DeFi Researcher: A Brief Analysis of 4 On-Chain Index Protocols Worth Noting

Written by: Ignas

Compiled by: Shenchao TechFlow

Last week, the Alongside Index Protocol announced a $11 million seed funding led by A16z, with Coinbase participating.

This is surprising because typically, DeFi projects raise between $1 million and $4 million, and all DeFi index projects have low capitalization (indexes ranging from $1 million to $15 million).

Few people have heard of Alongside, which piqued my interest; venture capital firms need to be forward-looking as their stakes will be locked for years.

Warren Buffet once said that a novice investor can outperform most investment experts by regularly investing in index funds. In traditional markets, stock indexes are used to track the performance of a range of stocks, with the S&P 500 being the most well-known example.

However, it is still too early for on-chain indexes; many cryptocurrency natives believe they can manage their positions better than centralized solutions, and the narrative is not there yet.

The numbers show: stock indexes account for about 18% of the TradFi stock market, while on-chain indexes only account for 0.077% of the cryptocurrency market, or 0.18% compared to DeFi's TVL.

Indexes Outperform ETH and BTC

Investors need benchmarks to measure the performance of various tokens and projects. For some time, Ethereum (ETH) and Bitcoin (BTC) have been seen as market benchmarks.

Therefore, on-chain indexes need to outperform them to prove their value. However, the largest DEFI index developed by Index Coop (DPI) has consistently lagged behind ETH.

If you believe in the development of DeFi, holding ETH makes sense as it is the foundation of the DeFi ecosystem, with blue-chip DeFi projects built on top of it.

The same applies to the NFT ecosystem, where ETH is the proxy token for NFT adoption growth. Additionally, ETH is not plagued by the inflation affecting DeFi tokens and is widely regarded as the best collateral in cryptocurrency.

However, some individual DeFi tokens have far outperformed ETH, so a well-designed index must provide higher upside potential while minimizing risk.

For example, during DeFi Summer, the DPI index was popular because new DeFi projects were emerging daily, making it hard to keep up with all developments in the space. High gas fees also hindered small investors from diversifying across multiple DeFi tokens. However, the market correction in the fall of 2021 led investors to believe that the risks of these indexes were too high, causing them to exit.

Index Financial Hack

In October 2021, Indexed Finance's DEFI5 index was exploited for $18 million. The attacker used the index pool to rebalance through flash loan transactions.

This hacking incident and story are compelling enough to warrant a movie. In fact, Bloomberg wrote an in-depth article about it. The protagonist is A. Medjedovic, an 18-year-old mathematician who was the mastermind behind the hack.

Thus, holding ETH or BTC is relatively safe as the correlation among cryptocurrencies is very high.

The Index Wave is Coming

With mass adoption and the market maturing, cryptocurrency indexes will gain more attention. Just before the last bull market, there was no DeFi, NFT, or metaverse.

These new sectors are still young and correlated with BTC/ETH, but each sector has its shining moments, so as the industry expands and more sectors emerge, indexes make sense.

The recent $11 million funding led by A16Z indicates that this sector is beginning to grow.

The Alongside Crypto Market Index ($AMKT) is a centralized solution that includes a basket of 25 market-cap weighted assets, with assets custodied by Coinbase.

In traditional finance, indexes are large-scale capital allocators. They follow a set of rules known as "methodology"—usually market-cap weighted—to add or remove assets based on their market capitalization.

While the S&P 500 supports 500 companies, AMKT is limited to 25 because more assets "lack liquidity depth" or have "security issues," and "some assets in the space are under regulatory scrutiny; AMKT cannot include these assets due to compliance requirements."

AMKT uses a fixed token supply inflation rate to collect fees.

On-Chain Index Protocols

This sector is still small, with a total market cap of only $90.4 million.

Nevertheless, there are some major on-chain index builders:

• Index Coop

• Phuture Finance

• Indexed Finance

• PieDAO.

Index Coop

Index Coop is the largest index protocol by market cap, with a TVL of $63 million.

They have a range of products, including:

• DeFi Pulse Index (DPI)

• Metaverse Index (MVI)

• Bankless BED Index (BED) - a ratio of Bitcoin, Ethereum, and DPI

It seems they prioritize staking ETH services, with most of the TVL being ETH liquid staking derivatives.

Phuture Finance

Unlike Alongside, Phuture Finance offers non-custodial, on-chain, yield-generating products.

These products include:

• Phuture DeFi Index (PDI).

• Colony Avalanche Index (CAI) - tracks the Avax ecosystem (JOE, sAVAX, AVAX, and QI).

• USDC Savings Vault (USV) - generates interest by managing a bond portfolio of 3-6 months. USV is powered by Notional (a DeFi protocol for fixed-rate lending).

Phuture's PDI has integrated with Yearn, allowing certain assets to generate yield, such as AAVE, SNX, and SUSHI.

Indexed Finance

Indexed Finance has not yet recovered from the hack; their last tweet was 6 months ago.

The governance token NDX has dropped 98.4%, with a market cap of only $132,000 and no trading volume. Currently, the amount left from the hack is available for withdrawal.

Surprisingly, there is still $1.3 million in their smart contracts.

PieDAO

PieDAO is an early adopter of indexes and recently announced a shift from passive to active management, "where holders manage the funds owned by the DAO to generate yield."

Token Performance

Except for DOUGH (PieDAO), the performance of index governance tokens has failed to outperform ETH.

If you have held them previously, this is bad news, but it is also good news because the narrative for indexes has not yet arrived.

Their token market caps and trading volumes demonstrate how early we are in on-chain indexes. Except for Index Coop's INDEX, they are all small-cap tokens with very low trading volumes.

Token Economics Overview and On-Chain Data

Alongside does not have a token yet, but perhaps holding the AMKT index could mean a potential airdrop in the future?

Index Coop - INDEX

The supply cap for $INDEX is 10,000,000, gradually vesting over three years. Of the total supply, 70% is reserved for the community, liquidity providers, and "Methodologists."

$INDEX is a governance token used to vote on protocol improvements, financial expenditures, and governance proposals related to the underlying tokens in $DPI and future index products.

According to Nansen's smart money data, there are currently no signs of on-chain accumulation. Wintermute is the market maker for INDEX, but they have not chosen to accumulate.

Phuture Finance

PHTR is the token used by Phuture for governance, rewarding users, incentivizing activities, and raising funds.

It has two main functions:

• Staking, earning interest represented by ePHTR;

• Liquidity incentives, where PHTR is allocated to users who add liquidity to Phuture's index funds.

The APY for ePHTR is 4.7%.

Similarly, smart money has not flowed in. 30 days of trading volume data shows private investors have unlocked and withdrawn from ePHTR, but these outflows have been absorbed by individual investors active on other EVM chains.

PieDAO - DOUGH

If users stake DOUGH for at least 6 months, they will receive PieDAO's new governance token veDOUGH, which allows them to propose and vote on proposals while being rewarded for their commitment and efforts.

The goal is to generate and redistribute income.

PieDAO redistributes 60% of its income proportionally to active community members based on the amount of veDOUGH they hold.

On-chain data shows that smart money currently has little interest in it. 29% of the supply is locked in staking addresses. 29% of the supply has been burned, and 4% is used for buybacks.

Conclusion

One of the main drawbacks of on-chain indexes is that they can only manage a limited number of assets, which restricts their potential. The S&P 500 index has 500 different assets, while current solutions support only about 30 tokens.

Nevertheless, diversified, sector-specific indexes may be the future of crypto investing, allowing investors to enter new, rapidly growing crypto sectors that they may not have time to focus on.

Personally, indexes like DeFi may not appeal to me as I prefer to pick tokens myself. However, for other indexes, such as those focused on the metaverse, AI, or NFTs, I would be more inclined to choose.

For on-chain indexes to outperform the market, they need to include newer, high-growth potential assets that are uncorrelated with BTC or ETH. Achieving this safely is not an easy task.

Overall, on-chain indexes are still in their early stages. But with market maturation and mass adoption of cryptocurrencies, they could be the future of crypto investing.