In a week where the entire market was gapping down, a curious case was how Index Coop’s indexed token ETH 2x – FLI did not reflect this price action proportionally in relation to its methodology, i.e. if ETH is up X, this index token should be up 2x, while if it’s down X, the FLI product should be down approximately 2x.
While token holders are hardly complaining (they 2xed ETH performance the way up, but matched it on the way down), the reason why the indexed product didn’t perform according to its methodology comes down to governance not acting as fast as the market moves.
In order to understand this, we need to look at the methodology around the ETH 2x – FLI token.
The ETH2x-FLI aims to stay at a leverage ratio between 1.7 – 2.3x. This flexible rebalancing nature minimizes the number of rebalances, and thereby gas costs, to maintain a leveraged position. It currently uses Compound as its lending protocol.
How does FLI manage inherent liquidation when the market gaps down like on May 19th?
Based on the methodology, it would seem that ETH 2x FLI should have moved ~2x lower than that of ETH at the height of the selling.
Why did this not happen?
What does this mean exactly? How does it affect the indexation pricing?
The amount of ETH 2x FLI tokens was capped 400k and required a governance vote to increase supply to 600k.
The lack of new supply meant that the leveraged token was seen trading anywhere from a 30-45% premium to NAV because a lack of new issuance meant that the new indexation pricing could not be discovered. The supply essentially prevented bots from minting new tokens.
Where are we today (May 24th)? What is the current premium?
It does appear that from the 85% move in the NAV, the DEX premium has narrowed significantly, thus alleviating investor concerns and reducing price uncertainty.
The problem that Index Coop faced was that there was a significant arbitrage where investors that understood this premium could sell the leveraged token on the DEXes in the knowledge that they could buy back the position once the supply cap was raised. This creates a challenge for the credibility of the product.
To be sure, the index performed perfectly well in terms of its core objective, which is to avoid liquidation.
There is currently a renewed proposal taking place to raise the supply cap of the ETH2x-FLI from 400,000 units to 600,000 units, ending this Wednesday, May 26. Hence, investors should continue to be aware of the premium (or discount) at which the NAV trades.
If the proposal to increase the supply cap succeeds, the price of ETH2x -FLI will decrease and return to ~1.8-2.3x tracking that is in line with the methodology.
Disclosure: The author is a member of the Index Coop DAO.