Crypto Index Fund Construction - Part 3
Smart contracts allow different approaches to index fund construction that are not practicable in Traditional Finance.
This was first published on my old blog in October 2020
Part 1 is here
Part 2 is here
Risk management within funds
Impact of individual token collapse
For a market cap based fund, the impact of a single component collapsing is the removal of that protocol’s value for the total market cap. So in the case in our example 4 token fund from part 2, if B collapsed, the total market cap would drop by 1,000,000 and each individual unit by 10%. At that point there should be no further consequences (although in reality, such a collapse is likely to impact other protocols prices)
For a constant weight fund in a AMM pool, as the value of B drops to zero, the pool would allow arbitrage to sell the other assets as they become overweight and the fund accumulates more B tokens. This is effectively a rug pull of the fund contract and should only occur for finalised pools. Smart pools have the ability to pause, or change weights so that they have the potential to manage this risk. in understand that PieDAO are developing advanced version of current smart pools with additional features including the ability to use voting rights of the underlying tokens. So this should further offer further downside protection.
Further discussion on the risk of pool collapse can be found in my YouTube presentation here.
A comparison between protocols
The table below summaries my thoughts on different aspects of the three different approaches I’ve been looking at:
Note: this is based on the types of protocols (not specific deployments of contracts) and my assumptions. I haven't examined any code in detail, so it’s possible that I’m misrepresenting the different risks.
Finally, I’ve not been able to find much info on sDeFi.
Final thoughts
The three approaches I’ve reviewed to date all have pros and cons in different areas. Personally, I’m drawn to the simplicity of market cap structures. The constant rebalancing, with potential fee extraction, for smart Balancer pools has it’s benefits. I don’t know enough about synthetic assets (TradFi or DeFi) to judge them properly (I’ve found minimal info about sDeFi). However, the lack of the underlying tokens make it less attractive to me.
Disclosure and Disclaimer
I’m a long term investor in crypto currencies including DeFi. I hold $SNX, $INDEX and $DOUGH as well as $DPI and $DeFI+S along with other others (You could say that I like to diversify my risks…). I am an active member of the INDEXcoop which manages the $DPI fund.
This is not financial advice, all investments are risky, crypto investments are more risky than most. Do your own research. Do not invest more than you can afford to lose.