ETP#2 Proposal: Macro Hedge against global Inflation

Greetings $WSB community,

We’ve been thinking, and what we see happening on a global basis has cause for concern. So we thought it was timely to spark up a discussion and further ideas around an Inflation Hedging ETP.

As a quick update: WSB Engineering team has been working almost daily with the core developer of Balancer Labs, to speed up getting our ETP’s out the door. The main issue is the time to audit the code. Currently we expect the audits to start next week and take 5–7 days. Then, subject to balancer v2 pools being liquid enough, we can launch not just the WSB Crypto 20 ETP but a 2nd ETP we are calling the “WSB Macro Hedge ETP”.

We are launching something first of it’s kind with our partners so the development is taking additional time, especially because we don’t want to settle for something that is just good enough.

Yes, we are making a global currency!

The process for ETP 2 will be similar to ETP 1:

  • Publish initial specs (this post).
  • Discuss with the community for a couple of days and reconcile feedback.
  • Publish final ETP 2 specs and open for on-chain vote.

Since we have just been through all of this for ETP 1, this 1–2–3 process should be relatively quick. Outside of ETP’s 1 & 2 (estimated to both be live during week 2 July), we have been working on a different but related product — it’s looking like it might be ready before the ETPs. This will bring huge utility and fees to WSB also.

Speaking of Fees; now that the base technology considerations are matured, we will be publishing both a diagram of how we propose the fees to be used (burn, add liquidity, etc etc) as well as aiming to finally publish an updated product roadmap!

Stay tuned to our medium and this forum.

Meanwhile let’s dive right into ETP #2!

Inflation risk in a portfolio is not always a straightforward problem to fix:

  • Traditional Treasury Inflation Protected Securities (TIPS) are driven by the Consumer Price Index (CPI) which is distorted by substitution that can understate the consumer’s inflation experience and make TIPS less effective. In simple terms, expensive goods can be replaced by less expensive goods (ie. Chicken for Steak).
  • Commodities are generally not owned by ETFs in physical or cash form instead are owned via futures contracts.

1: Money printer goes Brrrr …. Money supply (M2) is expanding rapidly, see below chart.

CHART (m2 money supply)

The yellow shaded area to the right of the chart is part of the recent US government Stimulus. An increase of this size has not been seen in over 50 years (since WW2). This is likely to expand with additional stimulus. This is a representation of expanding money supply to pay for short-term needs with possibly long-term consequences.

CHART 2 (Stimulus)

2: US Federal Debt has grown significantly since the GFC and the COVID-19 pandemic, where the pandemic has added $19.5 Trillion to Global Debt.

CHART (us total public debt)

3: US Interest rates approach 0%

CHART (10yr Treasury rate)

4: Energy prices have reached historic lows, America’s “binary” wealth distribution is likely to lead to higher wages, the availability of cheap goods may be ending and additional spending from the US government will be needed for business support etc etc. The list goes on.

Against this backdrop, we propose an idea for an effective Hedging ETP solution leveraging developments in the crypto sphere.

Investment Objective

A passive ETP that seeks to outperform inflation with the aim to retain purchasing power in an inflationary macroeconomic environment. The ETP would physically hold onto the underlying assets in a non-custodial way by deploying a Public Smart Pool on the Balancer protocol (Balancer.Finance).

The idea for this test portfolio was to use a basket of currencies (stablecoins) with a small exposure to precious metals (WDGLD) and Bitcoin (WBTC) and Ethereum (WETH). Due to the restrictions and liquidity of certain assets on Balancer Finance, not all inflation vectors could be included. However, over time the ETP could add tokenized representations of REITS, Royalty and Streaming company stocks and Traditional ETF Hedging Products. Even tokenizing the Internet Computer ICP cycles which are pegged to SDR (which was mentioned in the gov forum by a $WSB holder previously).

The ETP is a passively-managed ETP that seeks to achieve its investment objective by investing primarily in fiat-pegged stablecoins, tokenized commodities and wrapped crypto native assets.

Asset Constituent & Weighting

The below table was the starting allocation for the test basket portfolio. However, to capture historical data back to 2015, Tether USDT was used instead of USDC, and EUR/USD, NZDUSD and XAUUSD were used instead of their counterparts.

DGLD, more specifically Wrapped DGLD was chosen as it represents a digital proof of ownership of allocated gold, which is physically held in a vault in Switzerland.

The original weightings were based on a 60/40 rule; where 60% was currencies based on the IMF SDR ratios and 40% metals and crypto. 15% BTC, 15% ETH and 10% Gold. We are currently slightly constrained as we wait for more liquidity to migrate over from the BalancerV1 pools to V2. Because of this limitation, we dropped CNY, GBP and JPY and gave more weight to NZD. This can be amended in the future.

However, after back testing the above weighting mechanism, the 30% allocated to BTC and ETH gave too much exposure so we reduced these down to 5% each.

Another approach for the weighting mechanism is to design the currency side of the basket based on trade merchandise shares with the base (country) being the United States (US). So, a Trade weighted basket for 80% of currencies and disperse the left over 20% to metals and crypto’s. As mentioned earlier we can add further tokenised assets in the future for the purpose of hedging against inflation.

The below chart displays the cumulative returns of the ETP Hedge vs the S&P 500 since August 2015.

CHART (cumulative returns since Aug 2015)

The below chart displays the cumulative returns of the ETP Hedge vs the S&P 500 from the start of the year, Jan 2021.

CHART (cumulative returns YTD)

The below tables measure how much risk is associated with producing a certain return. I compare the ETP to the S&P 500 over a 5 year period and another year to date (2021).

We have used a conservative “risk free rate” of around 2% to calculate the Sharpe Ratio, although the crypto industry hasn’t quite established a risk free rate we could change this to 0% to see a slightly different measure of risk.

The below chart shows the Maximum Drawdowns (MDD) since August 2015. The MDD is the maximum observed loss from a peak to a trough of a portfolio, before a new peak is attained.

CHART (cumulative returns YTD)

Further research could include comparing this to the real-adjusted inflation rate, something like the Chapwood Index rather than the CPI or perhaps Purchasing Power Parity (PPP) such as the Big Mac Index.

Thanks for reading, it would be great to see get the feedback of $WSB holders on this proposal.