HomeCoinsIndex Cooperative (INDEX)Understanding the ETH2x-FLI Premium | by Abhishek Punia | The Index Coop...

Understanding the ETH2x-FLI Premium | by Abhishek Punia | The Index Coop | May, 2021

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Abhishek Punia

Authors: Allan Gulley and Felix Feng

With the downturn of Black Wednesday and the dislocation of ETH2x-FLI price from NAV, we recognize that there is frustration with the product and the lack of communication from the Set and Index Coop teams.

We recognize the need for more real-time and frequent communication, and to provide developing data as it comes up — which is something we will commit to doing going forward. As a first step, we plan on sharing FLI-related communications more frequently and dynamically via updated medium posts and tweets from the Set Protocol and Index Coop accounts.

This post aims to provide a thorough review of ETH2x-FLI’s supply cap and the premium many people identified over the past week.

The price of ETH2x-FLI is currently trading at a premium on secondary markets (ex. Uniswap v2, Uniswap v3, Loopring) because demand from buyers exceeds supply.

In an ideal scenario, the price of an ETH2x-FLI token is equivalent to a proportional share of underlying assets. This value is referred to as the NAV (Net Asset Value). The NAV for an ETH2x-FLI token is equivalent to cETH holdings minus USDC debt. As an example, TokenSets currently displays the NAV for each ETH2x-FLI token as being $119.71 ($200.49 [cETH] — $80.79 [USDC debt]).

However, when ETH2x-FLI tokens are traded on secondary markets (ex. Uniswap, Loopring), the price can deviate from the NAV if demand exceeds supply. If enough buyers in the secondary market want to own ETH2x-FLI, they may be willing to pay more for the token than what it’s intrinsically worth, causing the price to rise above the NAV. This can lead to a premium above the token’s fair price, which is what we’re seeing currently across different exchanges.

The price on Uniswap is $134.09, but the NAV on TokenSets is $119.71, which represents a premium of ~10%. This price discrepancy is unfavorable for buyers and DEX user interfaces do not currently display premium (or discount) values.

In order to minimize departure from the NAV, arbitrage bots have been deployed to mint new supply in response to demand in different markets. Non-U.S. users can also mint new supply through the TokenSets website. By introducing new supply to the market, premiums are kept in check because token supply dynamically responds to the demand for tokens in secondary markets.

An upper limit of tokens was agreed upon in order to ensure a guarded rollout of the product (because ETH2x-FLI is the first leveraged product of its kind). ETH2x-FLI recently reached its supply cap — 400,000 units — and because we have reached the supply cap, the arbitrage bots that have been deployed to mitigate premiums are unable to mint new tokens and increase available supply. However, demand for ETH2x-FLI tokens continues to grow, which is why there are significant premiums across secondary marketplaces for buyers of ETH2x-FLI tokens.

The ETH2x-FLI has a supply cap to ensure the safety of the product and prevent excessive liquidation risk. As the supply of FLI products grows, there needs to be a commensurate amount of safety features implemented to properly de-lever the product. Without these additional safety features and liquidity increases, increasing the supply cap will increase liquidation risk. Thus, we typically will increase the cap as there is increased comfort in the robustness of the systems de-levering the Set.

A proposal to increase the supply cap of ETH2x-FLI is being voted on currently, and once the vote has concluded, the upper limit of available tokens will be lifted and the price will return to the NAV as more supply enters secondary markets. The snapshot will end on May 26, 2021, at 4:30 PM US EST, and the changes to the supply cap will be made immediately thereafter.

The same proposal is being voted on for BTC2x-FLI in an effort to avoid similar premiums as we approach its supply cap.

Once the ETH2x-FLI cap is lifted, the price of ETH2x-FLI on DEXes will immediately snap back to the Net Asset Value — which you can find on the TokenSets website. If one were to have purchased the ETH2x-FLI product when there was a premium (anytime over the past week since the supply cap was reached), they will experience a loss when the price returns to NAV.

New investors should be aware that they are paying a premium above the token’s intrinsic value, and the price of the token is expected to return to the NAV when the supply cap is raised. However, the NAV at that time may be higher or lower than the current price based on ETH’s price movements.

Holders have two options: 1) They can sell the ETH2x-FLI product on Uniswap and buy back in when the supply cap has been increased or 2) They can hold onto the product and see if the premium will diminish due to NAV increases.

There is a proposal in the forum to delegate decision-making on FLI parameters (ex. supply cap, max trade size, rebalancing DEX) to a smaller work team that can respond more rapidly to changes in the market. The typical proposal and voting process can take upwards of two weeks to introduce, approve, and implement a single change, so this proposal aims to streamline that process while maintaining security of FLI products and transparency with the Index Coop community. Going forward, the supply cap and any other relevant parameters will be tracked and updated more proactively.

Anyone can monitor the current unit supply of ETH2x-FLI and the max supply cap for ETH2x-FLI using the links provided. The current unit supply of BTC2x-FLI and the max supply cap for BTC2x-FLI can be found using the links provided.

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