Set Protocol: Token Baskets and Dynamic Crypto Portfolios

What Is Set Protocol?

Set Protocol is a powerful Ethereum-based tool that allows users to create portfolios of ERC-20 assets called Sets — derivatives that are subsequently tradeable on exchanges as ERC-20 tokens themselves. Set Protocol offers a user-facing web application called TokenSets, which makes it easy to create, manage, and acquire baskets of tokenized assets.

Assets created on Set Protocol function similarly to exchange-traded funds (ETFs) — derivative assets that provide exposure to baskets of securities, and which trade like a stock. Users can create baskets of crypto tokens, bundle them up into a Set, and then buy, sell, or trade those Sets on exchanges. Set Protocol lets you carry out sophisticated asset-management strategies by determining the exact allocation of individual tokens, setting automated rebalancing parameters, and engaging with a developing suite of functions. Each Set is turned into an ERC-20 token via its own smart contract, so each Set token can be fine-tuned and customized to its creator’s liking.

By encapsulating asset-management strategies as ERC-20 tokens, a strategy can be easily replicated and integrated for use on other decentralized finance (DeFi) platforms like decentralized exchanges (DEXs), lending platforms, and automated market makers (AMMs). An ERC-20 token that represents a particular Set may be, for example, used as collateral on DeFi lending platforms, or be staked for yield farming.

Although each individual Set is represented by an ERC-20 token, the Set Protocol itself does not maintain a native utility token for its platform. The Set Protocol was initially announced in 2017, and launched its TokenSets web application in April 2019. It has since grown to hold more than $180 million USD of total locked value as of March 2021 as more and more users have come to use the platform.

How To Use Set Protocol

Set Protocol is designed to make it easier for users to gain exposure to several tokenized assets using a single, convenient vehicle and to pay only one Ethereum transaction fee, avoiding the costs associated with purchasing several tokens individually. From there, Set provides a relatively hands-off management experience for a user’s crypto portfolio. It is intended for those who don’t want to constantly monitor crypto trends and worry about manually rebalancing their portfolio. Its basket approach also provides peace of mind to users who otherwise would worry about missed opportunities — or price fluctuations — when holding only individual tokens.

To get started, you can connect your Ethereum wallet to Set Protocol via the TokenSets web application and fund it with a supported cryptocurrency, such as ether (ETH). The money you deposit into any given Set will automatically execute the portfolio strategy of that Set. When you eventually sell your Set, you’ll receive your original deposit back, plus or minus any gains or losses incurred by the overall Set of ERC-20 tokens that you chose originally.

Sets make purchasing baskets of tokens easy, and the process of creating a Set is straightforward as well. Anyone can create a Set in just a few minutes using TokenSets. The Set creator can determine the cost of their Set token and establish a streaming fee — an annualized fee based on the total market cap of the Set, which serves as an incentive for creating a Set. However, Set Protocol doesn’t charge any fees itself. The Set creator pays only the Ethereum network fees to cover the smart contract creation costs needed to publish the Set as an ERC-20 token.

A Set Protocol Case Study: DeFi Pulse Index

To best understand how Set Protocol works, let’s examine the DeFi Pulse Index (DPI) — one of Set Protocol’s flagship portfolios.

DeFi Pulse, a website dedicated to curating the most highly utilized DeFi resources, established the DPI Set in September 2020 using Set Protocol. The DPI Set is a weighted index that tracks several DeFi assets across the market. The most predominant tokens in the DPI Set by weighted allocation (as of April 2021) are Uniswap, Aave, Synthetix, SushiSwap, and Maker, though several other tokens are included with smaller representations, and the allocations are constantly in flux.

DeFi Pulse employs its own methodology to include DeFi assets that have significant usage and ongoing development, which means that the allocations of certain tokens can increase or decrease dynamically as time goes on and conditions shift. Because each Set has its own associated smart contract, rules regarding fees and how often the Set rebalances its strategy are coded directly into its smart contract. The DPI Set in particular is maintained and reconstituted monthly, so additions, deletions, and reallocations of tokens can take place as necessary.

Only tokens that meet DeFi Pulse’s stringent requirements can be added to the DPI Set. Among other criteria, DPI inclusions must:

• Be available on the Ethereum blockchain 

• Be associated with DeFi protocols or dApps

• Be at least 180 days old

• Have significant usage

• Have sufficient liquidity

• Have at least 5% of the five-year supply in circulation

• Not have locking mechanisms for staking

With these stipulations, the DPI Set seeks to track DeFi projects with the most promise and potential in the DeFi space. By purchasing the DPI Set, users can gain exposure to well-researched and vetted DeFi projects in a single index without needing to research and obtain the various assets individually.

Other Sets function similarly to the DPI but with their own respective characteristics and criteria. Some focus on baskets of DEX tokens, oracle tokens, or lending protocol tokens. Many Sets are indexes like the DPI, but some Sets focus on only one asset and fulfill range-bound strategies, buy-and-hold strategies, or other strategies that adhere to various technical indicators like moving averages. Information about each Set is publicly available along with a whole dashboard of data about its inception, historical performance, allocation, ownership, and more.

The Benefits of Bundling Assets on Set Protocol

Set Protocol presents an innovative approach to offering widespread market exposure via baskets of Ethereum-based tokens. It also enables creators to tokenize and share their asset-management strategies with a wider audience and earn streaming fees for doing so. Set Protocol can even be used to bundle collections of items in games. The protocol’s basket approach to tokenized assets also allows users to manage and transfer batches of assets and enjoy reduced transaction fees due to fewer individual transactions overall. There are diverse uses and benefits to the basket model of tokenized asset management, and Set has established itself as a leader in the sector.

Much like the S&P 500 is an abstraction that provides an index of the U.S. stock market, Set Protocol uses abstraction to provide indexes of the crypto market. With its unique basket model of tokenized assets, Set zooms out and helps users gain exposure to a wider array of assets, reducing their workload and lowering barriers to entry. Within seconds, a user can invest in the overall DeFi market by purchasing a single Set token, without needing to interact with its underlying tokens.