sDeFi, DPI, DeFi++, PIPT: Which type of crypto index is expected to become the leader in the field?

Bitcoin is a re-examination of currency, whether it is the end of money is beside the point. At the very least, Bitcoin is attempting to redefine finance, just as DeFi is trying to reconstruct and reshape financial product models. Although DeFi is still largely spinning in a small circle, the core heavy users are the old friends in the crypto circle. But let's not forget, all new things at the beginning seem like toys to people.

Although DeFi has yet to achieve the goal of inclusive finance, and despite the inevitable emergence of many waste products and defective items in the DeFi space, with projects running away, returning to the community, and being coerced by hackers, many problems will increasingly arise in the future. The collapse and exit of individual projects will, through a process of negation, make the overall ecosystem stronger.

According to Wikipedia, the Lindy effect refers to the idea that for things that are not going to disappear naturally, such as a technology or an idea, the longer they survive, the longer their expected remaining lifespan increases. Bitcoin has been declared dead over three hundred times; it is time to witness the Lindy effect. Have you not seen that Singapore's largest commercial bank, DBS Bank, has officially launched the digital trading platform DBS Digital Exchange, and starting next week, it will be possible to trade cryptocurrencies with fiat currency? The Singapore Exchange holds a 10% stake.

And JP Morgan, which has always been skeptical or even disdainful of Bitcoin, and hedge fund Bridgewater's Ray Dalio, have recently reached a stage of realization, beginning to compare Bitcoin to gold. In Ray Dalio's view, Bitcoin and other cryptocurrencies have established their position over the past decade, " as alternative assets similar to gold ."

With this background, we may be more confident in judging that for an ecosystem that can quickly learn and evolve, what does not kill me makes me stronger. And as mentioned earlier, all categories of traditional financial products will be replayed in the crypto world.

1. Index Funds and Crypto Asset Index Funds

Index funds are often one of the best introductory investment products for new investors. Over the past decade, the market share of index funds has continued to expand. Taking BlackRock as an example, this company has surged over the past decade to become the world's largest asset management company, managing assets exceeding hundreds of billions of dollars. The rise of index funds has contributed significantly to this.

In the past decade, with the emergence and increasing attention to Bitcoin, companies like Grayscale, CoinShares, and Bitwise have begun to attempt to integrate crypto assets into the existing financial system through trust funds, index funds, and other means. Grayscale's every purchase always sparks heated discussions in the market, and some argue that the current market is a bull market driven by institutions.

The approach of institutions like Grayscale and the views of Ray Dalio and JP Morgan is to choose to include Bitcoin and other crypto assets in the basket, packaging or transforming crypto assets to provide them to traditional financial product investors, allowing investors to purchase and hold crypto assets through IRA, brokerage accounts, and products listed on exchanges.

On the other hand, the rise of DeFi represents another attempt in a different direction. DeFi creates a parallel space. In this space, leveraging the internet's reach, DeFi provides financial infrastructure that is permissionless and accessible to everyone, allowing people to gain a new financial space beyond traditional banks, exchanges, stocks, and funds.

Decentralized exchanges (DEX), automated market makers (AMM), derivatives, decentralized lending, and many other product models have emerged. In the past year, DeFi has made rapid progress, with nearly $15 billion in market share today, including leading products like Uniswap, Balancer, AAVE, and Synthetix.

Naturally, in the wave of innovative experiments in DeFi, the index fund, which is an indispensable product in the traditional financial world, is also beginning to take shape.

Some entrepreneurial teams have started to create cryptocurrency index funds, especially DeFi index funds. For example, DPI reached an asset management scale (AUM) of $25 million in just three months.

What projects have been created on the DeFi infrastructure as crypto index funds, and how are they developing? This article will explore together.

2. What Problems Do Crypto Index Funds Solve?

For many investors, DeFi is one of the must-have products in the current crypto asset investment field. The projects that have survived and settled during the DeFi boom have gradually sunk to become infrastructure. On this basis, more variations can be played. Besides adding new investment targets, what can crypto asset index fund projects based on DeFi provide?

Decentralized index funds, similar to traditional index funds, offer the opportunity for passive diversified investment. There is no need to invest in individual crypto assets with limited funds, risking not recovering transaction fees. With reliable decentralized index fund products, investors can directly buy a basket of crypto assets' index and hold it simply while still enjoying the advantages of decentralization.

However, decentralized index fund products also have unique problems. Unlike traditional fund operators who are bound by securities and other laws, decentralized index funds need to prove themselves and require more effort, with time and consensus being the most important.

Suppose a project issues a box token, claiming it contains several BTC, large treasure coins, and faith coins. Then, does this box token have the ability to anchor the value of the corresponding underlying tokens? Is the proportion of the index composition reasonable, and how to solve the risks of fund operators' decision-making or even running away?

There are many factors to consider when designing a decentralized index fund, such as the composition structure of the index fund, management methods, management fees, and many other issues.

In the following sections, we will look at the four most representative products on the market: sDeFi, DeFi++, PIPT, and DPI.

3. sDeFi

sDeFi is an index product issued on the derivatives trading platform Synthetix, anchoring a basket of DeFi tokens. However, it uses a derivative method that anchors prices, meaning that this index only benchmarks the corresponding DeFi token prices, can be traded but cannot be redeemed, and does not have the underlying DeFi tokens as support.

At its launch, sDeFi included eight types of DeFi tokens, and the composition ratio of various tokens and the decision to add new tokens are determined by the community through Synthetix's governance system. Currently, sDeFi includes 12 tokens, including AAVE, SNX, YFI, REN, BAL, CRV, and others. The proportion of different token shares is determined by the community and adopts a fixed ratio method.

However, sDeFi's trading does not include liquidity mining. Users first need to use over-collateralized SNX to generate sUSD or purchase sUSD from a DEX, and then participate in trading sDeFi in the Synthetix market. In Synthetix's market, a no-slippage automated trading market mechanism is adopted; each time you buy, the system will mint sDeFi for you; and each time you sell, sDeFi will be destroyed, returning sUSD to you.

The trading of this index does not incur additional fund custody fees; it only charges a 1% trading fee, just like other trading pairs on Synthetix. In addition to sDeFi, the platform also has a bearish DeFi index: iDeFi. After buying iDeFi, if the DeFi index declines, the price of iDeFi tokens will rise.

However, the current market size of sDeFi is not large. According to current statistics, the combined 24-hour trading volume of sDeFi and iDeFi does not exceed $1.6 million. Since it uses derivatives rather than physical (real tokens) anchoring, sDeFi is just a price index and relies on the oracle chosen by Synthetix. Once the oracle fails or encounters network congestion causing delays in quotes, the market trading of sDeFi will also be affected.

To summarize the advantages and disadvantages of sDeFi:

Advantages

• sDeFi is the oldest DeFi index trading product;
• The Synthetix team has a good reputation in the DeFi ecosystem, having processed over $1.5 billion in trading volume, thus sDeFi has a robust infrastructure.

Disadvantages

• Uses a synthetic derivative structure, cannot redeem the anchored assets;
• Relies on the oracle system, which carries counterparty risk.

4. PieDAO

Unlike sDeFi, which uses a derivative structure, only anchors prices, and lacks real asset support, the index funds created by the DeFi team PieDAO in March 2020, such as DeFi++, DeFi+L (large-cap index), and DeFi+S (small-cap index), adopt a structure supported by real assets.

In simple terms, index funds like DeFi++ that are backed by real assets need to buy and hold a corresponding basket of DeFi tokens according to a set ratio. In contrast, index funds like sDeFi, which have a derivative structure, only anchor prices without holding assets or redeeming them, which can be considered air tokens, with their value serving as a price indicator for the corresponding basket of DeFi tokens.

To help readers better understand DeFi index funds, we will spend more time introducing the structure and operation of PieDAO's index products.

Overview of PieDAO Index Products

As seen in the image, PieDAO's index products include seven types, but the ones with larger trading volumes are BCP, DeFi+L, and DeFi+S. This article mainly focuses on DeFi index funds, particularly looking at DeFi++, DeFi+L, and DeFi+S.

DeFi+L has a market cap of $1.77 million, with a price of $1.3; DeFi+S has a market cap of $988,000, with a current price of $1.62, while the DeFi+S index product was created earlier than DeFi+L and includes six small-cap DeFi tokens, including UMA, REN, LRC, BAL, PNT, and MLN.

PieDAO's DeFi index products are built on Balancer. When users purchase DeFi index tokens, they buy tokens according to a fixed holding ratio through trading tools like Uniswap, or if users hold enough corresponding tokens, they can directly join the liquidity pool to issue DeFi index tokens.

Due to the fixed ratio method, as prices change, the funds allocated to different tokens need to be regularly reconfigured, which can be directly assisted by external AMM automated market-making mechanisms, making it much easier compared to traditional index fund products that require manual buying and selling of corresponding stocks, bonds, etc.

Taking DeFi+L as an Example to Understand Issuance and Redemption

The issuance mechanism of DeFi+L has two options: single asset and multiple assets. If a single asset is chosen, ETH needs to be paid, and the corresponding assets must be exchanged through swap trading tools like Uniswap or Balancer. To avoid the impact of slippage, an additional 5% of ETH needs to be paid, and the excess will be refunded.

If users choose the multiple assets option, they need to deposit the corresponding assets in proportion to provide liquidity for the DeFi+L fund. The following image shows the corresponding assets needed to generate 1 DeFi+L index token.

Since PieDAO's index products adopt a structure supported by real assets, they can be redeemed for assets in real-time, and no additional fees are required for redemption. On the DeFi+L fund page, click Redeem, and select the amount of assets to be redeemed.

Understanding the operation and mechanism of DeFi+L also clarifies the other index products of PieDAO, as well as the practices of similar structured products like PowerIndex.

To facilitate users who need both the DeFi+L large-cap fund and the DeFi+S small-cap fund, PieDAO has recently launched the DeFi++ index product, packaging these two for trading. Among them, the ratios of DeFi+S and DeFi+L are 30% and 70%, respectively. The current market cap of DeFi++ is $520,000.

PieDAO has designed liquidity mining incentives. If users provide liquidity for index products like DeFi+S and DeFi+L in the Balancer token pool, they can receive native tokens DOUGH and BAL as rewards. However, it should be noted that in Balancer, the token pool ratios for DeFi+S/sWETH and DeFi+L/sWETH are set at 7:3, which I believe is relatively high, and the current depth is insufficient.

PieDAO's DeFi series index products represent a paradigm for constructing crypto index funds, allowing for real-time redemption design and leveraging AMM to provide real-time liquidity and rebalancing convenience, which is expected to serve as a model project for many future crypto index products.

The assets covered by the index and their proportions, although fixed, can also be changed through community resolutions. The PieDAO community can make subsequent adjustments through proposals (PIP), including proportions and the types of tokens held.

A similar project is the PIPT index issued by PowerPool, which is also created based on Balancer and adopts a fixed ratio model.

5. INDEX Coop

Index Coop is a decentralized index community launched by the SET protocol (Set Protocol), with the governance token being INDEX, which is also used as a liquidity mining reward. The first index product is the DeFi Pulse Index (DPI) launched by the one-stop portal for DeFi, DeFi Pulse, and Index Coop, with a market cap of about $20 million.

DPI aims to track the performance of relevant tokens in the DeFi industry, calculating their proportions based on the circulating market capitalization of the tokens. The underlying assets of DPI are selected based on a complete set of criteria, primarily aimed at selecting projects that can be developed, maintained, and operated long-term and have a broad audience.

DPI is built on the Set Protocol V2 protocol, adopting a model supported by a basket of DeFi tokens, allocating corresponding holding ratios based on the market capitalization of the tokens.

DPI allows users to redeem, meaning users can exchange DPI tokens for the corresponding underlying assets at any time. Currently, it includes 10 types of DeFi tokens, as shown in the image below.

Among them, AAVE has the largest proportion, accounting for about 19.4%, while BAL's current proportion is 2.27%. Unlike PieDAO's DeFi++ and other index products that adopt a fixed ratio method, DPI's index composition based on circulating market capitalization weighting often requires rebalancing and token replacement.

The governance mechanism of the IndexCoop community introduces the role of index strategy providers, but these strategy providers are not the managers of the index.

In the two months after its launch, 7.5% of INDEX tokens will be allocated to strategy providers. For example, DeFiPulse, because they compile indicators, conduct research, and provide data, this portion of tokens will be distributed over 18 months. In addition, each IndexCoop index (such as DPI) may also have fees, part of which will also be allocated to index strategy providers.

DPI Issuance and Redemption

It is worth noting that the entry for issuing and redeeming DPI index on TokenSets is hidden by default and needs to be clicked to display.

Unlike PieDAO's DeFi index, which provides single asset/multiple asset options, DPI must be issued by transferring multiple underlying assets. Through the tokensets website, DPI tokens can be issued, requiring authorization for all relevant tokens to the contract. Since it is supported by real assets, DPI can also be redeemed for the corresponding assets in real-time.

DPI Liquidity Mining

In addition to the credibility added to DPI by DeFiPulse's participation, making DPI's market cap lead among DeFi index products, the liquidity mining mechanism adopted by DPI is also crucial.

Users provide liquidity for the ETH/DPI trading pair on Uniswap, and then they can mine through the Index Coop page to earn INDEX token rewards, with the current price at $4.6 and an estimated annual yield of 23%.

DPI Index Maintenance Method

DPI is divided into two phases: the determination phase and the adjustment phase.

In the third week of each month, decisions regarding the modifications to be made for the next token ratio update will be determined, referencing the current number of circulating market capitalizations from CoinGecko to decide which tokens to add or remove from the index. This work will be announced to the community before implementation. After the determination phase ends, adjustments, additions, and deletions of the component tokens in the index will be carried out on the first working day of each month.

Considering the impact of token allocation on the market, as the number of assets tracked by the index expands, the adjustment phase may be extended to more than one day to reduce the impact of buying and selling on market prices.

DPI adopts a circulating market capitalization weighting method, which does not require manual intervention, making it more efficient compared to community voting to change weights. To facilitate understanding, let's look at the relevant information from Index Coop's index asset balance report for November.

This process is carried out through the IIP-5 INDEX improvement proposal.

Before execution, DeFi Pulse, as the index strategy provider, announced the new DPI weights and notified the community for verification. After confirming accuracy, using the Index Coop Manager's smart contract, a multi-signature trustless method was adopted, including DeFiPulse, Set Labs, and the IC community, to complete the rebalancing of DPI.

6. YETI

PowerPool issued PIPT at the end of last month, created based on Balancer, and locked over $9 million in just nine days. PIPT has a mechanism similar to the index funds created by PieDAO.

On December 4, a user named Ryan Watkins proposed in the Power Forum (Power Pool's governance forum) to create the Yearn ecosystem index YETI, focusing on the Yearn ecosystem, including seven tokens: YFI, SUSHI, CREAM, AKRO, COVER, K3PR, CVP, and PICKLE.

YETI adopts a fixed ratio, real asset-backed issuance method, meaning each YETI is supported by underlying assets and can be redeemed at any time. There are three options for issuing YETI:

• Transfer ETH, USDC, DAI, or any asset to mint, as it requires converting ETH into the corresponding eight assets, so the slippage is high, with a default slippage of 2%;
• Single underlying asset, users can transfer one of the eight underlying assets;
• Multiple asset issuance, as shown in the image below.

YETI Liquidity Mining

To incentivize user participation and enhance YETI's liquidity, liquidity mining incentives for the first month have been created. This includes two parts: depositing YETI into PowerPool can share a reward of 200,000 CVP tokens; providing liquidity for the YETI/ETH pool on Balancer (with a ratio of 80:20) can earn 250,000 CVP tokens.

According to the display on the Power Index page, the equivalent APR is approximately 530%-595%, which is quite considerable. However, the eight tokens included in the YETI index have higher price volatility compared to ETH and other tokens, so participation should be cautious.

According to Power Pool's governance method, subsequent changes in the types and proportions of YETI tokens should also be conducted through governance improvement protocols, taking effect after voting.

7. Conclusion

The market prospects for index funds are broad, and several DeFi index fund products emerging in the DeFi space also indicate the community's unwillingness to settle and continue exploring. All products that can be reconstructed by DeFi will be reconstructed by DeFi; however, given that the crypto market itself is a niche world, I prefer to understand the exploration of DeFi products as being in the prototype testing phase. Before reaching a broader audience, this step is certainly essential, but it is also important to recognize that the road is long and not accomplished in a day.

Whether it is the derivative method adopted by Synthetix or the real asset-backed approaches taken by PieDAO, INDEX Coop, and Power Pool, they are all paving the way for DeFi+ index funds. Given time, I believe these accumulations will pave an interesting road for DeFi to break out. The emergence of YETI is an interesting example, and the concept of index products based on ecological scope could also be extended to the NFT and blockchain gaming fields.

DeFi has created a parallel financial space to explore various financial product models. On the other hand, traditional financial institutions are also approaching the crypto asset industry in their own ways, with both paths running parallel without contradiction.

This article summarizes four currently representative projects and discusses some common models and advantages and disadvantages of decentralized index funds in DeFi. Finally, it is worth reminding that although products like index funds attempt to reduce investment risks, given that various tokens in the current crypto asset market are still highly correlated, they cannot achieve much in terms of risk diversification. Therefore, it is necessary to remind readers once again that while product models are worth paying attention to, participating in them requires doing homework and managing risks properly.

References

https://docs.indexcoop.com/products/defi-pulse-index

https://bankless.substack.com/p/the-bull-case-for-decentralized-index

https://bankless.substack.com/p/how-to-mint-dpi-and-earn-index

https://medium.com/indexcoop/introducing-the-index-cooperative-a4eaaf0bcfe2

https://medium.com/powerpool/the-meta-governance-approach-applied-to-the-yearn-ecosystem-yeti-is-launched-d8417459f6e2