The Pilot Index Fund
*Updated on 24th March 2022*
Note: This excerpt is the third article of the series “Explaining the Pilot Protocol”. Read the previous article “A Nosedive into Pilot Protocol”.
In the last article, we revealed that protocol revenue is sent to an Index Fund where it acts as a backstop to the price of the $PILOT token.
In this article, we will explore the inner mechanisms of the Index Fund to better understand why it is so crucial to Unipilot. We will also expand on how holders of the $PILOT token can make their voice heard and influence key decisions. Finally, we will cover the possible strategies of malicious users and how the protocol will deal with them.
What is the index fund, and how does it work?
When liquidity providers exit their Unipilot position or when a position is rebased, a fee is collected and sent to the Index Fund, which over time will grow as it is filled with the array of tokens for which Pilots provide liquidity. The only way to access the value accrued to the Index Fund is to burn an equivalent portion of the $PILOT token supply. Therefore, the Index Fund provides a backstop to the price of the $PILOT token, as the value of the Pilot protocol cannot fall lower than the value of the Index Fund.
Here are how the two stages of the Index Fund will work:
Accumulating tokens (protocol to Index Fund):
Tokens are accumulated into the Index Fund from the protocol when LPs withdraw their earnings (fees) or rebase a position. These can be in two forms:
1. Vault fares:
When an LP wants to withdraw the fees generated while staying in the Pilot protocol, they’ll have two options.
a) Receive their fees in the native token (eg. ETH/DAI or WBTC/ETH) and pay a 20% fee (this percantage could change over time via governance) on the liquidity fees generated. This fee will be sent to the Index Fund.
b) Receive their fees in $PILOT tokens and pay a smaller (5%) fee. The native tokens (eg. ETH/DAI or WBTC/ETH) will be sent to the Index Fund.
2. Burning PILOT tokens (Index Fund to User):
The only way for users to access the tokens held in the Index Fund is by burning their $PILOT tokens. A percentage of the PILOT token supply can be burned to access the same percentage of tokens in the Index Fund.
- The index fund holds $10m worth of various tokens accumulated from Vault fares and LP fees.
- These tokens are: $1m LINK, $3m UNI, $6m USDC.
- John holds 0.1% of the $PILOT supply, which in this example is worth $8,000, and would like to use it to access his share of the Index Fund.
- John can burn his $PILOT tokens and receive 0.1% of the Index Fund’s contents ($1000 LINK, $3000 UNI, $6000 USDC) which is worth $10,000.
How does the Index Fund affect the $PILOT token price?
Whenever the total value of the Index Fund is greater than the $PILOT market cap, users will burn their $PILOT tokens to receive an equivalent share of the Index Fund’s contents. This reduces the supply of and therefore raises the price of $PILOT tokens. Therefore, the Index Fund acts as a collateralized backstop for the $PILOT token’s value.
As long as there is a delta between the two values, the burning will continue until the $PILOT token value matches that of the Index Fund. As the Index Fund grows over time, the impact on the price of the $PILOT token will become more apparent.
- Initially, the total value of the Index Fund and the market cap of PILOT are equal at $10m.
- The Index Fund accumulates tokens and grows in value to $15m.
- Sarah wants to take advantage of this delta and profit from it. She holds 0.1% of the supply of $PILOT, worth $10,000.
- Sarah can burn her $10,000 of $PILOT tokens and receive $15,000 of value from the Index Fund. 0.1% of the $PILOT supply is permanently burned.
What is the reasoning for an Index fund?
The Index Fund is another feature that differentiates Unipilot from other liquidity optimizers. It aligns the incentives of the protocol with its users, as the value of its native token will be dependent on the success of the protocol.
The more people that use Unipilot to provide liquidity, the more value will acrrue to the Index Fund. This, in turn, will reinforce the price of $PILOT token as the token burning will bolster its value proposition.
Consequently, the Index Fund can be thought of as the final piece in a positive feedback loop. The success of the protocol through high usage and fee generation will be captured and used to directly impact and increase the value of the native token.
Let’s talk about Governance
What can be voted on and how much say will voters have?
Holding the $PILOT token also grants users the opportunity to take part in the “Decentralized Governance” of Unipilot. With their tokens they can vote on key aspects, such as changing the “Vault Fare”, changing the reward percentages for “Captains” or even making tweaks to how the protocol readjusts liquidity ranges.
There is no minimum amount required for voting, even holding one $PILOT token will be sufficient.
$PILOT holders will also be able to vote on the future direction of the protocol, e.g. choosing between two development paths to go down or the implementation of one feature over another. In addition to this, there will also be a foundation fund making up around 35% of the supply and its resources will be at the full discretion of holders.
All these measures ensure that the Unipilot protocol will ultimately be indebted to the holders of the token and not any other third parties.
Safeguarding the protocol
Possible attack vectors
In order to be sustainable, the protocol is set up in a way where only those who put something in can get something back in return. The universal and permissionless nature of Unipilot means that anyone can deploy a Vault, contribute to its maintenance, and be rewarded for their efforts without needing to be whitelisted. However, this does open up the possibility for a minority who are looking for loopholes in the system to get back more than they put in.
This can be observed in malicious users who can try to drain the “Concentration Incentives” in the following way:
1. Deploy a Vault for a token pair with a very low amount of liquidity.
2. Cause a drastic price change in that liquidity pool, with a single trade on Uniswap.
3. When the price fluctuates greatly (by 30–40%), initiate a readjustment transaction on Unipilot.
4. Profit from the $PILOT rewards for bringing the liquidity back into the optimal range.
Possible attack prevention
The prevention is simple, we will always make sure that the premium is always less than the gas fees of a swap that the bad actor might make in step 2 above.
If a bad actor attempts to manipulate the price of an asset by sending it out of range through a swap transaction and then calls a readjustment function to alter the price range, he would have to pay more in gas fees than the premium he earns for playing a similar role to that of a captain.
Although the protocol offers anyone the ability to provide liquidity and deploy a vault to earn trading fees, it only enables the $PILOT token fee withdrawal option to whitelisted pairs to prevent unscrupulous projects from entering the system. The team will whitelist top token pairs at launch and in the future, $PILOT token holders can vote to whitelist any additional token pairs.
What we have learned so far
The Index Fund amplifies the success of the Unipilot protocol as it captures the value created from people using the protocol and returns it to the token that powers the ecosystem. The protocol employs a governance model that ensures that its token holders will be at the front and center of future developments and will also have power over changing the current decisions.
The Unipilot protocol also takes security very seriously and has contingency plans in place for possible attack vectors and penalties for “bad actors.”