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<p>Finding anything positive in last year&#8217;s performance is a challenging task. We still give it a try.</p>



<p>2022 was a bad year for <s>DeFi</s> <s>digital assets</s> <s>risk assets</s> almost all asset classes. Record high <strong>inflation</strong> added further headwind to real returns. The <strong>DeFi Pulse Index</strong>, <a href="https://www.scalara.xyz/"><strong>Scalara&#8217;s</strong></a> benchmark for the DeFi sector was no exception. The index fell 80% in dollar terms, compared to a 68% drop in the price of ETH.</p>



<p>The index ended the year with 10 constituents. It started the year with 17 index components but over the course of the year tokens <a href="https://www.scalara.xyz/blog/methodology-change-defi-pulse-index-introduction-of-minimum-weight-requirement"><strong>with a negligible weight were removed</strong></a> or <a href="https://www.scalara.xyz/blog/defi-pulse-index-update-rgt-tribe-merger"><strong>merged</strong></a> or were <a href="https://www.scalara.xyz/blog/defi-pulse-index-update-extraordinary-removal-of-tribe"><strong>delisted</strong></a>.</p>



<p>The best and worst performers of 2022 based on the current constituents are show in the table below. To paint a slightly more rosy picture, returns are based on asset prices denominated in ETH:</p>


<div class="wp-block-image">
<figure class="aligncenter size-full"><img decoding="async" width="494" height="434" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image.png" alt="" class="wp-image-1196 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image.png 494w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-300x264.png 300w" sizes="(max-width: 494px) 100vw, 494px" /><noscript><img decoding="async" width="494" height="434" src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image.png" alt="" class="wp-image-1196 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image.png 494w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-300x264.png 300w" sizes="(max-width: 494px) 100vw, 494px" /></noscript><figcaption class="wp-element-caption">Returns in ETH. Data source: Coingecko.</figcaption></figure></div>


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<p>The overall annual return does not look good. But how did the index perform <strong>throughout the year</strong>?<br>Surprisingly, within 2022 there were several longer periods of strong positive performance, both in USD and ETH terms. From mid-June to mid-August the DeFi Pulse Index <strong>rallied 107%</strong> slightly outperforming ETH. These gains were lost by end of the year though.</p>


<div class="wp-block-image">
<figure class="aligncenter size-full"><img decoding="async" width="481" height="285" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image002.png" alt="" class="wp-image-1198 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image002.png 481w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image002-300x178.png 300w" sizes="(max-width: 481px) 100vw, 481px" /><noscript><img decoding="async" width="481" height="285" src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image002.png" alt="" class="wp-image-1198 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image002.png 481w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image002-300x178.png 300w" sizes="(max-width: 481px) 100vw, 481px" /></noscript><figcaption class="wp-element-caption">DeFi Pulse Index in USD. 2022. Data source: Coingecko.</figcaption></figure></div>


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<p>When <strong>measuring the DeFi Pulse Index in ETH</strong> there have been times of positive absolute performance as well. From mid-May to mid-July the index <strong>increased by 81% in ETH</strong>.</p>


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<figure class="aligncenter size-full"><img decoding="async" width="481" height="284" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image004.png" alt="" class="wp-image-1199 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image004.png 481w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image004-300x177.png 300w" sizes="(max-width: 481px) 100vw, 481px" /><noscript><img decoding="async" width="481" height="284" src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image004.png" alt="" class="wp-image-1199 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image004.png 481w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image004-300x177.png 300w" sizes="(max-width: 481px) 100vw, 481px" /></noscript><figcaption class="wp-element-caption">DeFi Pulse Index in ETH. 2022. Data source: Coingecko.</figcaption></figure></div>


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<p>Lastly, we take a look at correlations as they are the drivers of <a href="https://www.scalara.xyz/blog/why-invest-in-an-index"><strong>diversification</strong></a>. The more uncorrelated two assets are, the greater is the reduction in risk when combining these two assets. The average pairwise correlation based on daily returns in 2022 was 0.67. This is somewhat higher than the average pairwise correlations seen in the S&amp;P 500 that is typically in the order of 0.3 to 0.5.</p>


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<figure class="aligncenter size-full"><img decoding="async" width="519" height="296" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-1.png" alt="" class="wp-image-1204 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-1.png 519w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-1-300x171.png 300w" sizes="(max-width: 519px) 100vw, 519px" /><noscript><img decoding="async" width="519" height="296" src="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-1.png" alt="" class="wp-image-1204 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-1.png 519w, https://matthewd210.sg-host.com/wp-content/uploads/2023/01/image-1-300x171.png 300w" sizes="(max-width: 519px) 100vw, 519px" /></noscript><figcaption class="wp-element-caption">DeFi Pulse Index pairwise correlations. 2022. Data source: Coingecko.</figcaption></figure></div>


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<p>Happy New Year!</p>



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<p><em>Scalara is dedicated to creating and maintaining indices for a decentralized world.</em></p>


DeFi Pulse Index 2022 in Review


<p><strong>Scalara</strong> announces the results of the <strong>October 2022 rebalance</strong> of the DeFi Pulse Index.</p>



<p>The <strong>DeFi Pulse Index</strong> is a digital asset index designed to track the performance of some of the largest protocols in the Decentralized Finance (DeFi) space. Over the last three months the DeFi Pulse Index returned <strong>-20%</strong>.</p>


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<figure class="aligncenter size-full"><img decoding="async" width="453" height="503" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/10/image.png" alt="" class="wp-image-1192 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/10/image.png 453w, https://matthewd210.sg-host.com/wp-content/uploads/2022/10/image-270x300.png 270w" sizes="(max-width: 453px) 100vw, 453px" /><noscript><img decoding="async" width="453" height="503" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/10/image.png" alt="" class="wp-image-1192 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/10/image.png 453w, https://matthewd210.sg-host.com/wp-content/uploads/2022/10/image-270x300.png 270w" sizes="(max-width: 453px) 100vw, 453px" /></noscript><figcaption>Coingecko data.</figcaption></figure></div>


<p>On a shorter time scale, just in October, the DeFi Pulse Index returned +8% led by Sushi (+53%), Balancer (+26%) and Maker (+23%).</p>



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<h2>DeFi Pulse Index rebalance weights</h2>



<p class="has-text-align-center"><img class="lazyload" decoding="async" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://lh6.googleusercontent.com/ZjBOJ4N_wykqoJlowa7KtYJTkVDzE8c7Sb5c6-tDVLxGPiRI0Uve-_8isceyG6FAHFm2970BOfUaiEQUtBYk2H5UmRenpmt7OpB_HzjB24E7S8igu-UE2H4Z_7DfXBKBPacYZzS1UP-BVgAhoClS2mn63TV5QLlAe2freiY0VtqSYcfnBN_J-py2MA" width="624" height="293"><noscript><img class="lazyload" decoding="async" src="https://lh6.googleusercontent.com/ZjBOJ4N_wykqoJlowa7KtYJTkVDzE8c7Sb5c6-tDVLxGPiRI0Uve-_8isceyG6FAHFm2970BOfUaiEQUtBYk2H5UmRenpmt7OpB_HzjB24E7S8igu-UE2H4Z_7DfXBKBPacYZzS1UP-BVgAhoClS2mn63TV5QLlAe2freiY0VtqSYcfnBN_J-py2MA" width="624" height="293"></noscript></p>



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<h2>Rebalance summary</h2>



<p>The above index weightfactors and weights were calculated using prices and circulating supplies of all 12 assets as of October 25, 2022.</p>



<p>At the October 2022 index rebalance, <strong>two tokens are removed</strong> from the DeFi Pulse Index while no new tokens are added, resulting in 10 index constituents. Both KNC and BADGER are removed due to their respective projects’ continued <strong>decreased usage</strong>. Coincidentally they are also the two smallest tokens by weight in the index (combined approximately 2%).</p>



<p>For <strong>most constituents</strong> of the DeFi Pulse Index, the index <strong>weight increased marginally </strong>this quarter to make up for the two removals and the capping of UNI. UNI’s 53% allocation under market cap weighting once again would have breached the allocation limit of 25% for any single constituent without any capping. The <a href="https://www.scalara.xyz/blog/methodology-change-defi-pulse-index-introduction-of-flexible-capping">Flexible Capping</a> rule moved its weight half the way from the current index weight to the 25% target to reduce turnover.<br>The total one-way turnover of the rebalancing is 4.5%.</p>



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<p><em>Scalara is dedicated to creating and maintaining indices for a decentralized world.</em></p>


October 2022 Rebalance DeFi Pulse Index


<p><strong>Index providers have rules for every possible capital markets event to accurately represent the underlying economic reality. But how would a TradFi basket index handle a fork?</strong></p>



<p>A group of developers and miners plan to fork the Ethereum blockchain after <a href="https://www.defipulse.com/blog/ethereum-merge-supply-dynamics-primer"><strong>the Merge</strong></a>. This new chain would continue to run a <a href="https://en.wikipedia.org/wiki/Proof_of_work"><strong>proof of work</strong></a> (PoW) algorithm as part of its consensus mechanism. Such a fork will create a new chain on which users will have an amount of &#8220;PoW ETH&#8221; matching their balance on the Proof of Stake (PoS) chain.</p>



<p>The distribution of tokens through the fork closely resembles the TradFi corporate action of a <strong>spin-off</strong>.</p>



<p>According to MSCI&#8217;s <strong><a href="https://www.msci.com/index-methodology" target="_blank" rel="noreferrer noopener">Corporate Events Methodology</a></strong>, <em>a spin-off is the free distribution of shares in a wholly-owned company to the parent company’s existing shareholders.</em></p>



<p>What happens next in the index? Usually an index methodology would not allow the holding of the newly added asset and <strong>remove it</strong> as soon as possible. In order to remove an asset from an index a price is required though. Effectively, the index<strong> “sells” the asset and reinvests the proceeds in the remaining assets</strong> proportionally. Therefore, most index providers&#8217; rules would remove the spin-off company immediately if there is a price available on the effective date (“ex date”) of the spin-off. Otherwise, the index will hold the spin-off until the security starts trading.</p>



<h2>Index adjustments</h2>



<p>Since any index composition change has to be <strong>self-financing</strong> in total return indices, i.e. money is neither generated nor lost across the removal, the <strong>index divisor is adjusted</strong> (lowered) when the asset is removed:</p>


<p>\[Divisor^{post} = {\sum_{i}p_{i} \cdot s_{i} \over \sum_{i}{p_{i} \cdot s_{i}} + \text{spin-off value}} \cdot Divisor^{pre}\]</p>



<p>Divisor adjustments implicitly distribute the proceeds proportionally across the index.</p>



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<p><em>Scalara is dedicated to creating and maintaining indices for a decentralized world.</em></p>


The index provider’s view on forks


<p><strong>Scalara will end maintenance and publication of the Passive Omnichain Net Yield (PONY) Index.</strong></p>



<p>Note: Scalara does not control any token implementations of its indices. The token contract tracking the index and any bridged versions are created in a completely permissionless fashion. If you have any related questions, please <a href="https://share.hsforms.com/1mLThvHcvTLiD6gWhvgWUIwd1av5">reach out</a>.</p>



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<p><a href="https://www.scalara.xyz/"><em>Scalara</em></a><em>, a subsidiary of </em><a href="https://defipulse.com/"><em>DeFi Pulse</em></a><em>, creates and maintains indices for a decentralized world.</em></p>


Scalara to cease support of PONY Index


<p><strong>Leverage is a powerful tool to amplify the gains (and losses) of a strategy – in this article we explain how it works.</strong></p>



<p>In finance, leverage refers to the concept of borrowing funds to buy assets and thereby have more exposure than the original funds would allow. Of course, the risk of insolvency is amplified as well!</p>



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<h2>What are leverage indices?</h2>



<p>Leverage indices such as <a href="https://www.scalara.xyz/indices/fli"><strong>Scalara’s Flexible Leverage Indices</strong></a> (FLIs) are designed to seek returns that are a <strong>multiple of an underlying asset’s return</strong>. For example, the ETH 2x Flexible Leverage Index (ETH2x-FLI) aims to return two times the return of the price of ETH. This also means that if the ETH price falls, the leverage index falls even more.</p>



<figure class="wp-block-image size-large"><img decoding="async" width="1024" height="574" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1024x574.png" alt="" class="wp-image-1145 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1024x574.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-300x168.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-768x431.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image.png 1316w" sizes="(max-width: 1024px) 100vw, 1024px" /><noscript><img decoding="async" width="1024" height="574" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1024x574.png" alt="" class="wp-image-1145 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1024x574.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-300x168.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-768x431.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image.png 1316w" sizes="(max-width: 1024px) 100vw, 1024px" /></noscript><figcaption>Schematic of single period return of leverage index.</figcaption></figure>



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<p>Intuitively, the leverage index performance can be formulated as:</p>


<p>\[LI_{T+1}=LI_{T} \cdot (1 + L \cdot r_{UL, T+1})\]</p>



<p>where <em>L</em> is the leverage ratio and <em>r<sub>UL</sub>, T+1</em> the return from time <em>T</em> to <em>T+1</em> of the underlying asset.</p>



<p>An alternative representation, that allows for greater insight, tracks the value of the <strong>collateralized debt position</strong> (CDP) that is entered into to generate leverage. The index value is the <strong>net asset value</strong> (<em>NAV</em>) of this CDP.</p>



<figure class="wp-block-image size-large"><img decoding="async" width="1024" height="574" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-1024x574.png" alt="" class="wp-image-1151 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-1024x574.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-300x168.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-768x430.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1.png 1315w" sizes="(max-width: 1024px) 100vw, 1024px" /><noscript><img decoding="async" width="1024" height="574" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-1024x574.png" alt="" class="wp-image-1151 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-1024x574.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-300x168.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1-768x430.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-1.png 1315w" sizes="(max-width: 1024px) 100vw, 1024px" /></noscript><figcaption>Leverage index implementation as a CDP with ETH 2x example.</figcaption></figure>



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<p>\[LI_{T+1}=NAV_{CDP, T+1} = Collateral_{T+1} &#8211; Debt_{USD, T+1} = Collateral_{T} \cdot (1 + r_{UL, T+1}) &#8211; Debt_{USD, T}\]</p>



<p>whereby we assume there is no cost to borrow (i.e. the debt balance is unchanged from <em>T</em> to <em>T+1</em>).</p>



<p>This second formula is helpful to understand how the performance of the underlying asset affects the <strong>leverage ratio</strong> (<em>LR</em>) of the CDP over time. The <em>LR</em> of the CDP is the value of the <strong>collateral divided by its NAV</strong>.</p>



<p>After one time period, if the underlying asset&#8217;s price increases, the leverage ratio decreases and vice versa:</p>


<p>\[LR_{T+1} = {Collateral_{T+1} \over NAV_{T+1}} = {Collateral_{T} \over Collateral_{T} &#8211; {Debt_{T} \over 1 + r_{UL, T+1}}}\]</p>



<p>which is less than <em>LR<sub>T</sub></em> if <em>r<sub>UL,T+1</sub> > 0</em> and greater than <em>LR<sub>T</sub></em> if <em>r<sub>UL,T+1</sub> &lt; 0</em>.</p>



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<h2>Why rebalance?</h2>



<p>As long as this collateralized debt position is left unchanged, the return over the holding period will be as expected: the underlying return multiplied by the leverage ratio at inception of the CDP.</p>



<p>There are two reasons why leverage indices are rebalanced:</p>



<p>Firstly, to <strong>avoid insolvency and liquidation</strong>. Rebalancing to a lower leverage ratio increases the health of the debt position. As we have seen above the leverage ratio increases when the underlying asset&#8217;s price falls.</p>



<p>Secondly, to ensure that the <strong>leverage ratio remains close to the target</strong> leverage. Otherwise, the leverage ratio of the index could deviate significantly from the target leverage depending on the time passed since entering the CDP. Rebalancing will set the LR back to the target leverage so it is providing the expected return (over short holding periods) no matter when a user starts tracking the index.</p>



<p>As we will later see, the tradeoff of this decision to frequently rebalance is that <strong>over longer time periods the leverage index return will not necessarily be close to the the underlying return</strong> <strong>multiplied with the &#8220;advertised&#8221; leverage</strong>.</p>



<p>The following chart shows the performance of a leverage index over <strong>two time periods with rebalancing</strong>. In this example, the index is rebalanced “fully”, i.e. the CDP is adjusted to a leverage ratio of 2 again after the first time period. As a result, during the second time period the leverage index returns two times the underlying return again. The two period return is simply the compounded return <em>(1+r<sub>1</sub>)(1+r<sub>2</sub>)-1</em> (which is clearly not equal to <em>r<sub>1</sub> + r<sub>2</sub></em> !).</p>



<p>In practice this resetting of the leverage ratio is done by either selling collateral assets and repaying debts (if the underlying asset&#8217;s price decreased) or borrowing more and adding to the collateral (if the underlying increased).</p>



<figure class="wp-block-image size-large"><img decoding="async" width="1024" height="266" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-1024x266.png" alt="" class="wp-image-1160 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-1024x266.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-300x78.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-768x199.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2.png 1310w" sizes="(max-width: 1024px) 100vw, 1024px" /><noscript><img decoding="async" width="1024" height="266" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-1024x266.png" alt="" class="wp-image-1160 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-1024x266.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-300x78.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2-768x199.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-2.png 1310w" sizes="(max-width: 1024px) 100vw, 1024px" /></noscript><figcaption>Schematic of two period return of leverage index.</figcaption></figure>



<p>We see that while each single period alone returns twice the underlying return of the corresponding period, over both periods together this holds not true. We will answer why in the next section.</p>



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<h2>What is volatility decay?</h2>



<p>Redrawing the above chart with a smaller return difference between the first and second time period, i.e. <strong>lower volatility</strong> in the underlying asset, shows the impact of volatility on the multiperiod performance of a rebalanced leverage strategy.</p>



<figure class="wp-block-image size-large"><img decoding="async" width="1024" height="271" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-1024x271.png" alt="" class="wp-image-1162 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-1024x271.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-300x79.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-768x203.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4.png 1312w" sizes="(max-width: 1024px) 100vw, 1024px" /><noscript><img decoding="async" width="1024" height="271" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-1024x271.png" alt="" class="wp-image-1162 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-1024x271.png 1024w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-300x79.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4-768x203.png 768w, https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-4.png 1312w" sizes="(max-width: 1024px) 100vw, 1024px" /></noscript><figcaption>Schematic of two period return of leverage index with less volatility in underlying asset.</figcaption></figure>



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<p>By comparing the two charts, we can see that in the first more volatile case the leverage index performed worse in relative terms (<em>8 </em>compared to &#8220;naive&#8221;  <em>2*4.5=9 </em>if not rebalanced). In the second less volatile case the leverage index actually does better than &#8220;expected&#8221; (<em>32</em> compared to <em>2*15.5=31</em>).This <strong>underperformance compared to the un-rebalanced strategy</strong> due to volatility is often referred to as <strong><a href="https://en.wikipedia.org/wiki/Volatility_tax">volatility decay or volatility tax</a></strong>.</p>



<p><strong>There is of course no money stolen or taxed!</strong> As seen above, introducing rebalancing changes the strategy’s leverage &#8220;path&#8221; compared to keeping the CDP unchanged. Every period in the example starts at <em>LR=2</em> if fully rebalanced. On the other hand if the index is not rebalanced the LR is not equal to 2 at beginning of each period.</p>



<p>A more mathematical explanation can be derived from the <a href="https://en.wikipedia.org/wiki/Inequality_of_arithmetic_and_geometric_means">difference between arithmetic and geometric averages</a> but is beyond the scope of this article.</p>



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<h2>Flexible is better</h2>


<div class="wp-block-image">
<figure class="aligncenter size-full"><img decoding="async" width="80" height="80" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-5.png" alt="" class="wp-image-1169 lazyload"/><noscript><img decoding="async" width="80" height="80" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/09/image-5.png" alt="" class="wp-image-1169 lazyload"/></noscript></figure></div>


<p>So far we assumed rebalancing fully back to the target leverage after every time period. This is true for most daily leverage ETFs in traditional finance.</p>



<p><strong>Scalara’s Flexible Leverage Indices</strong> do not fully rebalance to the target leverage at each rebalance though. Instead, as long <strong>as the leverage ratio remains in a band around the target the CDP is only partially adjusted</strong> (e.g. in the case of <a href="https://www.scalara.xyz/indices/fli"><strong>ETH2x-FLI</strong></a>, at each rebalance the CDP is rebalanced to move the LR 5% of the “distance” from its current <em>LR</em> to the target <em>LR</em> of 2). </p>



<p>Since every rebalance requires a swap between borrow asset and collateral asset this flexible algorithm <strong>reduces the overall turnover</strong> (and hence transaction fees).</p>



<p>As a side effect, because the leverage is not set back to its target every time, FLIs may also <strong>closer align with an unrebalanced position</strong> that returns the targeted return multiple over a longer holding period.</p>



<p>This is achieved <strong>without sacrificing safety</strong> since if the <em>LR</em> moves beyond the acceptable band the index is rebalanced back to that upper or lower band level fully. </p>



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<p><strong><a href="https://www.scalara.xyz/indices/fli">Flexible Leverage Indices</a></strong> are implemented as single tokens by the <a href="https://indexcoop.com/products#leverage-inverse-section"><strong>Index Coop</strong></a> and are currently available for ETH, BTC and MATIC. In addition, <a href="https://www.scalara.xyz/blog/launching-inverse-eth-fli"><strong>inverse versions</strong></a> that provide -1x exposure, i.e. increase when markets fall, to these assets are available.</p>



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<p><em>Scalara is dedicated to creating and maintaining indices for a decentralized world.</em></p>


A Practical Guide to (Flexible) Leverage


<p><strong>Scalara</strong> announces a change to the composition of the <strong>DeFi Pulse Index</strong> as a result of the <strong>impending wind-down of Tribe DAO</strong>. On August 26, 2022, TRIBE will be removed from the index.</p>



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<h2>Background</h2>



<p>On August 19, Fei Labs <a href="https://tribe.fei.money/t/tip-121-proposal-for-the-future-of-the-tribe-dao/4475"><strong>proposed</strong></a> the <strong>shut-down of the Tribe DAO</strong> and a <strong>redemption program</strong> of its TRIBE governance token. Fei Labs is the entity behind the development of Fei Protocol and one of Tribe’s constituent protocols. According to the proposal, TRIBE holders would be able to redeem for a pro rata share of remaining DAO controlled assets after accounting for FEI redemptions as well as compensations for April’s Fuse hack.</p>



<p>In order to ensure the <strong>investability</strong> of the DeFi Pulse Index and <strong>not disadvantage passive holders</strong>, TRIBE is removed from the index.</p>



<p>TRIBE’s price reacted positively to the proposal:</p>



<p class="has-text-align-center"><img class="lazyload" decoding="async" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://lh5.googleusercontent.com/UJFTPylgvlikLNm2grsRyQYwdpb55XKtPtN_qTFw6mq9NC011yP8jMEdnd6URrVYkvyDlybcIFSB18_nQQwNH6D7Z44_JXB4_y24KSXNjFuhkKnoJTnr6tSKlFMELVEnjJZi53d-sMFMD5lhZFDnRL7RA0yBCpIuvDRNvg_CZ49ONT_uWTNM6bNiig" width="425" height="239"><noscript><img class="lazyload" decoding="async" src="https://lh5.googleusercontent.com/UJFTPylgvlikLNm2grsRyQYwdpb55XKtPtN_qTFw6mq9NC011yP8jMEdnd6URrVYkvyDlybcIFSB18_nQQwNH6D7Z44_JXB4_y24KSXNjFuhkKnoJTnr6tSKlFMELVEnjJZi53d-sMFMD5lhZFDnRL7RA0yBCpIuvDRNvg_CZ49ONT_uWTNM6bNiig" width="425" height="239"></noscript></p>



<p>The DeFi Pulse index currently holds approximately 6.4439 units of TRIBE since the <a href="https://www.scalara.xyz/blog/defi-pulse-index-update-rgt-tribe-merger">conversion of its RGT position</a>. All units of <strong>TRIBE </strong>are <strong>removed </strong>and the corresponding index weight is <strong>redistributed proportionally</strong> across all remaining index components. Circulating supplies are not updated for this extraordinary index update. Token prices as of August 23, 2022 were used.</p>



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<h2>DeFi Pulse Index weights</h2>



<figure class="wp-block-image size-full"><img decoding="async" width="938" height="472" src="data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7" data-src="https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5.png" alt="" class="wp-image-1132 lazyload" data-srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5.png 938w, https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5-300x151.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5-768x386.png 768w" sizes="(max-width: 938px) 100vw, 938px" /><noscript><img decoding="async" width="938" height="472" src="https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5.png" alt="" class="wp-image-1132 lazyload" srcset="https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5.png 938w, https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5-300x151.png 300w, https://matthewd210.sg-host.com/wp-content/uploads/2022/08/image-5-768x386.png 768w" sizes="(max-width: 938px) 100vw, 938px" /></noscript></figure>



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<p><em>Scalara is dedicated to creating and maintaining indices for a decentralized world.</em></p>


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DeFi Pulse Index 2022 in Review

October 2022 Rebalance DeFi Pulse Index

The index provider’s view on forks

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