Ten Key Parameters of Flexible Leverage Index (FLI) Products

There are 10 key parameters that affect the functionality of FLI products and it is crucial for FLI investors to understand these parameters as well as the mechanics that enable leveraged exposure to ETH or BTC.

Our flexible leverage index products are distinct from the Index Coop’s passive index products in that they employ leverage to double token holders’ exposure to the underlying asset. In order to create this leverage and abstract away collateral and debt management for the user, a series of smart contracts monitor and manage capital allocation in an automated fashion. A variety of parameters dictate how the FLI smart contracts function and they are configured to ensure a safe and seamless user experience. As AUM grows and upgrades are approved by the community, these parameters are updated by members of the Leverage Indices Pod. This post is designed to help you understand these 10 key parameters

• Targeted Leverage Ratio

• Leverage Ratio Range

• Recentering Speed

• Max Trade Size

• Supply Cap

• TWAP Cooldown Period

• Ripcord Parameters

• Decentralized Exchange

• Borrowing and Lending Protocols

• cTokens

1. Target Leverage Ratio

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, over the long term, FLI products are programmed to rebalance back towards the Target Leverage Ratio. You can see the target and real leverage ratios for ETH2x-FLI and for BTC2x-FLI on TokenSets

The Target Leverage Ratios for ETH2x-FLI and BTC2x-FLI is 2x.

The Target Leverage Ratio defines the expected returns for a FLI 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 decay).

2. Leverage Ratio Range

A safe Leverage Ratio Range is defined for each FLI product. This range is bound by minimum and maximum leverage ratios, with equivalent distance in either direction from the target leverage ratio.

For ETH2x-FLI, the safe Leverage Ratio Range is 1.7x — 2.3x and the target leverage ratio is 2.0x. For BTC2x-FLI, the safe Leverage Ratio Range is 1.8x — 2.2x and the target leverage ratio is 2.0x.

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 FLI product. At any point in time, the real leverage ratio may be 1.83x or 2.12x, but over time, it will gravitate back towards the target leverage ratio.

3. Recentering Speed

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

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.

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.

4. Max Trade Size

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).

Let’s 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 short cooldown period.

The Max Trade Size is one of the critical parameters for leveraging and deleveraging FLI products. When markets are volatile, it is important to be able to reduce leverage as quickly as possible in order 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 FLI products. For this reason, Max Trade Size and Supply Cap are often adjusted in tandem.

5. Supply Cap

The Supply Cap is the maximum amount of FLI tokens that can be minted. New FLI products tend to launch with a smaller supply cap in order 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 FLI tokens can be minted. However, FLI tokens can still be redeemed for the underlying assets and traded on exchanges if the Supply Cap has been met.

At time of writing, the current Supply Cap for BTC2x-FLI is 400,000 units.

If the Supply Cap has been reached while there is excessive demand in the market, tokens may trade at a premium above the NAV (Net Asset Value) 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.

6. TWAP Cooldown Period

Description: The TWAP Cooldown Period (TWAP: Total Weighted Average Price) specifies the amount of time that FLI 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.

The Cooldown Period for ETH2x-FLI is 30 seconds.

The TWAP Cooldown Period allows time for the relevant liquidity pools that the FLI 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 FLI products from unfavorable slippage, minimizing operational costs, and preserving AUM.

7. Ripcord Parameters

A separate set of emergency parameters apply to Ripcord transactions. Ripcord transactions only occur when the leverage ratio is dangerously 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

If the real leverage ratio for BTC2x-FLI is 2.45x, the ripcord function can be called to aggressively delever the product. The special parameters enable much more rapid delevering compared to the standard, operational parameters.

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 FLI product is operating outside the bounds of its safe leverage ratio.

8. Decentralized Exchange

“DEX” is an acronym for Decentralized Exchange, and in the context of FLI parameters, it specifies the decentralized exchange that a FLI product trades against during rebalancing. The most commonly used DEXs for FLI products are Uniswap v2 and Sushiswap, though Uniswap v3 will likely be used in the future.

Whenever USDC is borrowed in Compound to lever up ETH2x-FLI, the Strategy Adapter Contract swaps USDC for ETH using the ETH/USDC pool on Sushiswap (aka the DEX). Similarly, whenever ETH2x-FLI needs to be delevered, the Strategy Adapter Contract will swap ETH for USDC using the same Sushiswap pool in order to pay down the borrowed USDC balance.

Because the process of interfacing with DEXs is abstracted away from token holders, there is little impact to investors. DEX liquidity pools are analyzed for favorable fees and minimal slippage in order to minimize costs for investors and preserve AUM.

9. Borrowing and Lending Protocols

In order to establish fully collateralized, leveraged positions, FLI products use Borrowing / Lending protocols like Compound or Aave to deposit collateral assets and borrow stablecoins (those stablecoins for more of the collateral asset).

When new ETH2x-FLI tokens are minted, the smart contracts that manage AUM deposit ETH into Compound (aka the Borrowing / Lending protocol) as collateral and then borrow USDC from Compound against the deposited collateral. That USDC is then swapped for more ETH using a DEX and the new ETH is added to the collateral balance in Compound.

Because the process of interfacing with Borrowing / Lending Protocols is abstracted away from token holders, there is little impact to investors. In the event that a protocol (ex. Compound) is distributing rewards (ex. COMP) to users, those rewards will be swapped for the token’s underlying asset (ex. ETH, wBTC) and deposited as collateral to the Borrowing / Lending Protocol, increasing AUM and each token holder’s representative share of underlying assets.

10. cTokens

cTokens — often identified by a leading “c-” in the ticker — are received whenever you lend cryptocurrency through Compound. cTokens act as a sort of receipt for your deposit and the interest that you earn from a lending position is also accumulated in cTokens. When it’s time to reclaim your deposit, cTokens are redeemed for the corresponding asset. Click here for more info on cTokens.

When you deposit wBTC to Compound, you receive cwBTC in return. Earned interest accrues to your cwBTC balance, and when you want to reclaim your deposited assets, you redeem your cwBTC tokens for wBTC plus interest earned.

Each FLI token’s share of the underlying assets is displayed on the TokenSets website. The collateral asset is listed as a cToken — either cETH or cwBTC — because it has been deposited to Compound in order to create the leveraged position. Assets posted as collateral can also earn interest as deposits and they may also receive protocol rewards (ex. COMP, stAAVE).

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