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PONY Index: A methodology deep dive

Find out how the PONY Index methodology screens the vast universe of yield opportunities in DeFi to find its constituents.

The PONY Index is a passive strategy that simplifies the tedious task of finding and earning stablecoin yields across the blockchain universe. The index is maintained by Scalara, the methodologist and index provider of DeFi Pulse. The index is available as a single token, PONY, through the Pony Finance. In the following article, Scalara highlights the selection criteria that a yield opportunity has to pass to join the PONY Index.

PONY Index logo

Goal and rationale

The PONY Index is a Passive strategy that simplifies the task of harvesting yield on top of secure stablecoin exposure. Its Omnichain approach allows it to find attractive yield opportunities beyond Ethereum. Utilizing curated vaults allows users to get the Net Yield without all the work: Claiming, selling and reinvesting of incentives or other distributions is costly and takes a lot of time. PONY Index’s major features are:

  • Secure principal
    The number one priority of the PONY Index is to minimize the risk of loss to the index notional.
  • Transparent
    On-chain implementations of PONY Index such as $PONY token allow users to benefit from full blockchain transparency. At all times users can verify their holdings and exposures.
  • Attractive yield
    The PONY Index seeks to provide a stable and competitive yield. Its goal is to beat “local” yield opportunities on Ethereum Mainnet such as simple lending.
  • Single token
    The index is investable and makes a single ERC20 token that tracks the index possible.
  • Passive
    The index methodology aims to balance the trade-off between yield and risk.
  • Low cost
    Pooling of assets through an index and utilization of curated yield farming vaults socializes large parts of the maintenance fees.

Related: Why invest in an index?

Methodology

The core of the PONY Index methodology is the rigorous selection of eligible yield opportunities. The index is reviewed on a monthly basis.

PONY Index funnel

Chain screening
PONY Index’s goal is to bring “omnichain” yields back to Ethereum. Therefore, it has to be possible to bridge any selected yield vault to Ethereum Mainnet. Only chains that allow for efficient bridging in both directions are eligible. Bridges have to be audited and be considered safe and mature.
In addition, the chain needs to have a Total Value Locked (TVL) of at least $1 billion.

Yield farming platform screening
Yield farming vaults play an important part in the PONY Index design: They are the actual index constituents. Hence, the vault tokens have to be transferable.
Farming vaults compound the trading fees, deposit fees or incentive tokens that build up the yield of a strategy.
PONY Index only selects vaults that do this process automatically as the index is a passive vehicle. Claiming of rewards, selling, and reinvesting has to be an automated part of the vault design.
Only existing, “off the shelf” vaults are considered. Vaults have to be live for at least a month to ensure that the design has been thoroughly tested.
In order to do a fair comparison, only the yield net of fees are considered in the selection process.

Stablecoin exposure screening
PONY Index applies a very strict screen when it comes to its stablecoin selection. This means that only vaults that farm a small set of high quality stablecoins can be selected.
Most importantly, the stablecoin has to be pegged to the US Dollar.
The stablecoin has to be either fully collateralized with fiat USD or be significantly overcollateralized with crypto assets. This means that so-called “algorithmic” stablecoins, that are undercollateralized and hence are completely depending on the peg mechanism for stability, are not eligible.
The market cap of the stablecoin has to be greater than $100 million and the its price must have shown price stability over the past 6 months.
The stablecoin cannot have hidden dependencies to or backing by ineligible stablecoins.

Yield source screening
There are plenty of strategies that a vault could employ to generate yield. In order to not put the index notional at risk and avoid impermanent loss only a small set of strategies can be selected:
Only overcollateralized lending and stable-stable liquidity pools pass these strict criteria.

Risk score screening
PONY Index utilizes the Beefy “Safety Score”. This score aggregates several important safety aspects of yield farming: Complexity and maturity of the strategy, impermanent loss, market capitalization of assets and their volatility, audits by trusted reviewers and contract verification. Only vaults scoring above 8 (out of 10) can be selected.
If the Safety Score is not available Scalara will mimic Beefy’s methodology.

Weighting
Several metrics have to be considered when determining the final weights of the eligible yield opportunities: Yield, risk, diversification, capacity, and turnover. PONY Index solves this problem by solving a simple optimization problem:

PONY Index weighting optimization.

In the objective function the exposure to a yield-capacity score is maximized. The score is a weighted geometric average of yield and underlying TVL. The second term in the objective function is a measure for diversification (Herfindahl Index, the larger the more concentrated).

The constraints ensure a minimum weighted risk score of the index (1) and minimum weighted underlying TVL to lower the dilution sensitivity (2), limit turnover (3) and concentration (4).

Conclusion

PONY Index simplifies the complex, time-consuming and costly job of finding attractive yields to be earned on top of stablecoin exposure. At times of low real rates globally this task becomes more pressing for more and more people. But simplifying a strategy into a one-token solution isn’t the only benefit of PONY Index. Full on-chain transparency allows users to verify at all times their index holdings and underlying exposures.


Scalara, a subsidiary of DeFi Pulse, creates and maintains indices for a decentralized world.

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