How the Community Fund can use BarnBridge's SMART Alpha to hedge risk

Hey everyone – so this is Tyler Ward from BarnBridge. I said a while ago I was going to come in and add to this proposal but I actually talked to Travis/Defi Dad and he had a 2nd proposal for how Nexus could use our SMART Alpha product so I wanted to consolidate it.

To start, this conversation started in reference to this Forum post and then resulted in me lurking in your Discord about on what the feedback would be:

This is where this thought process originated for reference:

“Community Fund - DPI INDEX Proposal” ← this was the name of the proposal.

You can find out more about SMART Alpha here:

Or you can watch Defi Dad’s longer explainer here:

  • A bigger long term conversation is figuring out how we may even be able to use SMART Alpha for re-insurance of some of your pools with the deepest liquidity but I don’t think either of us are there yet in the short term. Maybe in a few years from now with the growth of defi these things will be possible.

The first proposal is in response to the DPI purchase by your treasury.

Background & Problem

  • Based on this conversation it seems like a ton of the community is apprehensive about adding DPI via purchase from the treasury.
  • I was approached by one of the larger 5 Defi funds (I am pretty sure they are an investor in Nexus Mutual) who said they would take the junior side if your treasury took the senior side. In other words, they want to be levered long the DPI and you, in return, would have covered downside protection.
  • I merged background and problem because I think you are more aware as a community of the feedback on this proposal so we don’t need to get too deep into details vs. us offering a solution that you also may not like, which I would understand. I don’t want to sway or sell you on your decision, more I want to inform/educate you that this is an option.

Solution: A SMART Alpha pool for DPI is already deployed, the basis for the peg/unit of account can be ETH or USDC. The fund said they would take either one. In the scenario that one of you removes from the pool (Nexus’s treasury or the fund) you’d both be spot long on the position of holding the DPI. I think realistically if they matched you on your deposit you’d have 35% downside protection while still being long the asset since this isn’t a short position. This is naturally less risky than being spot long the position.

The second is in response to the my conversation with Defi Dad about giving WNXM more utility.

Background

  • So Nexus Mutual has a capital pool of $537,634,280 (129,446 ETH).
  • The native token which aligns the incentives of NXM stakers (underwriters) and those seeking cover who can pay in ETH or NXM.
  • The bonding curve of NXM works basically like this: the larger the capital pool (due to ETH deposits when buying NXM or from ETH or NXM deposited to buy cover, the price of NXM/ETH moves up the bonding curve. If the Capital Pool is shrinking due to a lack of covers bought or folks selling NXM to withdraw ETH, the price moves down along the bonding NXM/ETH bonding curve.
  • So the “book value of NXM” is currently locked at 0.0382 ETH. And there are no bonding curve redemptions so the mutual can maintain a healthy book value ratio of 1.6:1, reflecting some historical numbers from the traditional insurance industry. (Book Value Ratio = NXM Market Cap / Capital Pool Size)
  • Now if you own NXM, you own a claim on the capital pool of ETH.

Problem

  • Today, WNXM is a freely trading ERC20 token that is intended to remain pegged to NXM. Any NXM holder can wrap/unwrap WNXM and so WNXM has become a proxy of the “true price” of WNXM but clearly there’s a market misunderstanding of the capital pool of ETH backing NXM.
  • WNXM today trades near 0.014 ETH while NXM based on the bonding curve is locked at 0.0382 ETH.

Solution: A SMART Alpha pool for WNXM/NXM or WNXM/ETH pool where those who wish to remain long WNXM can bet with leverage on WNXM returning to peg with NXM vs those who wish to protect / hedge against the WNXM peg in the future. I believe the WNXM/ETH pool would be most popular because it’s the number the community fixates on and wants to see grow so their claim on ETH grows larger.

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One other reason I like a pool for WNXM/ETH or WNXM/NXM is:

  1. It requires no work from the Nexus team
  2. It brings together 2 well known profiles in Nexus (those more degen long WNXM/ETH vs those wanting to hedge)
  3. You only have to deposit WNXM and the weekly epochs settle the difference between Juniors (leveraged) vs Seniors (hedged).

The simplicity of depositing a single asset is what makes this easily adopted. However, it will still require community members to participate in the SMART Alpha pool.

Longer term, my hope is that more can hedge against WNXM/NXM going down with the peg back to 1:1. That’s another example where this tool becomes very useful to the Nexus community.

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Thanks @lordtylerward appreciate the detailed post.

I’ll leave the Investment Committee to comment on the DPI aspect @Rei @Dopeee @nsantini @oSaaT

On the wNXM Smart Alpha Pool, this seems like a no brainer to me. I don’t believe a wNXM/NXM pool works technically as NXM has ownership restrictions, but the wNXM/ETH pool makes complete sense to me. Please comment below if you’d like to see this happen and especially if you’re interested in participating in a pool.

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To clarify @Hugh & @DeFi_Dad points… the 2nd part is more an effort on our end… because we can deploy it on our end (it’s permissionless), the bigger question is if people would use it because it takes time to deploy and if there is little liquidity in the pool it won’t make a ton of sense. So if wNXM/ETH has more demand it may make sense for us to open just one and not both since it would splinter liquidity.

So the 2nd part is gauging community sentiment on this being something they would see value in using at all. But Travis is right, it wouldn’t require work from your end.

Longer term though these types of collaborations can lead to other cool things we can do together where an obvious one that would require some work on your end was insuring the SA pools for smart contract risk and we let users purchase those at point of sale… much longer I think SMART Alpha opens up opportunities for re-insurance of Nexus insurance positions, but again, I think those are both less low hanging fruit.

In order of effort on your end I think it goes like this:
2/ Least Effort: the 2nd part of the post
1/ Low Effort (DAO Vote or Community Treasury team decision) on the DPI piece.
3/ Insurance point of sale stuff ← not something I expect either of us can get done in 2021.
4/ Re-insurance ← this is a ways out because it’s not in our hands only it’s affected by liquidity.

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I had to rewrite that because it sounded flippant and it wasn’t supposed to at all on the permissionless part. :hugs:

Personal opinion is DPI isn’t sensible investment for the mutual, even as the senior tranche of a smartalpha.

On the wnxm/eth pool idea - what would be the minimum size where you believe it to be viable/worthwhile for you to do the work? Also is there any flexibility on the timing of the rebalances? Although weekly isn’t as guaranteed a trainwreck as daily leveraged etfs in tradfi, monthly would definitely be better.

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The daily liquidity requirements are more important for 2ndary and we def aren’t there yet on any of the pools.

I got the vibe that DPI may not be a fit anyway, wanted to propose it.

For the monthly piece, is this just your preference or is there a specific component of WNXM that this is important for? Because the short answer is, yes, that can be edited but I am trying to figure out what the intention is past what you said so I fully understand it.

In terms of reasonable deposits - I think it being used at all makes it worth our while to build more closely with the NXM community but if there is only $30k in there at the end of the year, it may cost more to rebalance each week than what it is worth. The biggest whale would probably pay ETH to rebalance if its 7 figures, if its more it just kindof happens automatically by us or the community.

Was just a personal preference on Monthly in terms of lessening the impact of rebalances on l-t performance - nothing wnxm related.

Thank you, @lordtylerward and @DeFi_Dad for presenting this to our community. BarnBridge has something really special with SMART Alpha. Happy to see a use case presented for the mutual.

I would be in favour of exploring the wNXM/ETH pool because it would give us a way to grow our community treasury even when market sentiment isn’t on our side. This can also be used as a hedge against future loss events, but, like I always say, I’ll leave it to the galaxy brains in the Investment Hub to give us more insight. I see this as a greater value add for wNXM/NXM holders and as a solution for our Community Fund.

Thank you again! Great to see DAO-to-DAO proposals :turtle:

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Thank you :slight_smile:

I can wait on your community or @Hugh to let us know what we should do or what information you may need on our end. I’m not 100% sure of your processes so it would feel assumptive for me to propose anything.

Dear @lordtylerward,

Thank you for reaching out with these 2 proposals in 1.
Congrats for getting some good comments from the Community already.

We feel we need to address the 2 topics separately:

Let’s start with the DPI investment you first suggested:

We sincerely appreciate you starting to put together an investment for Nexus treasury (not Capital Pool), and especially already finding buyers for the other side!
Your judgement is right, that we would rather go for a senior tranche for such investments.
It is a good feature which BarnBridge is offering in DeFi with Smart Alpha.

As the DPI pool is already live, this would be a quick implementation for the Community Fund.

However, as commented by member @dcc, we don’t see DPI as an appropriate investment at the moment, for the same reasons as raised in our feedback to the initial proposal.

Going for a senior tranche would not really address these reasons in our perspective.

So, this is not something we would recommend pursuing for the Capital Pool.

Now moving forward onto your second proposal.

As you could probably gather from the initial feedback from @Hugh and @Defi_Dad, we are very open to discussing new markets and use cases for wNXM.

BarnBridge Smart Apha seems to offer quite a unique solution which should be explored further for the benefit of the Nexus Community.

Member @dcc asked 2 important questions and I’ll give you some additional context based on your feedback above:

  • On minimum viable size for the pool:
    You’re right to remind us it should be worth the effort for Barnbridge to build something for wNXM. Rest assured, the community fund has well into the 7 figures worth of wNXM, so we would not be wasting your time. But still, it’s important to get a feeling of an appropriate range for these pools to function properly, based on the design and your experience.

  • On epoch duration: weekly vs monthly (pros & cons based on various criteria)
    There is no specific component in wNXM. @dcc mentioned a personal preference. This reflects the long-term orientation of investments by Nexus (such as stETH). Day-to-day or weekly volatility is not and should not be a focus. Having weekly epochs kind of go against this approach (laid out in the Investment Philosophy).

  • Another item:
    In your proposals, both Nexus Community Fund as well as the Capital pool are mentioned.
    So this would need to be addressed and discussed, which of the 2 vehicles would you expect to be the right one and why?

As a wrap-up, we are

After this feedback, would you be willing to expand on your initial proposal (or start a new one focused on a wNXM/ETH pool…), addressing the 3 questions above?

A few additional items would be good to mention as well:

  • Smart Alpha: Risks and audits
  • Scenarios for participants in a pool.

I find that your docs are well structured.
→ Could you maybe give more color on the “significant risk” for junior depositors which is mentioned?

Also, as you have a good tool for simulation, it would be interesting to go through some scenarios in a proposal for the Community to get a better sense of the possible outcomes.

Once again, as @BraveNewDefi said, we love DAO-to-DAO proposals, and we really appreciate you taking the time to put this together.

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