professional investors are complaining about multiples on Tesla, Zoom, Square, you name it. At the same time, if you were complaining about high multiples on these stocks you missed massive rallies. This is even more pronounced in DeFi. Using an equivalent of price/earnings to growth ratio (PEG) might be a better option. It will allow to capture price per unit of sales growth, and is imo a much more relevant metric for DeFi.

Again, thanks @TokenTerminal for this proposal, love what you guys are doing!

Edit: I’m a big supporter of a fundamental DeFi index. I just think that we need to make it more robust than just P/S.

2 Likes

Thank you for your comments @Etienne and @Verto0912. We compiled your questions and our answers into one post:

1. Low P/S ratios in stocks usually mean that you’re holding mature companies stocks with little room for improvements - and sometimes, it also means that there aren’t any growth opportunities - How do you plan to prevent the Index to catch falling DeFi projects with this methodology?

In our view, the DeFi industry as a whole is still in its earliest stages with the potential of growing into a global parallel financial system. This means that all of the current DeFi projects are more similar to high-growth startups than mature companies. The reason we think P/S is a great metric is because our initial asset universe comprises only early-stage, high-growth protocols. And now, because they all operate transparently on-chain, we can track their usage in real-time and include those with meaningful usage relative to market cap in the index.

2. I know we are still early in DeFi and P/S ratios might help to better assess tokens value, but still : usually in Stocks, Dividends focused portfolio are actually cool because of…the dividends that you receive periodically, but the stock prices are not increasing a lot because there is not much room for the stock price to increase when dealing with mature companies on mature markets - As a consequence, a yield farming system should come with the Index to make sure people actually benefit from these low P/S ratios. Otherwise, it could end up like holding tokens with no future. Don’t you think ?

In our view, the price to sales ratio is an ideal valuation method especially for early-stage protocols, which often have little or no net income (because the revenue is reinvested into growth, often by subsidizing the use of the protocol’s service).

3. Cannibalisation concern has already been raised. I just wanted to reiterate that I think it might be a problem. DPI is already a blue chip DeFi index, I’m not sure if having a “fundamental blue chip DeFi” index makes sense.

Similar to traditional finance, we believe that the crypto market will have multiple different products that aim to capture the inefficiencies of market cap-based indexes. As stated earlier, we believe that being able to offer complementary index products would make Index Coop more attractive for new investors and strengthen the long-term vision of the Coop. Again, as the crypto market continues to mature and more focus is given to protocol fundamentals, we believe that it’s inevitable that a similar smart beta product will be released, either from the Index Coop or some other actor.

4. Using P/S as the only metric for index construction presents certain challenges. Similar to P/E in traditional finance, there are many reason why P/S might be low. One of them is the underperformance of a token, due to factors not captured by the P/S metric. Maker is one example as despite growth in its revenues from adding more collateral types and raising stability fees, there are known problems with the MKR token. Overall, P/S in itself is just a number. Without context it holds little value. Is there room to use multiple fundamental metrics for this index?

For the advantages of using the price to sales ratio for comparing early-stage protocols, see answer to question #2 above. Also, before the protocols are compared based on the price to sales ratio, they have had to satisfy the qualitative and quantitative criteria set out in the proposed methodology.

In our view, the investment thesis for an individual protocol is something that should be discussed in a separate forum.

5. Another issue I see is that P/S will invariably exclude high growth projects due to lower revenue/higher price. This is similar to the traditional finance where many professional investors are complaining about multiples on Tesla, Zoom, Square, you name it. At the same time, if you were complaining about high multiples on these stocks you missed massive rallies. This is even more pronounced in DeFi. Using an equivalent of price/earnings to growth ratio (PEG) might be a better option. It will allow to capture price per unit of sales growth, and is imo a much more relevant metric for DeFi.

For the advantages of using the price to sales ratio for comparing early-stage protocols, see answers to questions #1 and #2 above.

Hopefully these answered your questions.

9 Likes

@TokenTerminal I would still argue on the usefulness of P/S here. Maker, for instance, is not an early-stage protocol, same with Uniswap. Your approach favours older protocols and DeFi blue chips, which is exactly what the DPI is meant to represent. This is at the expense of younger protocols with higher valuations but also explosive growth rates which is why an equivalent of PEG might be a better metric to use.

I consider P/S to be a valuable metric, and I would consider investing in the index. In fact, I have been using Token Terminal to find those metrics for a while, which is how I know that the criticism about using inclusion on Token Terminal as criteria is well-founded.

Yes, Token Terminal includes protocols that are not ERC20, but you have not explained why certain ERC20 protocols were included but not others.

  • The token must be listed on Token Terminal.

Sushi was there, then it wasn’t. Now it’s back? I guess not… it’s included in your latest Medium analysis and has a low P/S ratio but is not included on Token Terminal and not included in the index. Does it fail on Market requirements because it has locking? So do SNX and CRV and those are both in your index. It makes sense to have some market requirements before inclusion (so many projects, so little time!) but you need to be consistent in their application.

  • The token must be the native token of a protocol.

Is this why UMA isn’t included? Because the token is used for governance and not ‘native to the protocol’? But UNI is included and the ‘native token’ of Uniswap is ETH. BAL is included and while BAL is favored in its own Liquidity Mining, its protocol does not have a ‘native token’. REP is not included, but is the native token of its protocol.

  • The protocol must be recognised as having a high-quality product and team.

Recognized by whom?

  • The determination phase takes place during the third week of the month.

The third full week? The third business week? If New Years Day falls on a Monday, is the third week the week starting on the 15th still? If a protocol reaches 90 days on Thursday of the third week and has no other marks against it, is it eligible for inclusion or does it have to wait another month?

Some of these points seem pedantic, but when your initial index has apparent exceptions to your stated criteria, then there must be some explanation. Either you are narrowly defining particular bullet points (pedantry) or you are arbitrarily excluding projects based on discretionary factors.

In the case of the former, every bullet point requires much more detail. In the case of the latter, the index as proposed is not investable. To me that’s disappointing because my first reaction was ‘finally a defi index I can get behind’!

5 Likes

Coming from the world of traditional finance, it’s really nice to see crypto and tradfi finally converging.

6 Likes

As someone that would never buy DPI and would be interested in buying TTI I would say the strategy is very different and has a wider scope so does not cannibalize although they are all shared tokens at the moment.

I don’t see any criteria about what has to be done with sales revenue to be included here. Do all sales have to go into protocol treasury or distributed to token holders? MANA by Decentraland has pretty high sales (idk exact P/S) but all fees earned are used to burn MANA tokens, would this token be eligible to be included in TTI? Would ETH qualify once EIP-1559 is implemented? Are there non-DeFi tokens you guys are considering adding?

On P/S not being a good metric: market-cap weighted indexes also don’t give exposure to low caps with higher growth potential. If I’m understanding methodology correctly it is comparing P/S ratios relative to each other not a static target number. At the current stage of crypto networks there isn’t as wide a divergence in P/S as in traditional stock market. PEG is a good suggestion but DeFi is too dynamic and unpredictable to make accurate growth projections.

Keyword is ‘risk-adjusted returns’ sure you can invest in the most risky asset with high P/S, low marketcap, etc. and hope it moons but is that the best strategy to ensure positive returns?

1 Like

Why use fully diluted market cap instead of 1 year forward market cap?

Are there additional metrics for the back test such as sharpe ratio for TTI and DPI and Beta vs ETH or BTC?

Can you provide a csv for historical index weights used in the backfilled index values?

This should be a no-brainer for Index Coop. Not only because TTI is a great proposal, but also because of the fact that the team at Token Terminal would be a valuable contributor long term.

Arguments regarding “cannibalisation” of an existing index does not support long term thinking. Looking at the traditional financial markets, it seems pretty clear that there is a demand for alternative products that are not simply based on market cap. I would also argue that the first mover advantages are powerful here.

5 Likes

Thank you for your comments. Below are answers to the most recent questions raised during the weekend:

1. Token Terminal includes protocols that are not ERC20, but you have not explained why certain ERC20 protocols were included but not others (eg. SUSHI)?

Section 3.2 of the proposal includes an initial set of criteria sufficient to launch the proposed index, and is subject to additional requirements (if any) from Index Coop and/or Set Protocol.

Regarding SUSHI, it is among the assets to be included in the index. The reason it is not included yet, is due to the early stage of the project (see also answer to question #2 below).

2. What does it mean that the protocol must be recognised as having a high-quality product and team? Recognized by whom?

This requirement aims to ensure that the protocols included in the index are developed by a full-time team and/or community. Here, the Index Coop is able to step in to exclude assets that display undesirable characteristics or have yet to reach a sufficient maturity in their development.

3. What does it mean that the determination phase takes place during the third week of the month?

This refers to the monthly process of determining the necessary rebalances to the index. Technicalities regarding specific dates should be specified together with the Index Coop and Set Protocol to ensure best possible execution of necessary rebalances to the index.

4. I don’t see any criteria about what has to be done with sales revenue to be included here. Do all sales have to go into protocol treasury or distributed to token holders? MANA by Decentraland has pretty high sales (idk exact P/S) but all fees earned are used to burn MANA tokens, would this token be eligible to be included in TTI? Would ETH qualify once EIP-1559 is implemented? Are there non-DeFi tokens you guys are considering adding?

The price to sales ratio (P/S) is a top-level metric and is not affected by how the protocol decides to use its revenues. In general, early-stage protocols tend to reinvest the majority of their revenues into growth, often by subsidizing the use of the protocol’s service. The current focus on Ethereum-based DeFi assets is motivated by the index’s aim to find fairly valued and widely used protocols.

Although, we don’t see a reason not to include non-DeFi assets later on, should they satisfy the rest of the criteria in the proposed index.

5. Why use fully diluted market cap instead of 1 year forward market cap?

In our view, a fully-diluted market cap serves as a more accurate comparison point between different protocols. The fully-diluted market cap determines the price that an investor ultimately pays for a given asset.

Hopefully these answered your questions.

6 Likes