In the stock market, investors have been accustomed to having one of the greatest passive investment products of all time with index funds (created in 1976).
Indexing allows for diversification across a variety of sectors in the economy, as well as exposure to companies of varying sizes. It’s the ultimate passive investor strategy to just buy index funds and over a long enough period of time watch the power of compound interest work its magic. Actively managed hedge funds often have a difficult time beating an index fund in something like the S&P 500 over a longer timeframe (10+ years).
Since I have gotten involved with the crypto space, I have seen a ton of tribalism (maximalists claiming one project is superior) over crypto projects. For example within the decentralized finance (DeFi) space, you may have two decentralized exchanges such as UniSwap (UNI) and SushiSwap(SUSHI). Which one is better?
They both offer similar features to swap different cryptos for a liquidity fee, allows people to be liquidity pool providers, and they both can run on the Ethereum blockchain. So you do what everyone does when they are trying to understand anything…google it.
Then you may run into the situation where the articles/videos found have a bias unknown to you (maybe they have a vested interest). So what are you to do, read through the code of each project to determine who has the cleanest code and best development team? Do you compare the projects by user interface? Do you go with the one with more trading volume?
As you can see the questions can be endless.
Then you think to yourself “I have $1000 to invest, maybe I just buy $500 in each”. Pretty reasonable, then you find out there is like 10 other cool projects focused on different aspects within the DeFi space. Damn. “Uhhhh $100 into each?”.
I’ll be honest, I run into the same situation researching all these projects tackling similar problems within the crypto space (Metaverse, NFTs, Web 3.0, Smart Contract Platforms, etc.).
Turns out you can actually invest in indexes of crypto sectors like the ones mentioned above.
Except it isn’t on any traditional market like the stock market where there is a team of analysts and a fund manager behind decision making.
I found a project that focuses on this indexing aspect as well as some leveraged tokens (similar to leveraged ETFs in the stock market). But for this post, we’ll be focused more on the indexing products.
Index Coop (INDEX)
Purpose & How It Works
This indexing of different crypto sectors allows people to get price exposure to a variety of projects within a crypto space. One of the indexing products that we’ll focus on is DPI (DeFi Pulse Index) which indexes a variety of DeFi projects.
In a very crypto fashion (as it should be), the decision making for this project is done through a Decentralized Autonomous Organization (DAO).
This allows for agreed upon rules in order to manage the current indexing products, introduce new product ideas, and further improve the project going forward with a group consensus.
The INDEX blockchain runs on the Set Protocol which is a non-custodial protocol built on Ethereum that allows for the creation, management, and trading of Sets, ERC20 tokens that represent a portfolio or basket of underlying assets. Creating a set is a simple process as seen below.
This is a pretty cool concept as a finance nerd, because you can build into the fund an automated rebalancing of assets or to buy and sell on certain criteria being met or not. It’s like an automated portfolio manager which can be more efficient and reduce emotional decisions!
See below infographic on how they pick different crypto assets to include in a Set.
Once a set is created then on a monthly basis it goes through the following 2 phases:
To sum it up, the Index Coop is in charge of setting methodology and governing the products and creating the set (can include outside contributors such as DeFi Pulse) which then automatically rebalances each month via smart contracts.
So you have products like DPI, but the project itself is the INDEX token. So what exactly is the difference? The Index Token is the governance token and used to vote on the proposals at the Index Coop. It is also used to reward contributors and partners. DPI is just a the product token that can be bought by people without ever getting the details on Index Coop.
Tokenomics & Market Share
There is a max supply of 10 million Index tokens which will be distributed. The release schedule looks to be a gradual over a 3 year period.
Below we see how the tokens are planned to be distributed. It seems as though a huge portion is being allocated to the treasury as well as set labs Inc (which does not have their own native token, but is a company focused on building out the Set protocol).
Definitely looks like Index token is more being used for funding the project and Methodology contributors to build out more products and make the best indexing products.
The value is based on what people think the value of having governance over this project holds as well as a possible cut of revenue streams in the future (see streaming fees below).
In my eyes, Index Coop is the portfolio managers side and coming up with the methodology behind funds and then Set protocol is the actual technology being used to create the funds on the blockchain using smart contracts.
Index Coop isn’t the only project focused on on chain AUM products, but they do have the majority of the market share based on the assets under management.
I would say the pros are consistent with normal index related products:
- Passive – Someone can invest in a crypto theme without having to do research on individual projects in the space. They also don’t have to worry about rebalancing their own DeFi cryptos as the market caps fluctuate.
- Diversification – With indexing you spread your risk across multiple projects, so if one goes down but the DeFi space in general moves higher then you can still make a return on your investment.
- Redeemable – The way the set protocol works is that you can actually redeem the underlying assets in DPI at anytime as the owner of the DPI product. So if the fund is 50% Ethereum and 50% Aave, you would actually receive those token upon redemption.
- Themes – You can buy into crypto narratives that you think will do well and avoid those that you believe are overhype or deliver lower utility.
- Diversification – Woah! I thought this was a positive? Well it can also be a negative if you are passionate about the crypto space and have done your research. The more concentrated you are in a few projects that you believe have the most potential could result in higher returns compared to a crypto index which may generate less volatility but lower comparative returns.
- Fees – With something like DPI, within the Set protocol there is something called streaming fees which is a % that is paid out to the asset manager or the one who created the Set. So with DPI it is 0.95% and is a split between DeFi Pulse and Index Coop (70/30 split). Example below.
- Data Sourcing – This is my biggest concern just reading through the website, as a big piece of how the rebalancing and pricing seems to work is based off of CoinGecko. If that was somehow interfered with, then there could be a rebalance that is incorrect or it could effect the value of the index momentarily if there is a glitch on the website for circulating supply or price. I can’t find anywhere in the documentation or on Set protocol specifically stating if they cross reference multiple sources for data or use something like Chainlink, but it would be one of my concerns.
- Smart Contracts – So it looks like Set protocol is the backbone of all these different products that are being created by Index Coop, if there is issues with any of the set protocol you could have locked tokens or maybe a malfunction that causes weird activity within the created Sets. Not saying it has happened, but the set is a programable fund. With anything programmed, due to human error the fund may perform actions that hurt those invested in the Set.
- Trust – There is still an aspect of trust that the Index Coop created a set that functions as intended.
I love that this type of product is being developed and excited to see what other index products can be introduced. It allows for people to get access to a diversified portfolio of crypto assets with a single purchase. I don’t love the streaming fees that are set on the fund, but understand that people aren’t going to create great funds with thoughtful methodology without getting paid.
I would think that over time as this is more of a proven concept and attracts more assets going into set protocols that the streaming fees would go down (similar to index funds through vanguard who’s management fees are small but they manage a crazy amount of money so the amount collected is still solid). Plus I would think these types of funds wouldn’t require too much maintenance after the upfront methodology is created and implemented as a set.
If you are really nerdy you could always skip Index Coop and create your own Set and include a small streaming fee for your automated portfolio! Hey maybe I should create a Set myself 🙂