Methodology
One Click Crypto DeFi Yield Index Methodology
In the rapidly evolving DeFi landscape, the potential for earning yield through various protocols and platforms has attracted significant attention. However, navigating this terrain demands a sophisticated understanding of the associated risks and rewards. One Click Crypto's DeFi Yield Index provides a structured approach to optimize a portfolio of DeFi yield products. This methodology document outlines the rigorous process we employ to construct and maintain the index.
Objective
The One Click Crypto DeFi Yield Index aims to curate a balanced portfolio focused on optimizing returns from DeFi yield products over a targeted time frame, while diligently managing the associated risks.
Eligibility Criteria
To safeguard the stability and profitability of the portfolio, it's crucial that each yield pool we consider meets a stringent set of criteria:
Risk Score Threshold
Rationale: Every yield pool undergoes a rigorous evaluation by the 3rd party risk assessment providers of One Click Crypto, resulting in a risk score, R. Pools that don't achieve a certain threshold in this score aren't fit for a portfolio. This metric is crucial as it provides a comprehensive view of the pool's overall risk profile.
Specifications: Depending on the aggregated risk score, the maximum allocation to a single protocol varies:
Best - 30%
Good - 15%
Average - 7.5%
Watch out - 3.25%
Minimum TVL
Rationale: A robust Total Value Locked (TVL) threshold ensures that we are investing in pools with substantial backing, indicating trust and stability.
Specifications:
Individual pools must have a minimum TVL of $250k.
TVL size should be 10 times the position size. This guarantees liquidity and minimises impact risk when entering or exiting positions.
The protocol’s TVL should be at least $10m.
Age and Audit
Rationale: Age serves as a proxy for the reliability and consistency of the pool. The longer the pool has been active without major issues, the more trustworthy it is. Audits are critical for ensuring the security of the protocol.
Specifications:
Pool age should be a minimum of 6 months.
The protocol should be at least 12 months old and must have undergone an audit.
Underlying Asset Criteria
Rationale: The assets within a pool determine its risk and return profile. By setting criteria for these assets, we aim to strike a balance between potential rewards and risks.
Specifications:
The asset must rank within the top 100 in terms of market capitalization. This ensures we're dealing with assets that have established themselves in the market.
The asset must be at least 6 months old, ensuring it has some track record.
Blue-chip assets, defined as ETH, USDC, USDT, wBTC, DAI, and USDC.e, are not constrained by these criteria owing to their proven stability.
All other assets have a maximum exposure limit of 5%.
A minimum of 35% of the portfolio will be maintained in stablecoins to provide stability.
Maximum allocation to a single pool is capped at 5%, except pools with only blue-chip assets which can go up to 10%.
The specifications provided are meticulously designed to construct a portfolio that is not only expected to deliver optimal returns but also safeguards against the volatile nature of the DeFi landscape.
Risk Assessment
At the core of our index's robust construction is an intricate risk assessment mechanism that prioritises security, transparency, and operational excellence. By harnessing insights from independent risk assessment providers, we are able to generate a composite protocol risk score, which greatly informs our portfolio construction process.
The following parameters, while not having explicit inclusion/exclusion criteria, they are considered when determining the overall risk profile of a protocol:
Smart Contracts and Team:
Ease of finding smart contract addresses
Activity of the primary smart contract
Presence of a public software repository
Visibility of development history
Public visibility of the team (not anonymous)
Code Documentation:
Presence of a whitepaper
Documentation of the protocol's software architecture
Coverage of software documentation over deployed contract's source code
Traceability of documented software to its implementation in the source code
Testing:
Whether the protocol has tested their deployed code
Documented code coverage from tests
Availability of scripts and instructions to run tests.
Detailed report on test results
Undergoing of formal verification
Admin Controls:
Clarity and accessibility of admin control information.
Labelling of contracts as upgradeable or immutable.
Indication of contract ownership type.
Description of contract change capabilities.
Documentation around Pause Control and Time locks.
Oracles:
Adequacy of the protocol's Oracle documentation.
Mitigation strategies against front running.
Vulnerabilities and safeguards related to flash loan attacks.
Operational Security:
The protocol's proactive measures against potential threats.
Reward systems in place, like bounties, to discover vulnerabilities.
Previous security breaches and the protocol's response.
The scores from the risk assessment providers are integrated into a weighted average to produce a composite risk score, denoted as R for each protocol. This composite score not only encapsulates the diverse risk parameters of the protocol but also provides a holistic view of its overall security and reliability profile. Any protocol / pool which fails to meet our minimum risk threshold will not be included in the index. This minimum threshold will depend on the risk level of our index.
Implications
The risk score R is instrumental in our portfolio construction process. By ensuring that we give due consideration to the multifaceted risk landscape of the DeFi sector, we aim to optimise returns while prioritising the safety of the assets within our index. Pools operating under protocols with unfavourable risk scores are either given a reduced weight or excluded altogether, thereby aligning the index's structure with the core tenets of risk-adjusted performance.
Our comprehensive risk assessment approach forms the bedrock of our methodology, ensuring that our index reflects the best of the DeFi yield landscape while safeguarding against potential pitfalls.
Index Construction
The construction of the One Click Crypto DeFi Yield Index is a blend of quantitative analysis and financial modelling. Each constituent's inclusion and weighting are determined through a systematic process, ensuring the index's robustness and alignment with our objectives.
APY is measured as 75% base yield (regular, foundational returns) with 25% reward yield (additional incentives or bonuses).
Constituent Selection
For each yield pool p within a protocol q, the pool risk score PRS(p) is computed as:
Where:
R(q) is the risk score of the protocol, as described in the Risk Assessment section.
TVL(p) denotes the Total Value Locked in the pool.
A(p) represents the age of the pool.
MC(a) is the market capitalization and liquidity of the underlying asset a in the pool, respectively.
h is a function that aggregates these parameters to produce a composite risk score for the pool.
Expected Value Calculation
For each yield pool p with its associated base and reward yields, the expected value EV(p) is computed as:
Where:
BY as the Base Yield
BTP as the Base Token Price
RP as the Rebalance Period
RY as the Reward Yield
RTP as the Reward Token Price
C as the total cost function, which includes slippage, gas, and any other fees.
Constituent Weightings
Once the constituents are selected, their respective weights in the index are determined through an optimization process:
Objective:
Subject to:
The risk constraint:
Asset weight constraints:
For "blue chip" assets:
For all other assets:
Protocol weight constraint:
Where:
wp represents the weight of pool p in the index.
RT is a given risk threshold.
P is the set of all selected pools.
Q is the set of all pools within a specific protocol.
EV(p) is the expected value of pool p.
Wmax, blue chip is the uncapped maximum weight for "blue chip" assets.
By integrating these mathematical models and constraints into our methodology, we ensure that the index provides an optimal blend of yield and risk, while maintaining diversification across assets and protocols.
Note: The exact parameters stated above are dynamic and subject to change. This flexibility ensures our approach remains responsive and tailored to the unique and evolving conditions of each blockchain’s ecosystem, which may include variations in the availability of pools and other critical factors.
Glossary
Admin Controls: Measures and functions that allow administrative access and control over a protocol or smart contract.
Annual Percentage Yield (APY): The real rate of return earned on an investment, taking into account the effect of compounding interest. In our case APY is weighted 25% Reward Yield and 75% Base yield.
Audit: The examination and evaluation of a protocol's smart contracts and codebase by an independent security firm.
Base Yield: The return on an investment in a DeFi yield pool, given in the underlying asset of the pool. This is the standard interest or profit earned from the primary economic activities of the pool, such as lending fees or trading fees.
Blue-Chip Assets: High-quality and widely-recognized cryptocurrencies that are seen as less volatile and more stable. Our Blue-Chips are wBTC, ETH + DAI/USDT/USDC
Formal Verification: The process of using formal methods of mathematics to prove or disprove the correctness of a protocol’s algorithms.
Maximum Allocation: The highest permissible percentage of a portfolio that can be invested in a single yield pool or asset.
Operational Security: The practices and processes designed to protect the integrity, confidentiality, and availability of a protocol or system’s information and resources.
Optimization Process: A mathematical process to find the best solution from a set of alternatives, given certain constraints.
Oracle: A system that provides external data to smart contracts on a blockchain.
Protocol: In DeFi, a protocol is a blockchain-based platform that allows users to engage in financial activities such as lending, or providing liquidity to earn yield. These platforms employ smart contracts to automate financial strategies and transactions.
Reward Yield: An additional return on an investment in a DeFi yield pool, given in a protocol's incentive token. This yield is offered as an extra incentive to pool participants and is typically paid out in the form of the protocol's own token, separate from the base yield which is earned in the underlying asset of the pool.
Risk Assessment Providers: Third-party services that provide evaluations and risk scores for DeFi protocols and yield pools.
Risk Score: A numerical expression of the risk associated with a DeFi investment or decision, considering various factors.
Smart Contract: A contract that executes itself based on its code without the need for an intermediary.
Stablecoin: A cryptocurrency designed to maintain a stable value, often pegged to a fiat currency or commodity.
Total Value Locked (TVL): The total amount of assets deposited in a DeFi protocol, indicating its popularity and security.
Underlying Asset Criteria: The standards that assets within a DeFi pool must meet for inclusion in a portfolio, such as market capitalization and age.
Whitepaper: A comprehensive report or guide that informs readers concisely about a complex issue, often used to help people understand an issue, solve a problem, or make a decision in the context of DeFi protocols.
Yield: In DeFi, yield refers to the earnings generated from investing in various financial activities within a protocol or pool, such as interest from lending or rewards for providing liquidity. It is distinct from capital gains, as it does not include the appreciation or depreciation of the underlying asset itself.
Yield Pool: A DeFi mechanism where participants deposit different types of cryptocurrency assets to gain exposure to multiple yield-generating opportunities. The pool leverages these assets to engage in activities like liquidity provision, lending, or staking, allowing participants to earn yields from the pool's diversified operations.
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