Weekly Gauge #35 : Strategic DeFi Market Exposure
Weekly Gauge #35 : Strategic DeFi Market Exposure
An introduction to indexes in DeFi
Structured Products can be defined as pre-packaged investment products, their return is linked to the price action of at least 1 underlying asset. Interestingly, some of them allow users to bet on assets' passive yield rather than a price direction.
Indexes typically measure the performance of a basket of assets intended to replicate a certain area of the market. A traditional index fund is usually described as a type of mutual fund structured to match the composition and performance of a particular financial market index.
In short, an index fund is made to diversify a portfolio and offer broader market exposure. However, given the highly positive correlation of alt coins to the major currencies like bitcoin or ethereum, it has been demonstrated that market cap or price-weighted indexes weren’t as efficient to scale down investors’ risk as expected in DeFi.
The traditional structure of mutual funds, where the portfolio is designed by a fund manager, does not fit to the ethos of decentralized finance, thus builders strive to empower algorithms to ensure transparency and efficiency for this financial vehicle, while reducing the operational risk.
Vaults are the most common DeFi native product used to mutualize investors' funds, and it can also serve to hold a basket of assets responsible for backing the price of a tokenized share representing the index of assets in the vault.
Although it brings several advantages in terms of transparency and operational risk, vaults alone don’t address the issue of capital efficiency and market risk for the index performance. Hopefully, the DeFi stack bears its name well and allows a lot of composability to generate yield and passive incomes with originally idle backing assets, and counter potential dumps in valuation.
Yield-bearing index representation from author’s interpretation
The theory behind yield-bearing indexes (YBI) is to combine the equity portion of a portfolio which tends to carry more risk and volatility, but also greater growth potential, to the income portion that is considered “safe” money.
In order to be competitive with other market opportunities for investors, the YBI needs to fulfill a list of requirements :
Token inclusion criteria : To protect investors’ funds by ensuring that the index is composed of tokens that meet high standards.
Revenue generation : This is imperative as it provides avenues for the token to gain intrinsic value through cash flows or claims on protocol assets in the future and avoids investing into purely speculative tokens.
Supply distribution : It is important that passive holders of tokens (index products) are not significantly disadvantaged through the distribution of new tokens via locking mechanisms or unfettered minting functions.
In a recent article, Paladin introduced the first YBI oriented toward governance markets, called $WAR. It is not a secret anymore that the ecosystems built around Curve and Balancer are extremely competitive yield factories for farmers, where numerous flywheels contribute to support intrinsic values for their native tokens.
Governance markets passive yields
An overview of revenues generated on various layers of yield within governance markets shows the great potential of the index in terms of passive incomes.
Fees
https://dune.com/mrblock_buidl/Curve.fi
Liquidity Mining / staking
https://dune.com/queries/1219620/2088626
Voting incentives
source : Votex
Strategic assets weights and liquidity
To avoid the downside of financial risks associated with finding yield in DeFi like impermanent loss, the warlord strategies only require single-sided liquidity. Moreover, the issue of active management of the index is addressed by a system of upgradable whitelisted assets held by the treasury vault, which will ensure its optimal composition.
As we get closer to the launch of Warlord and $WAR, you can expect us to dive deeper into its mechanisms in a future weekly gauge.
