Leverage Token Parameters

Summary

A variety of parameters dictate how leverage products function and they are configured to ensure a safe and seamless user experience. These parameters are contained within a series of smart contracts and they are updated by Index Coop to accommodate changes in the market according to the methodology.

Target Leverage Ratio

Description: Target Leverage Ratio is the ideal balance between the underlying asset and the borrowing asset (i.e. 2 to 1 ratio). As the price of the underlying asset fluctuates, so does the real leverage ratio. However, leverage products are programmed to rebalance back toward the Target Leverage Ratio.

Example: The Target Leverage Ratio for ETH2x and BTC2x is 2.0x, while the Target Leverage Ratio for ETH3x and BTC3x is 3.0x.

What this means for users: The Target Leverage Ratio defines the expected returns for a leverage token relative to the performance of the underlying asset. When the price of the underlying asset changes, a constant Leverage Ratio of 2x translates to twice the gain or loss (without factoring in volatility drift).

Leverage Ratio Range

Description: A safe Leverage Ratio Range is defined for each leverage product. This range is bound by minimum and maximum leverage ratio.

Example: For ETH2x, the safe Leverage Ratio Range is 1.74x - 2.30x and the target leverage ratio is 2.0x. For BTC2x, the safe Leverage Ratio Range is 1.82x - 2.20x and the target leverage ratio is 2.0x.

What this means for users: Though the target leverage ratio may be 2x, it is important to understand that the real leverage ratio may fluctuate within the safe range defined for the leverage product. At any point in time, the real leverage ratio may be 1.83x or 2.12x, but over time, it will gravitate back toward the target leverage ratio.

Recentering Speed

Description: Recentering Speed is the rate at which the leverage ratio can adjust on a routine basis in order to revert back to the Target Leverage Ratio. Recentering Speed is measured as a proportional percentage of the target leverage ratio.

Example: If the Recentering Speed is 5% while the current leverage ratio is 1.9 and the target leverage ratio is 2.00, then the smart contracts managing the product will adjust the ratio of underlying assets so that the new leverage ratio is 1.995.

What this means for users: the Recentering Speed affects a product’s ability to realign the real leverage ratio with the target leverage ratio. Depending on the leverage ratio’s distance from the target, you can use the Recentering Speed to predict the amount of time it will take to return to the target leverage ratio.

Max Trade Size

Description: The Max Trade Size limits the trade size for rebalance transactions in order to avoid excessive price impact and slippage to adjust leverage during volatile price swings. When swapping the underlying asset through a DEX, there is an upper limit denominated in the underlying token that rebalance transactions cannot exceed. In practice, if the total trade amount required for rebalancing exceeds the Max Trade Size, the sum will be broken down into multiple transactions (aka iterateRebalance transactions).

Example: Say we have a leverage ratio of 2.3x and a max trade size of 200 ETH. When a rebalance is initiated, the smart contract will delever by swapping ETH for USDC through a DEX. If the amount of ETH to be swapped is less than 200, then the entire rebalance trade will be processed as a single transaction. But, if the amount of ETH to be swapped exceeds 200 (ex. 275 ETH), then one trade will be initiated with 200 ETH and a subsequent trade will be made with 75 ETH after a brief cooldown period.

What this means for users: the Max Trade Size is one of the critical parameters for rebalancing leverage products. When markets are volatile, it is important to be able to reduce leverage as quickly as possible to avoid liquidation. If the Max Trade Size is too small relative to the total AUM, it could take an excessive amount of trades (and time) to delever leverage products. For this reason, Max Trade Size and Supply Cap are often adjusted in tandem.

Supply Cap

Description: The Supply Cap is the maximum amount of leverage tokens that can be minted. New products tend to launch with a smaller supply cap to ensure stability and the Supply Cap is gradually lifted as the product’s performance is validated. Once the Supply Cap is reached, no more leverage tokens can be minted. However, tokens can still be redeemed for the underlying assets if the Supply Cap has been met.

Example: at the time of writing, the current Supply Cap for ETH3x is 5,000 units.

What this means for users: If the Supply Cap has been reached while there is excessive demand in the market, tokens may trade at a premium to NAV (Net Asset Value) on DEXs because buyers are willing to pay more for the token than it is intrinsically worth. Click here for more information on FLI product premiums and NAV dislocation.

TWAP Cooldown Period

Description: The TWAP Cooldown Period (TWAP: Total Weighted Average Price) specifies the amount of time that leverage token contracts must wait to initiate another rebalance transaction. The unit of measure for the Cooldown Period is seconds and it is compared to the timestamp of the last transaction. Delaying consecutive rebalance transactions allows the liquidity pool to be arbitraged back to the correct price before placing the next trade, which has a favorable effect on price impact and slippage for the relative liquidity pools.

Example: the Cooldown Period for ETH2x is 30 seconds.

What this means for users: the TWAP Cooldown Period allows time for the relevant liquidity pools that the leverage token contracts trade against during rebalancing to absorb the most recent rebalance transaction before submitting a subsequent one. Allowing the liquidity pool to rebalance after each trade shields leverage products from unfavorable slippage, minimizing operational costs and preserving TVL.

Ripcord Parameters

Description: A separate set of emergency parameters apply to Ripcord transactions. Ripcord transactions only occur when the leverage ratio is outside the bounds of the safe range and leveraged positions are at risk of liquidation.

Ripcord transactions have the following parameters that are different from the parameters that apply to routine operations:

• Ripcord Max Trade Size

• Ripcord TWAP Cooldown Period

• Ripcord Slippage Tolerance

Example: if the real leverage ratio for BTC2x is 2.70x, the ripcord function can be called to aggressively delever the product. These special parameters enable much more rapid delevering compared to the standard, operational parameters.

What this means for users: Ripcord Parameters act as a last line of defense for investors by protecting against liquidation. The ripcord function is publicly callable and incentivized by an ETH reward so that anyone can initiate deleveraging if a leverage product is operating outside the bounds of its safe leverage ratio.

DEX

Description: “DEX” is an acronym for Decentralized Exchange, and in the context of leverage token parameters, it specifies the decentralized exchange that a product trades against during rebalancing. Uniswap V3 is the primary DEX used by leverage tokens today, but other DEXs may be supported in the future.

Example: Whenever USDC is borrowed in Aave V3 to lever up ETH2x, the Strategy Adapter Contract swaps USDC for ETH using the ETH/USDC pool on Uniswap V3. Similarly, whenever ETH2x needs to be delevered, the Strategy Adapter Contract will swap ETH for USDC using the same Uniswap pool in order to pay down the borrowed USDC balance.

What this means for users: because the process of interfacing with DEXs is abstracted away from token holders, there is little impact to users. DEX liquidity pools are periodically analyzed for favorable fees and minimal slippage to minimize costs for investors and preserve TVL.

Borrowing / Lending Protocol

Description: In order to establish fully collateralized, leveraged positions, leverage tokens use Borrowing / Lending protocols like Aave V3 to deposit collateral assets and borrow stablecoins (then swap those stablecoins for more of the collateral asset).

Example: When new ETH3x tokens are minted, the smart contracts that manage TVL deposit ETH into Aave V3 (aka the Borrowing / Lending protocol) as collateral and then borrow USDC from Aave against the deposited collateral. That USDC is then swapped for more ETH using a DEX (ex. Uniswap V3) and the new ETH is added to the collateral balance in Aave.

What this means for users: because the process of interfacing with Borrowing / Lending Protocols is abstracted away from token holders, there is little impact to investors. However, if supply caps for relevant markets are reached in Aave, re-levering tokens may be temporarily disabled. Similarly, if the utilization rate is 100% for a relevant market, rebalancing and withdrawals may be temporarily disabled.