Background

Set Labs (the company behind TokenSet) was founded in 2017 around the idea of allowing users to create a basket of on-chain securities. They have since raised $2M in funding from multiple investors and venture capitalists and now have a team of 9.

The total value locked grew rapidly to over $26 million at its peak in August 2020. As of September 2020 it sits at an impressive $15 million.

The basic idea behind the Set protocol was simple, similar to an ETF a Set represents a basket of crypto assets that the user can hold rather than each token individually. The idea has expanded and now there are three main ways you can use Sets: holding a portfolio of assets, replicating a traders transactions or following a robo strategy. All while just holding the one token and letting TokenSet take care of the rest. A set is backed by a portfolio so can be bought and sold at any time, because Sets are ERC-20 tokens they can be held in a standard wallet.

What does TokenSet offer?

Portfolio Sets

Currently the only portfolio Set available is the DeFi Pulse Index but even though it is new it is a very cool idea and brings an advanced finance concept of indexes to the DeFi space.

DeFi Pulse Index is a market cap weighted DeFi index, used to track the performance of the DeFI space by holding a mix of the top 10 tokens on DeFi Pulse. Essentially the concept of the S&P 500 for the DeFi space, this is a great idea for those who believe in the potential of DeFi but don’t want to or don’t know how to research projects individually.

As of mid September 2020 no portfolio rebalances have occurred for the index but there will be soon so now is a good time to look at what a rebalance is and how it works.

A rebalance occurs when a portfolio no longer represents what it initially intended to, in this case the DeFi Pulse Index is meant to represent the top 10 DeFi tokens weighted by market cap. Of course over time some tokens will increase and some will decrease so the initial weightings will no longer represent the market cap weights. When this happens the portfolio needs to be rebalanced, instead of trading on the open market TokenSet runs a dutch auction where profit driven traders can trade the Sets overvalued assets for their undervalued assets (that the Set needs more of) until the ratio is back to what it should be.

With the DeFi Index reaching nearly $1 million in investment in less then a week after launch I wouldn’t be surprised if more portfolios representing different long term strategies appear on the platform soon. The one other thing to be aware of is that because the portfolio was created and maintained by DeFi Pulse and not Set Labs themselves there is a management fee of 0.95%.

Robo Sets

There are so many crypto trading bots on the market it can be difficult to find the right strategy let alone the right bot to use. The problem is there is little accountability for the people who sell these trading bots, as soon as they sell you the strategy you are often on your own. TokenSet offers robo sets. Simple strategies that execute trades between 2 assets (one crypto and one stablecoin) depending on a key indicator, for example, RSI ratio or MA crossover.

Looking at each strategy you can see the amount of money people have put into the Set, the price of the set (based on a share of the underlying portfolio), it’s current position (bullish or bearish) and its returns since inception.

Clicking into one of the Sets you can see a more detailed explanation of the strategy, a historical performance graph and an ability to buy and sell the Set straight away.

Generally, there are no fees associated with Robo Sets as there is nobody needed to evaluate and place the trades, just someone setting the initial strategy parameters. However as there are trading fees whenever the Set makes a trade this is taken out of the total value managed by the portfolio, meaning you are still indirectly paying trading fees.

Social Trader Sets

Robo strategies can be great but they certainly lack the flexibility of a human trader. Following the trades of others is nothing new in crypto, one problem is a lot that appear as gurus are often just running pump and dump scams and as soon as they make a profit disappear into the night with your funds. Social trading is something we’ve seen in the Forex and Stock trading world but is relatively new to crypto, the main advantage being the accountability the traders face, the incentives are also closer aligned with fees coming from a management but also performance fee, incentivising the traders to profit.

As of September 2020 there are over 50 strategies you can choose from with the top strategy trading with over half a million dollars. Before you decide to invest you can see:

• Portfolio performance over time

• The maximum drawdown in the past

• Number of trades made

• Broad trading strategy

• Fees

• Number of people holding the Set

• The trader who created the Set and any information you need to know about them

• The individual trades made and when they were made

There is also a trader leaderboard showing which traders (not just their individual strategies) hold the highest market cap.

What’s more interesting is looking at the leaderboard for individual strategies which shows that some strategies are up over 100% in the last quarter.

Using Trading Sets the question is no longer about how to trade but which strategies could be profitable and who are the best people to execute those strategies. While handing off your trading to someone else and watching the profits roll in sounds like a nice idea, the reality is you still have to put a lot of work into picking the trader if you want to be successful and feel confident you have made the right choice in the long term.

Luckily for people looking at investing not everybody can become a trader and there is an application process in which TokenSet evaluated candidates on experience and knowledge before allowing them to create and market their own strategy.

Why Use TokenSet?

One of the main benefits to users seems to be the passive nature of Sets for the user, they can get the benefit associated with following an active trading strategy without having to do the trading themselves. This would suit someone who knows about individual trading strategies, believes in the idea but lacks the time to constantly be hands on and execute the individual trades.

If you are confident in an individual's trading ability the social trading Sets essentially allow you to buy into a fund the trader then runs with the added benefit that you can withdraw quickly and easily.

Sets can be used to achieve diversification without having to trade and manage individual token holdings, ETF passive investing has risen in popularity as a favourite of millennials, why not bring the same concept to crypto? You can invest in a piece of the market or a specific industry as a whole rather than have to pick individual coins.

The Risks of Sets

While a portfolio set such as the Defi Prime Index introduces market risk the main risks of using Sets are around the Robo strategies and social traders.

Basing a strategy of an indicator can work well in the short term but there are few, if any leading indicators that have proven successful in various market conditions. The market is currently volatile and rising. What happens when the market is slow and falling? It is unlikely an indicator that makes profitable trades in the first also does so in the second. What’s worse is that because there is no trader making the trades and instead a machine it won’t realise market conditions have changed and will just keep doing what it was initially programmed to do.

The other issue is how good the individual traders are? Here we are talking about survivorship bias, we don’t know how many traders signed up to become a Set trader whose portfolio flopped, we only see the successful few that remain.

The idea here is if 100 traders signup by chance alone one or two could be immensely profitable and the remaining 98 just leave the platform. The market is also rising which makes it easier for traders to profit as even if they made no trades they would still be profitable.

Here are some tips to keep in mind when choosing a trader to follow:

• How long have they been on the platform?

• Are they consistently profitable?

• How many trades have they made?

• Have they followed the strategy they set themselves when they signed up?

All these will help determine the reliability of a trader and see how accountable they have been.

With all this in mind there is one strategy you can use to reduce risk with robo or social traders. TokenSet makes it really easy to withdraw your funds, there is no lockup period, if you feel conditions have changed or no longer trust a trader all you have to do is sell your Set.

Tax Implications

While it differs from country to country there are certain tax events and potential tax advantages to be aware of when using TokenSet.

Using the following example, you’ll see what tax events occur and how it is different from trading yourself:

1. You buy Set tokens for 1 ETH representing a portfolio of the top DeFi tokens

2. Over time the market cap of YFI increases significantly while COMP falls

3. A rebalance is needed so the portfolio holds a rebalancing auction and rebalance the portfolio

4. Your Set tokens are now worth 2 ETH as the DeFi market has done well, you sell your Set back to ETH

Step 1 triggers a capital gain event as you have sold ETH, based on the dollar value of ETH at the time of the trade and when you bought the ETH you will either have a capital gain or loss. This transaction also determines the cost basis of your Set tokens for when you sell later.

Step 4 triggers another capital gain event as you are selling your Set, assuming the ETH remains the same in dollar terms from when you bought and sold Set you will have a capital gain.

The main difference between Sets and trading yourself is when the rebalancing occurs.

In most countries a token to token trade is a capital gains taxable event. So if you were to rebalance the portfolio yourself every time you bought one coin and sold another it would trigger a potential tax and you would have to record this.

With a Set, because it just represents an underlying portfolio of assets the number of tokens you have doesn't change when the portfolio rebalances, so there is no capital gains event. This gives you the benefit of a rebalancing portfolio/ strategy but allows you to choose when you recognize the tax event.

News

There have been two major pieces of news Set has announced recently. The first being the new DeFi Pulse Index Set talked about above, released recently the idea has taken off, you can buy and sell the Set directly from their website.

Even bigger was the announcement of Set V2 in August 2020, with plans for more Index Sets, multi asset support, yield farming, flexible trade execution and reduced gas costs over the coming months. Set plans to roll out V2 in three phases:

• Phase 1: Multi-Asset Support and Index Sets

• Phase 2: Yield Farming Sets

• Phase 3: Set Managers and Trading Improvements.

Resources

• TokenSet Website: https://www.tokensets.com/

• Set Whitepaper: https://www.setprotocol.com/pdf/set_protocol_whitepaper.pdf

• Visualize the performance of past Sets: https://tokenviz.io/

• Set Labs on Medium: https://medium.com/set-protocol

Wrapping Up

TokenSets are an interesting idea with some unique use cases in the DeFi space, for junior investors not sure where to start to seasoned veterans looking for tax advantages, there could be a place for Sets in your portfolio.