Doc's Daily Commentary
Mind Of Mav
How To Invest In DeFi Indices
Since January 2020 the total value locked (TVL) in decentralized finance (DeFi) has grown from $9.8B (USD) to $108B (USD). This is an increase of 1,102% in a year and a half. As you can see from figure 1 below, this growth has been parabolic. However, to put it in perspective, the market cap of Netflix is $294B (USD), almost 3x that of the entire DeFi sector, and DeFi is aiming to do a lot more stream your favorite show. DeFi is offering an alternative to banks, credit companies, insurance companies, as well as causing a renaissance in the art and gaming industries.
There are a great many entities becoming interested in what DeFi has to offer. Trying to invest in this space can be a fairly daunting task, what with the constant influx of new tokens promising to be the future of finance. For this reason, several different decentralized autonomous organizations (DAOs) have taken it upon themselves to provide easier methods for investing in DeFi. They have done this by offering a basket of tokens wrapped up in one token — this is called a synthetic asset. A synthetic asset basically tracks the underlying assets data feed, whether that is price related or not. Although, in this case it is related to the prices of all the underling tokens.
There are several different synthetics which track an index of DeFi tokens on the market, therefore, I am going to give a brief overall analysis and performance comparison. I will then break down the top performing synthetic and delve into why it is outperforming the competition.
Some of these DeFi index tokens are passively managed and simply track the top tokens by market cap such as DEFI5. Whereas others are actively managed by the DAOs who created and get reassessed on a quarterly or bi-yearly basis. The actively managed model definitely provides better returns; however, it requires community engagement and more work by the team — both on the contract writing side as well as the community management side.
Analysis
In order to get an idea about the price action of the different synthetic indices over the last month a basic comparison needed to be done in order to show the mean daily return and the standard deviation. The mean daily return was calculated by taking the average of all the daily returns. The outcome represents your daily return rate if you were to dollar cost average into the index every day over the past month. The standard deviation represents the variation in daily return; which basically shows us that the larger the standard variation the more exaggerated the price swings in the index. This analysis below compares the seven most popular DeFi indices, unfortunately some indices had a significant amount of missing data which makes their mean daily return less relevant. Ignoring DEFI+S, because it is missing a third of the days in the analysis, nDEFI is a clear winner. nDEFI has the highest mean daily return and lowest standard deviation making it the most attractive investment for someone looking for exposure to the DeFi sector.
Below is a graph (Figure 3) representing the price action of the seven DeFi indices over the past month. Since they all have varied net asset value (NAV) prices I normalized them to make for an easier visual comparison. The past month did not have particularly good returns in DeFi, however nDEFI came out flat with both sDEFI and DEFI++ not far behind. Unfortunately, DEFI5 (by Indexed finance) was hacked last week and funds were stolen from the DEFI5 pool so its graph has been cut short.
Below in figure 4 is an image representing the percentage gains for all these index tokens except DEFI5, since the mid-September sell off. nDEFI is clearly the best performing asset followed by sDEFI.
While this data is useful in the short term, I am very curious about performing this comparison over the next five years and seeing the how these different indices compare. So, stay tuned.
nDEFI
nDEFI was created by Polly Finance and exists on the Polygon Network; and no, this is not the Poly Network that suffered an exploit earlier this year. Polly Finance is actually a franchise created by Bao Finance. Bao Finance has been working hard over the last year spreading franchises onto several chains — including xDAI, Polygon, and BSC. These franchises exist mostly for experimental purposes and testing ideas for Bao Finances home base on Ethereum, but they do have their own governance and models for future utilization. nDeFi is the first actual product created by the Bao Finance other than exchanges and farms, which exist mainly to provide fair distribution of governance over the various protocols. Bao Finance is planning on releasing soft synthetics or “Indices” across all of its franchises in the near future. As well as providing a hard synthetic option on Ethereum before the end of the year. This first hard synth will look something like a synthetic stable which can be minted using LP tokens as collateral. To learn more on this and the vision of Bao Finance please reference the docs.
Now, more on the winning DeFi index product nDEFI.
nDEFI is unique in the synthetic index token space for several reasons. The first reason being the distinctive method in which assets are chosen to be included in the index. As you can see in figure 5 below the team at Polly Finance chose a mix of categories within the DeFi space, each with a weighting corresponding to their maturity and share of the overall market. They then chose to include several assets within each category that were then weighted according to their TVL/FDV. In other words, the weightings are based on the ratio of total value locked divided by fully diluted value. The higher this ratio, the higher the weighting of the token. This method of selection has proven successful because projects that are undervalued in comparison to the amount of money that they have locked in their protocol received a much higher weighting than well-known projects with inflated market caps.
On top of having a unique selection strategy the team at Polly Finance also implements yield strategies on the assets locked in nDEFI. Currently they are using AAVE and CREAM on the Polygon Network. However, they are in the process of implementing yield on the remaining assets with KASHI by SUSHI. Below is a pie chart (Figure 6) representing the asset allocation. It also shows which assets have an active yield strategy.
As you can see from the chart above the ETH in nDEFI is being lent out on AAVE, while CRV, SUSHI, AAVE, MATIC, LINK, and SNX are being lent out on CREAM. Soon, once KASHI by SUSHI is fully functional on the Polygon network, the rest of the assets will have yield strategies.
If you do decide to invest in nDEFI you can actually farm governance tokens for Polly Finance ($POLLY) with your nDEFI. You can do this in either a single nDEFI pool or paired with tokens such as RAI or ETH. I would certainly recommend checking out the pool options available to you — enjoy yield farming.
The $POLLY token is burnt with the minting of every index token and will also be used for the governance of the protocol. Therefore, if you wish to create new indices, $POLLY will be necessary. The goal of Polly Finance is to make it very easy for any user or team to create an index if they wish.
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