IIP: 147 Build LAYER1 on a Managed Balancer Pool

Status: Proposed Author: @JosephKnecht (Index Coop, MoonRock) Reviewer: @anthonyb.eth Status: Proposed Author: @JosephKnecht (Index Coop, MoonRock) Reviewer: @anthonyb.eth Gov Review: @asira Background link: IIP-135: DG - Launch the Alt Layer 1 Index (LAYER1) Created: 01 Apr 2022 Notification: @GovNest Discussion to: (https://gov.indexcoop.com/t/iip-147-build-layer1-on-a-managed-balancer-pool/4095) Quorum: 139380 INDEX (5% of circulating supply)

Summary

This IIP proposes to build LAYER1 on a Managed Balancer Pool (MBP) instead of on TokenSets.

LAYER1 is an index of alternative Layer 1 protocols. The product passed the final Decision Gate in IIP-135 with a 100% vote. Since that time, MBPs have emerged as an attractive alternative technology to TokenSets for simple sets such as LAYER1. MBPs have multiple major advantages; most notably rebalancing has negligible gas costs and can access much deeper liquidity. Moving to MBPs would also help Index Coop achieve greater technical independence, a goal which Set strongly supports. The Balancer leadership is also strongly interested in partnering specifically with Index Coop to co-develop index products on their MBP platform.

Proposal

Managed Balancer Pools are a new pool type from Balancer designed to “provide a framework for fund managers”. They provide features not available in conventional Balancer liquidity pools such as the ability to charge an AUM fee.

The major benefit of MBPs is that rebalancing is done by a permissionless market auction so the gas costs and manual effort are externalized. As has been extensively discussed through the product profitability initiative, gas costs for rebalancing on mainnet are extraordinarily expensive to the point of making rebalancing economically infeasible (Index Coop product profit dashboard).

Pros and Cons of building simple sets such as LAYER1 on MBP instead of TokenSets are as follows.

Pros

• Gas costs and effort for rebalancing are negligible since rebalancing is externalized to the market via auction.
• Rebalancing can access much deeper CEX and L2 liquidity. The deeper liquidity reduces the asset decay in our products and also opens up compositions to otherwise ineligible tokens.
• Swap fees (not available on TokenSets) provide a new source of potential income for holders and managers. Note that Balancer takes a fixed 50% protocol charge on the swap fee income.
• Much lower gas costs for minting and redeeming, which reduces the acquisition costs for our customers.
• Reduced need for seed liquidity. The harmonic liquidity philosophy shows that required liquidity for a product is based on how much it costs to mint/redeem a product. In MBPs, the equivalent of mint/redeem is a Join/Exit.
• More types of ERC20s can be put into an MBP index such as LPs, derivatives, and options.
• The ability for the manager to add and remove assets from the set which could potentially unlock new forms of productivity.
• Impermanent loss only when trading is activated within the pool
• Testing the MBP protocol before using it for other products.
• Potential for a strategic and operational relationship with Balancer for product co-development.

Cons

• The MBPs are not battle-tested and there are unknown smart contract, operational, and marketing risks.
• The MBPs have many new options for customization that on the one hand create new design possibilities but will also require more design effort.
• Impermanent Loss (applicable only when trading within the set is active) is according to the Weighted Math formula which potentially creates greater IL risk.
• Given the novelty of the protocol, the products will potentially be considered lower quality collateral on lending markets such as Aave.

The fee options for a MBP are different from TokenSets. Accordingly, the new fee structure would be:

Fee	New	Prev	Description
AUM Fee	2.95%	2.95%	Annual fee based on AUM (or NAV). aka Streaming Fee in TokenSets
Swap Fee	0.1%	n/a	Fee for swaps within the set
Protocol Fee	50%	n/a	Portion of the swap fee given to Balancer
Management Fee	100%	n/a	Portion of the remaining swap fee (post-Protocol fee) given to the manager
Mint/Redeem Fee	n/a	1%	Fee for mint/redeem

The Swap Fee provides a source of income for rebalancing but disincentivizes auction bidders and so pushes the cost onto asset decay. Hence, we are proposing to pilot with a small Swap Fee of 0.1%. The overall fee split would be unchanged from IIP-135.

If LAYER1 is successful on MBP in terms of AUM at month 6, gross profit margin, user experience, and no severe technical issues then we will consider launching future simple sets on MBP.

We look forward to your feedback and questions.