Uphold DeFi Income Index Proposal

Uphold DeFi Income Index

Summary

Uphold DeFi Income Index tracks the top 15 DeFi tokens and generates a yield via staking and lending index tokens. The index is rebalanced on a quarterly basis to reduce turnover and negative gamma scalping. Dividends are paid out quarterly to encourage holders to keep their assets invested in the index.

The DeFi Income Index is an attractive offering for long-term investors as it generates a stable yield and captures the upside of the large and middle DeFi protocols.

Objective

The objective is to have an on-chain version of the Income Index Fund that will enable retail participation. Uphold is launching an on-shore version of this fund for institutional and accredited investors. A tokenized version would allow retail investors to participate as long-term investors in DeFi.

Value Proposition - Investors

  • A diversified portfolio of top DeFi protocols
  • Lower transaction costs and turnover results in larger upside participation
  • Yield accrual from staking and lending distributed on a quarterly basis

Value Proposition - Index Coop

  • A co-branded product that can be listed on Uphold (subject to Uphold internal compliance approval)
  • Marketing support from Uphold as the off-chain version will be marketed to institutional investors and family offices on-shore and off-shore

Research

Size of Opportunity

The DeFi Income Index (DII) fund should rival DPI and Bitwise DeFi Index in terms of AUM. A first-year target AUM of $100mm is realistic given the growth of DPI and BDPI.

Differentiation

  1. Quarterly Rebalancing

DII is different from current DeFi index funds as it is rebalanced quarterly versus monthly. Token selection is also based on the trailing 3-month average market capitalization to smooth volatility associated with DeFi token prices and circulating supply changes. It also generates a yield from staking and lending which is currently only achieved via BDPI.

  1. Token Universe

The universe of tokens is also different from DPI as it includes projects not associated with a decentralized finance protocol or dapp listed on DeFi Pulse - i.e. ChainLink and The Graph Protocol. The token universe consists of the top 50 tokens sorted by market cap from CoinGecko for the previous 3 months. Please the Methodology section for the details of which tokens were included in the list.

On-chain Liquidity Analysis

All assets are available on DEXs with deep liquidity.

Back Test

Data

The data used in the backtest was the weekly historical data from coinmarketcap.com. The top 50 names sorted by market cap were used after first filtering to exclude tokens per the methodology listed below.

Back Test Methodology

Four different indices were created to determine the effects of 1) having 10 or 15 constituents and 2) monthly or quarterly rebalancing. The indices created are:

  • Monthly_10: 10 constituents, rebalanced monthly
  • Monthly_15: 15 constituents, rebalanced monthly
  • Quarterly_10: 10 constituents, rebalanced quarterly
  • Quarterly_15: 15 constituents, rebalanced quarterly

The index start date was 9/30/20 and the backtest ended on 3/31/21. The index weighting follows the free-float market capitalization methodology listed below.

Performance

After six months, the quarterly_15 index outperforms the other indices in terms of the overall return on a gross and net basis.

Figure 1. Monthly return analytics

Figure 2. Monthly index returns from 9/30/20 to 3/31/21

defi_index_index_values

Figure 3. Index values from 9/30/20 to 3/31/21

Index Composition

Quarterly 15 component index

Date Constituents Additions Removals
9/30/20 LINK, AAVE, MKR, COMP, SNX, YFI, ZRX, UMA, KNC, REN, AMPL, LRC, BAND, NXM, UNI
12/31/20 LINK, UNI, AAVE, YFI, MKR, SNX, COMP, UMA, ZRX, REN, SUSHI, LRC, KNC, AMPL, RSR SUSHI, RSR BAND, NXM
3/31/20 LINK, UNI, AAVE, SNX, MKR, COMP, SUSHI, GRT, YFI, UMA, ZRX, REN, LRC, BNT, RSR GRT, BNT AMPL, KNC

Methodology

Eligibility Requirements

  • Be an ERC-20 token
  • The token must be a digital bearer instrument. The following are excluded:
    • Wrapped tokens
    • Stable coins
    • Synthetic assets
    • A derivative token that is pegged to another crypto asset, fiat currency, hard asset, or group of currencies
  • The token must not be considered a security by the corresponding authorities across different jurisdictions

Token Supply & Liquidity

  • Tokens must trade on 2 or more crypto exchange trading venues
  • The 30-day trading volume on 2 or more crypto exchange trading venues must be > 10% of its circulating supply

Safety Requirements

  • The protocol shall have undergone security audits for each major release and follows best practices to ensure that its users’ assets are safe
  • The protocol team must have significant communication and interaction with their community and respond to major issues promptly
  • Tokens shall be lent on platforms that have a significant safety track record and has a treasury > 100% of the tokens lent to their platform

Composition

The DeFi Income Index consists of the top 15 largest DeFi assets based on the trailing 3-month free-float adjusted market capitalization. The market capitalization calculation utilizes the circulating token supply from TBD (currently deciding between CoinGecko and Messari) and the closing price as of 00:00 UTC.

Third-Party Index Provider

The underlying DeFi index calculation, without income generation, shall be generated by TBD using TBD (currently deciding between CoinGecko and Messari) proprietary circulating token supply calculation and pricing.

Rebalance

The DeFi Income Index shall be rebalanced on the last Friday of the quarter.

Base Level

The index uses a base level of 1,000 as of 00:00 UTC on its inception date.

Index Maintenance

Determination Phase

The index constituents and weightings are determined on the third-to-the-last day Business Day of the quarter at 00:00:00 UTC. This date shall be considered the “record date”.

Reconstitution Phase

The index composition is reconstituted quarterly at 00:00:00 UTC on the last Business Day of the quarter.

Fees

60% Index Coop; 40% Methodologist based on Methodologist fee menu.

Uphold methodologist score:

  • Comprehensive Methodology 1.0
  • 50% of the seed initial liquidity 0.5
  • 0% liquidity mining incentives 0.0
  • Business development & sales effort 0.5

Author Background & Commitment

Tesa Ho is a portfolio manager for Digital Asset Alpha, a cryptocurrency hedge fund under Uphold Asset Management Ltd. Tesa’s background is in quantitative and high-frequency derivatives trading.

About Uphold

Uphold is a digital aggregation platform and fiat on-ramp that allows people to purchase crypto assets, carbon credits, and fractionalized US equities. Uphold serves over 184+ countries with a dominant consumer base in Latin America and Europe.

3 Likes

I was only able to post 1 image. Here are the other figures:

defi_index_monthly_return_analysis
Figure 1. Monthly return analytics

defi_index_monthly_index_returns
Figure 2. Monthly index returns from 9/30/20 to 3/31/21

There will be an off-chain real-world fund available for QIP’s in the US and off-shore investors. The timing for the on-chain fund is flexible as I understand the Index Co-op new index pipeline is full.

Welcome to the forum @tesa_daa ! Great to have you join the coop with the proposal! Certainly, having Uphold as a place to offer the index would be important for marketing, and the performance research looks promising.

I think any difficulties would come from similarities to DPI, at least notionally from a buyers perspective. There will be others in the community who will have a far clear picture of where DDI might fit than I do but perhaps something powerful can develop.

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Hi @tesa_daa welcome to our forums and thank you for this solid proposal. There is a lot to like here and I will highlight some of these things below.

Intrinsic productivity is extremely important for IC products - over the next year we need to optimize every single product we launch for intrinsic productivity. @Kiba is working hard on this. I see intrinsic productivity as one of the most important issues for our competitive moat, the index products that eventually win will maximally lever the power of their underlying tokens.

Effective rebalancing and distribution of staking rewards will be critical for the success of intrinsic productivity indexes. I suspect implementing staking strategies into our indices will cause us to carefully re-examine our timelines for rebalancing indices.

On the other hand - here are some areas I see for improvement / further discussion

A product like this will require a massive engineering, business development, marketing, and product lift from Index Coop. In order to justify these startup costs we release products that we believe will have strong market fit. Central to our Protocol Strategy is on-boarding institutional investors to our products( @Metfanmike @fallow8 ).

There is simply no way to justify us developing and releasing an index if there is an off-chain version of that same index being sold to institutions. Index Coop is a $320 million dollar asset manager - co branding is important but is not reason enough to expend valuable resources to launch an index in which we will be cut off from the majority of the profits.

Getting our core products such as $MVI and $DPI into the hands of institutional investors is a core priority. We are committed to setting up the infrastructure that enables major financial institutions to hold on-chain assets. We appreciate any help or partnership that Uphold can offer in that area.

I will vote no on this proposal until the above the issue is resolved. Looking forward to further discussion!

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Is there stats on the investors in DPI and MVI? Maybe a number of shares / notional per wallet average or distribution. That would be useful for Index Coop marketing and index creation.

The real-world off-chain investors that we target do not use DeFi at all but want exposure to it. They are also QIP’s which require a minimum of $5mm in assets. This is not the same as accredited investors. Some investors are even prohibited from trading DeFi or crypto themselves. The off-chain fees will also be more expensive than the on-chain fees and will stake / lend more than the current Index Coop capabilities. I view them as 2 separate products with the on-chain Index Coop product perfect for retail / accredited investors that do not qualify for the off-chain fund.

There are regulatory issues that need to be addressed as an asset manager. Not just for the US but also for countries like Singapore and Hong Kong where anybody marketing crypto assets whether on-shore or off-shore require licensing.

There are dashboards for DPI and MVI that look at exposure by wallets size, etc.

DPI

MVI

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I’m echoing @BigSky7 to the letter.

There is simply no way to justify us developing and releasing an index if there is an off-chain version of that same index being sold to institutions.

I believe that we can achieve more by focusing our efforts on DPI than through a jointly managed product that is similar. Getting our products listed on more exchanges is a great goal but not worth such a compromise of our autonomy.

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I think there are two key criteria for early-stage proposals:

  • ease of implementation
  • potential market size

Downsides for implementation that need to be addressed would be on-chain liquidity (we can’t use CEX liquidity and we have had problems with LRC within DPI and wDGLD for CGI) and integration of the income-generating methods. Quarterly rebalancing makes both easier, and we are working on income-generating strategies for three products (SMI, DPI and MVI) so it’s not impossible.

Market size is the biggest concern for me, as I see this fund trapped between DPI (particularly when we introduce income on DPI) and the off-chain version of the same fund. I don’t see how the on-chain fund has the space to grow.

3 Likes

If by “hold on-chain assets” you mean custodial services, most institutions have custodial solutions in place as that is the lowest hanging service that they can offer their customers. If financial institutions do use 3rd party custody providers, they look for ones that have insurance and sufficient security and dedicated customer service / sales account managers.

If you mean by shopping $DPI and $MVI to their institutional / accredited clients, the Index Coop would most likely have to pass a stringent risk review and pay a fee or give some sort of discount for the introduction. Why would a financial advisor choose to promote the Index Coop product rather than the Bitwise DeFi Index? If I was a financial advisor responsible for client money, the Bitwise DeFi Index is a much safer product because there is an actual company behind it and that company can be held liable for any negative issues. If it becomes a listed ETF, the market for trading the ETF would be more accessible to my clients than if it existed on DeFi only.

I believe Coinbase or Galaxy would be a better partnership fit if you want to promote $DPI and $MVI to institutional investors. Uphold is more concentrated on retail investors.

Hi Index Coop,

Thank you for your feedback. It seems the biggest concerns are the following:

  1. Off-chain cannibalization.

“Releasing an index if there is an off-chain version of that same index being sold to institutions.”

  1. DPI on-chain competition.

“Market size is the biggest concern for me, as I see this fund trapped between DPI (particularly when we introduce income on DPI) and the off-chain version of the same fund. I don’t see how the on-chain fund has the space to grow.”

I’d like to address those issues and see if that improves the proposal.

  1. Off-chain cannibalization

This data was pulled from the Dune Analytics suggested by @verto0912. The main premise is that an off-chain version of the fund will hurt the AUM of the on-chain version. I view the Bitwise DeFi Index as the off-chain version of DPI since they have similar methodologies.

a. Off-chain funds do not cannibalize their on-chain counterparts

The following graph shows that the AUM and rate of AUM growth for $DPI was not negatively impacted by the launch of the Bitwise DeFi Index in February 2021.


Figure 1. DPI AUM per address.

b. The customer base of $DPI is different than the Bitwise DeFi Index customer

Bitwise requires accredited investors to invest a minimum of $25,000. From the SEC filing March 3, 2021, Bitwise took in $32mm in AUM from 262 investors or roughly $124,261 per investor. Compare that the current DPI mean AUM per wallet address of $8,496 and the max of $16,068.

AUM per wallet Median Mean Min Max
$DPI $8,881 $8,496 $1,291 $16,068

Table 1. $DPI AUM per wallet from 9/14/20 to 5/17/21.

The Uphold DeFi Index Fund is open only to Qualified Institutional Purchasers (QIPs) which requires a higher hurdle of having $5mm in investable assets versus the lower hurdle for accredited investors.

Bitwise DeFi Index was able to raise $100mm in 3 months per Matt Hougan, CIO at Bitwise. The fact that Bitwise DeFi Index was able to raise this without DPI dropping in AUM further confirms that there are different buyers of on-chain vs off-chain index products. Traditional finance investors will invest via the traditional off-chain fund route while newer, crypto-savvy investors will prefer the liquidity of the on-chain route.

  1. DPI on-chain competition

There seems to be an appetite for more funds as seen by the growth of BasketDAO’s BDPI to $35mm in AUM as of 5/17/21 after launching in early April 2021. Even with liquidity incentives, BDPI’s launch did not detract from DPI’s growth.

Figure 2. DPI vs BDPI AUM.

Having two similar products could potentially further increase DPI’s AUM and daily volume as trading firms would be able to arbitrage price discrepancies between the two products. A real-world example of this is Singapore Exchange’s launch of the Nikkei 225 mini and CSI-300 futures. The majority of volume for these products comes from trading firms capitalizing on arbitrage opportunities.

Index Coop would be able to control the uptake in AUM in a new fund via liquidity mining incentives. If they feel that the growth rate was too slow, a liquidity mining program would attract farmers and attention to the new product without a detrimental effect to DPI or their current stable of tokens.

Conclusion

Any new index fund that launches on-chain will be in competition with the Index Coop. The question is whether or not Index Coop benefits from that token’s AUM and trading volume. This is compounded by the fact that there is a low barrier to entry in terms of protocol code. A more strategic approach to the on-chain battle would be for the Index Coop community to concentrate on launching as many quality indices as possible and marketing those to the ever-growing crypto community.

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NGMI. Also if you believe this why are you even proposing to Index Coop?

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