The other day I stumbled on PieDAO. PieDAO’s ambition as a self professed “decentralized asset manager for tokenized portfolios, with a mission to bring automated wealth creation to everyone with an internet connection.” was simple, intuitive and appealing to understand (and did I mention the pretty colours?). But how does it really accomplish this?
Anyway, these few days I’ve been kind of thinking about ETFs a LOT. Personally, PieDAO (and I guess, by extension, its comparable competitor protocols Index Co-Op, Set, etc.) is the paragon of what decentralised finance can and might achieve— elegant use of technology improving efficiency as well as enabling greater financial inclusion and empowerment. In sum, PieDAO enables a more efficient, inclusive and empowering ETF issuance and redemption process.
To substantiate this conclusion, this essay will be structured in the following stages:
- The traditional ETF creation and redemption process
- How does PieDAO offer a more efficient, inclusive alternative to the current dogma?
Traditional ETFs
Claiming innovation / improvement from the ways of old, it is necessary to first understand what ETFs are. As this is only an auxiliary point, I won’t go into much here, just as much as required. Here is what I think is salient for current purpose.
What & Why:
- Generally refer to security that is not synthetic — the underlying fund actually owns the underlying assets (e.g. thematic stocks).
- ETFs enable easy exposure to a basket of different things like mutual funds (e.g. a basket of thematic stocks, or market indexes like the Hang Seng / S&P) easily. (Imagine having to buy all the stocks and having to rebalance your exposure all the time in your basket / portfolio**).
- ETFs are great because they provide investors with diversified exposure with lower risk. Assuming those who design your ETF is competent and knows far more about portfolio construction than you do —for example a basket for TMT or healthcare sector exposure.
- As a financial product, ETFs are ‘better’ than mutual funds because they are cheaper (create and manage) and more liquid / tradable. They are sold on the stock market and boast easier unit creation (minting) and redemption (burning).
How:
- ETFs have primary and secondary market offerings. Primary market is only accessible by authorised participants (‘APs’)— institutions, banks, or market makers. Secondary markets can be accessed by anyone with a broker.
- The process of creation and redemption is what enables ETFs to be more liquid than their mutual fund cousins. But this process is intermediated by APs.
- APs basically enable the creation and redemption of ETFs units between ETF issuers and ETF buyers / sellers.
The main point to be made about ETFs for the purposes of this is to do with the method and mode in which they are created and redeemed. That is, the process is intermediated with APs in the primary market.
PieDAO
In exploring how PieDAO contributes to the innovation of traditional method of ETF creation (and its subsequently ‘bring wealth automation to everyone with an internet connection’), we focus on two aspects of the protocol: ‘Exchange’ and ‘Ovens’.
Logically, I suppose Ovens should be discussed first, but this is the meatier part — the part that took me some time to understand properly. Starting with Exchange first.
Exchange
Exchange innovates by decentralising the existing ETF trading process — the secondary market. It enables anyone with an internet connection to enter and exit an ETF position via instant swapping of their chosen Pie (index, e.g. Defi large cap or PLAY) against a liquidity pool (e.g. PLAY/ETH). Notably, the redemption process also allows redemption to individual assets. Your PLAY token can be instantly be swapped into 14 of the underlying coins in their proportions to you wallet). Compared to the old model you don’t need a broker — just an internet connection! The ETF secondary market has become more permissionless and disintermediated.
Ovens
Using PieDAO, understanding the Exchange function and its value add is simple and intuitive enough. Liquidity pools and token swapping is a basic DeFi building block. At first glance, the value add of Ovens, their teleological reasoning wasn’t clear. However, Ovens are also an example of PieDAO’s innovation on the traditional ETF process — the creation (minting) of ETF units.
The Oven feature allows anyone to ‘bake’ their chosen ETF indexes (i.e. primary market) by batching together many users’ orders together until they have about 10 ETH deposited together. Then the smart contract will automatically buy the underlying assets required for the index creation order. The pie is then minted for the user. This process saves gas, aggregating what would be multiple individual transactions when buying the underlying assets from external venues like Uniswap etc. Key to understanding the purpose of Oven is also to note that users can mint pies on primary market from single assets (i.e. have ETH, swap it externally for all individual assets) or multiple assets (e.g. have all the individual assets in the right proportions already and bake a pie). But each individual transaction would require gas…and as we all know, that’s the bane of everyone’s existence. According to PieDAO, baking your own pie could take up as much as 73 transactions….73!
To return to the point, compared to traditional ETF issuance, PieDAO makes the process permissionless. Anyone with deep enough pockets can mint their own ETF units without the need for APs and ETF issuers (institutions like Blackrock). However, most notably, the Oven specifically makes it even cheaper (hence more accessible) for the average person to enter ETF position on the primary market.
Personally, Ovens only make sense confined to the primary issuance of ETFs. The issuance still requires you to wait for all pie-specific ovens to collect up to 10ETH. For instant pies, the Exchange function is more natural (although, liquidity pools on exchange are vulnerable to variables such as gas, price impact or congestion on the ETH network).
Conclusion
To conclude, this is only one very small aspect of how DeFi ETF protocols innovate tradFi processes and how it truly can lower the barriers of entry for this kind of financial investment. Anyone with an internet connection can now get access to PieDAO’s indexes which they design and craft themselves.
Of course, this is only the ice-berg of PieDAO and general asset management DeFi protocols in the space. I haven’t even begun to think about PieVaults or the backward incentive mechanics of the liquidity pools, interest bearing tokens and meta governance. Perhaps another time. I wanted to focus on understanding the ways of the old (i.e. ETF issuance, redemption and market flows) to understand how DeFi protocols can improve it and make it better than before. Interest-bearing tokens might be a topic for another time.
Its a shame that these write-ups can’t be ever green due to the breakneck speed builders work. But it’s been a pleasure nonetheless.
- *on this point, Balancer is cool— setting up a private pool on Balancer is akin to creating an ETF that is rebalanced by free market forces (which is very cool). BUT PieDAO is no longer Balancer based (? own AMM pievault)
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