Set Protocol: Abstraction as a Solution

Set facilitates the creation, issuance, redemption, and rebalancing of fungible, collateralized baskets of tokenized assets (“Set tokens” or “Sets”). The protocol utilizes liquidity from decentralized exchanges for Set issuance and redemption. Users who desire to track an index or have their portfolios automatically updated based on a trading strategy can subscribe to a Rebalancing Set.

I spoke with Felix Feng, Co-Founder and CEO of Set Protocol, to get a deeper look into Set Protocol, TokenSets, and potential use cases going forward.

Justin Gregorius: Felix, thanks for taking the time to speak with us. To start, what is Set Protocol?

Felix Feng: Put simply, Set is a protocol that bundles crypto-assets into tokenized baskets that are programmed to automatically restructure based on certain management or trading logic. Each Set is an ERC20 token that lives on the Ethereum blockchain and acts as a claim on the underlying collateral that is locked within the Set Vault.

JG: Interesting, so Set allows people to tokenize baskets of multiple crypto-assets into one token. How have people used Set Protocol to date?

FF: The first product that Set Labs has built is called TokenSets — this is the main gateway that almost all of our users access in order to interact with Set Protocol in the way of minting and selling Sets.

People have been most excited about our Trend Trading Strategies — these Sets can be thought of as tokenized trading positions. For example, our most popular Set, the ETH 20 Day Moving Average Crossover (ETH20SMACO), rebalances based on changes in the 20 Day Simple Moving Average (20 SMA) technical indicator. If the price of ETH crosses above the 20 SMA, ETH20SMACO will rebalance into ETH to capture upside in ETHs price movement. Conversely, if the price of ETH crosses below the 20 SMA, ETH20SMACO will rebalance into USDC in order to protect itself from further downside.

JG: So if the end-user only has the Set token, which is a tokenized basket of various crypto assets, how do the underlying assets in a Set get acquired and where are those underlying assets stored?

FF: When a user mints a Set using the TokenSets website, they can choose to use either ETH, USDC or DAI. If the Set they want to mint is currently positioned in ETH, but they want to mint it using DAI, then the DAI is swapped for ETH automatically using Kyber Networks on-chain liquidity reserves and the user is issued their Set. The user’s assets that back up their Set tokens are stored in the Set Vault smart contract.

JG: It sounds like the Set Vault is a core piece of abstracting this process for the user, can you explain what the Set Vault is and how it works in more detail?

FF: The Set Vault is a smart contract where all of the collateral for the issued Sets is stored and is able to be audited by anyone at any time. When a user mints a Set, the collateral for that Set is deposited into the Set Vault contract and kept there until it’s either swapped for another asset via the rebalancing mechanism or the user redeems their collateral by selling their Set tokens.

JG: That makes sense. Their configurable nature means that TokenSets could be constructed to act as a crypto ETF. ETF’s typically trade at a discount due to the counterparty risk investors are exposed to. Do TokenSets trade on a similar discount?

FF: Users currently get exposure to Sets directly via the primary market by minting it themselves via TokenSets. If Sets were traded on secondary markets, we imagine they would trade very close to NAV — as the issuance and redemption process is completely open to anybody. With ETFs, only special parties called “Authorized Participants” are allowed to create and redeem ETFs using their underlying components. The ability for users to perform this greatly de-risks counterparty risk — in addition to the protocol being completely open.
JG: Okay, because the underlying assets are deposited into an open-source smart contract and no other party is actually in possession of the funds, the counterparty risk found in ETFs does not necessarily apply here. TokenSets can also rebalance in a trustless manner. Can you explain how that works?

FF: Each Set has it’s own set of pre-programmed rebalancing criteria. For example, a proposal to rebalance the ETH20SMACO Set can only be triggered if the price of ETH crosses below or above the 20 SMA (depending on if the Set is positioned in USDC or ETH) and a minimum of 4 days has passed since the last rebalance. Once a rebalance is triggered, there is a 6–12 hour waiting period before the auction begins to weed out false positives in the signal.

Once a minimum of 6 hours has passed an open dutch auction can be initiated in which the goal is to swap out the current assets of a Set for the new assets. In this auction, the price of the assets starts very high and decreases over a certain period of time until reaching “fair value”. Once this point is reached, market makers compete with each other to swap out the underlying collateral for the new asset. For example, if the ETH20SMACO Set is rebalancing from ETH to USDC then market makers bid on the ETH that is currently in the Set Vault by using USDC.

It’s important to note two things: once an auction begins the minting and redeeming of Sets is disabled and that the liquidity for rebalancing is not sourced from Kyber Network.

JG: It sounds like dutch auctions play a large part in the rebalancing process, how do those dutch auctions work and who participates in them?

FF: Unlike a traditional auction, dutch auctions are special in that they start with a relatively high price that declines over time. For Set, this represents the primary mechanism in which rebalances are performed. These auctions are modified in the sense that they are not awinner takes all and not everyone receives the same price (e.g. Gnosis DutchX). Bidders can take a fraction (e.g. 1% of the auction). These auctions are open for anybody to participate.

Currently, we have multiple market makers who bid on these auctions to provide liquidity for Set holders. We recently performed the biggest auctions to date — totaling around $2M in volume in a day last week.

JG: That is a really compelling approach, especially because the entire rebalancing process is abstracted away from end-users. Besides acting as the primitive for various financial products in crypto, Set also has the potential to improve upon the user experience in crypto by solving the problem introduced by the many interoperable protocols with native tokens, as mentioned in the Set whitepaper. How can Set improve UX in crypto and has that solution manifested in the market?

FF: In traditional markets, most people get exposure to investment products via packaged products such as ETFs, mutual funds, etc. In the same way, Set has the potential to be presented to the masses as the wrapper to get access to complicated products like money markets, margin trading, etc. Essentially, what we’re saying that if we want to export DeFi to the masses, using an abstracting like Set seems to be the most natural way to do it.

You can learn more about Set Protocol here.

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