Status: Proposed Author(s): @allan.g , @JosephKnecht (Index Coop, MoonRock) Reviewed By: @afromac, @dochabanero, @twoodward (Notional) Gov Review: @sixtykeys Created: 7th March 2022 Discussions to: https://gov.indexcoop.com/t/iip-136-dg-launch-the-fixed-suite/3974 Quorum: 218,138 INDEX (10% of circulating supply) Passing Thresholds: 60% or more of participating tokens must vote FOR

Note: This proposal has been abbreviated to conform with snapshot character limits. Full proposal can be found in 'Discussions to' above.

A Decision Gate is the final vote for onboarding products to the Index Coop. A full overview of the product onboarding process can be found here. A passing vote here signals a commitment by the Index Coop to launch the FIXED Suite in a timely manner.

Product Requirements

FIXED leverages proprietary information so please request access to the PRD from the Product Nest if needed to make your voting decision.

1.0 Simple Summary

The Product Pod would like to propose that the Index Coop launch a suite of fixed-rate yield products, starting with DAI-FIXED. This will be the first fixed-rate yield token to give token holders passive exposure to high, fixed interest rates.

2.0 Abstract

The advent of fixed-rate lending brought about by Notional has laid the foundation for crypto-native fixed income products and the infrastructure required for creating and managing a fixed-rate yield index has been enabled by Set. As a result, the Product Pod would like to launch a suite of decentralized, fixed rate yield tokens that give investors high, market-neutral yield, starting with a DAI-denominated index, DAI-FIXED.

3.0 Motivation

Establishing a fixed-rate lending position today requires a certain degree of expertise and users are often forced to choose between earning a higher yield or keeping their assets liquid. By abstracting the complexity of managing this position and creating a secondary market for the index token to be traded, both of these pain points can be addressed. Holders also benefit from matured assets being rolled forward for them, as opposed to manually initiating new lending positions after maturity and dealing with high gas fees and taxable events.

3.1 ‌Rationale

In traditional finance, a typical portfolio is balanced between stocks and bonds, with 60% stocks / 40% bonds being the most prominent. However, in decentralized finance today, there are very few options for anchoring a crypto portfolio in the same way that bonds secure a traditional portfolio; available options also require a certain level of sophistication that average crypto investors may not have. While crypto markets are known for their volatility, there is an opportunity to offer the stability that a well-balanced crypto portfolio requires.

Additionally, most Index Coop products today are built for bull markets. In a bear market, holders of existing products may seek to de-risk their portfolios and sell into stables, creating a net outflow of capital for the Coop. With a market-neutral product earning stable, dollar-denominated yield, investors can cycle into lower-risk positions and the Index Coop can retain accumulated capital.

FIXED tokens deliver value to customers by…

• filling a hole in a well-balanced portfolio where bonds would traditionally fit
• offering a safe haven during bear markets or heightened volatility
• offering a predictable, high yield that is unavailable in the leading lending markets
• offering capital preservation and preventing loss of value within a portfolio
• shielding holders from early withdrawal penalties by creating secondary market liquidity
• abstracting the management and rolling of fixed-rate lending positions
• socializing gas costs associated with maintenance

FIXED tokens deliver value to the Index Coop by…

• diversifying our product offering
• positioning us as a one-stop-shop for any investor’s needs
• retaining accumulated capital if customers want to rotate out of existing products
• expanding the yield-bearing category of index products

4.0 Specification

4.1 Overview

‌The first index we propose launching within the suite is a DAI-denominated product. The underlying assets will be sourced and stored within Notional v2 and utilize Set’s battle-tested asset management infrastructure. The core allocation will be spread amongst the highest-yielding fDAI maturities with a preference for longer-dated maturities in order to minimize the rolling frequency. As fDAI positions reach maturity quarterly and automatically convert to cDAI, funds will be rolled forward into new maturities (akin to rebalancing).

4.2 Differentiation

Not only is this the first fixed-rate yield product for the Index Coop, but it is also the first fixed-rate yield token in DeFi. The most explicit difference from other proposed yield products is that holders receive a stable, predictable return on their assets. The interest earned on fixed-rate maturities has been substantially, consistently higher in DeFi compared to the variable rates available on Compound and Aave, and DAI-FIXED gives token holders access to those rates while also providing a secondary market for seamless exchange and instant liquidity.

An example composition and expected return at launch for DAI-FIXED are provided below:

Asset	Portfolio %	Yield	Type
fDAI 3mo (core allocation)	25.00%	7.53%	Fixed
fDAI 6mo (core allocation)	75.00%	8.56%	Fixed

Deposit	$10,000.00
Annual Return	$779.00
Effective APY*	7.79%

*includes slippage

It is worth noting that as AUM grows and new fDAI maturities are added to the index, marginal fixed rates will decline if the borrow side of the Notional market remains constant.

4.3 Example composition

DAI-FIXED will have a core allocation of fDAI 3mo and 6mo maturities (also known as “tenors”) at launch. To provide some background, fCash positions vary depending on date of maturity (3, 6, or 12 months) and each tenor may have a different fixed rate depending on prevailing market conditions at time of origination. The index’s core allocation will be distributed amongst 3mo and 6mo fDAI positions, with preference shown to the highest-yielding, longest-dated maturities. The core allocation is not constrained by a specific average maturity/duration target, but there is an upper limit to the allocation percentage a single fDAI maturity can have (75%). In the event that yield curve for fDAI inverts, 3mo maturities may be included in the core allocation to maximize effective yield.

The expected annual return for this particular composition would be 7.79%, matching the tables within the “Differentiation” section above. Note that for the above allocation the index will alternate every 3 months between having 1 and 2 tokens. This is because the 6mo and 3mo tenors will have the same expiry date when the 3mo tenor rolls over. The effective annualized yield for the index will be influenced by prevailing rates during quarterly rolls and the inherent interest rate decay resulting from rolling forward large notional amounts of capital.

4.4 Backtest data

Forward simulations were conducted instead of backtesting because the fCash ERC20s are novel and hence price history is not available. The forward simulation incorporated the slippage due to the rotation of the 3mo and 6mo tenors. The asymmetric price action around NAV is due to there being a redeem fee but no mint fee. Assumptions: $2M AUM; Price-NAV drift = 0, corresponding to neutral buy-sell pressure; Price volatility = 0.2/day; Resolution: Daily; Reference currency: DAI.

5.0 Size of opportunity

In traditional finance, the outstanding value of global bond markets was over $123 trillion 1 in 2020, which is ~17% larger than the global equities market the same year. Since their inception in 2002, bond ETFs have been the fastest growing category of fixed income products; in the last year alone, global bond ETF AUM has increased by over +50% 2. There are a variety of bond and fixed income instruments besides bond ETFs - like bond mutual funds or index funds - but they typically require active management because of their complex compositions and/or limited automation opportunities. Additionally, YTD returns for US Bond ETFs have been negative which could drive institutional investors to crypto to seek above average returns compared to traditional financial products 3.

However, because of the programmable nature of digital assets, there is a compelling opportunity to create an automated bond-like product that minimizes costs and maximizes value for customers. In DeFi today, there are no fixed rate yield ERC-20 tokens, though there are several protocols that enable fixed rate lending through a variety of mechanisms. The TVL for the three largest fixed rate lending protocols on Ethereum at time of writing are as follows:

1. Notional: $473m
2. Element: $170m
3. Ondo: $56m

It is worth noting that in late November 2021, the collective TVL across the three protocols listed above exceeded $1.25B. Additionally, Notional v2 launched in November 2021 (less than 3 months ago) and amassed nearly $1B in AUM before more recent market corrections. We estimate the AUM to reach $2m in the first month, $25m in the sixth month, and $50m in the twelfth month; these approximations are derived from DAO treasury research.

7.0 Methodology

7.1 Token inclusion / exclusion criteria

In order to be included in a FIXED product, a token must meet the following criteria:

• the token must be native to Ethereum main net
• the token must be issued by Notional v2
• there must always be an active, tradeable market within Notional for the token

DAI-fixed will initially be composed of fDAI 3mo and fDAI 6mo positions. Eligible assets in the future include different fDAI maturities, like fDAI 12mo, once a solution is in place for idiosyncratic fCash.

7.2 Index weight calculation

In order to avoid unnecessary re-balancing on main net, the core allocation will not be prescriptive when weighting different maturities. As maturities expire or new capital flows in, new fCash positions will be minted and added to the index according to 1) the highest available fixed rate and 2) the longest-dated maturity. An upper limit of 75% will be set for one maturity’s share of the core allocation.

For example, if fDAI 3mo is paying 7% and fDAI 6mo is paying 8%, then capital will be allocated to fDAI 6mo up to a point where the marginal yield on a new 6mo falls below the yield of the 3mo or the constituent cap of 75% kicks in (at which point we would allocate to fDAI 3mo). In the event that yields on different maturities are identical, the longer maturity is preferred. This same strategy will apply to new constituents that meet the inclusion criteria.

7.3 On-Chain liquidity analysis of underlying tokens

DAI-FIXED constituents will be sourced from the Notional AMM, which exclusively supports fCash markets.

Price Impact for a $1m exchange issuance trade: 0.234%

7.4 Index maintenance / Rebalancing frequency

FIXED tokens will rebalance on a quarterly basis as underlying fCash positions expire and must be rolled forward into new positions. It is worth noting that this will function more as a recomposition (adding new fCash tokens) than a traditional rebalance (adjusting the weighting of existing tokens). Rolling into new fCash positions will be optimized to avoid any significant slippage based on Notional’s AMM and will factor in interest rate decay resulting from roll volumes. Core team members from the Product Nest will be responsible for executing rebalances on a quarterly basis.

9.0 Liquidity

For DAI-FIXED, the primary pair on secondary markets will be DAI-FIXED / DAI. It is worth noting that LPs would have limited impermanent loss because of the stable nature of the product and more certainty around potential profitability brought about by trading fees.

Seed liquidity will be provided by the Index Coop per budgetary allocations defined for 2022 and deployed on Uniswap v3 (main net).

Target Access Cost %	1.00%
ETH/USD Price	$3,000
Gas Price	65 gwei
Exchange Issuance Gas Required	920,000 wei
Exchange Issuance Gas Cost	$179
Total Baseline Liquidity	$8,209,771
Concentration - Lower Bound	-2%
Concentration - Upper Bound	2%
DAI Required	$40,443
Tokens Required	404
Total USD Required	$80,886

10.0 ‌Author Background

The Product Pod is responsible for designing, developing, and deploying index products for the Index Coop, as well as managing and maintaining products post-launch.

11.0 Marketing support / distribution / partnerships

As the first internally-produced product for the Index Coop, there will be a joint effort amongst Product, BD, and Growth to market, distribute, and maximize composability for FIXED products.

Option to Extend

If approved by Index Coop governance, this suite proposal can be extended to other products that adhere to the same methodology (ex. USDC-FIXED, FEI-FIXED, etc).

Copyright

Copyright and related rights waived via CC0.