Index Methodology

Methodology & Derivation

The ISFR is the foundational benchmark for onchain risk, designed to function as the Risk-Free Rate of the agentic economy.

DeFi yields are driven by two distinct forces: the cost of spot borrowing (hard capital) and the cost of secured leverage (derivatives). ISFR formally separates these forces, calculating a solid Base Rate and adjusting it dynamically using a dampened Risk Premium.

The result is a highly robust, manipulation-resistant benchmark that captures real-time market sentiment without being broken by short-term noise.

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1. Base Rate (Spot Lending)

The foundation of the ISFR is the Base Rate ($R_{base}$). This represents the absolute floor cost of capital - what a user can earn by lending stablecoins to over-collateralized, blue-chip smart contracts with zero directional market exposure.

We derive the Base Rate by taking a weighted average of the deepest spot lending markets in DeFi (the Lending Tier):

$R_{base} = \sum_{i \in L} (w_i \cdot r_i)$

• L - The set of approved Lending Tier sources (e.g., Aave V3, Compound V3).

• r_i - The current annualized supply APY for USDC on source $i$.

• w_i - The governed weight of source $i$ based on total liquidity depth (\sum w_i = 1).

Example: If Aave is yielding 1.97% (60% weight) and Compound is yielding 2.56% (40% weight), the Base Rate is established at 2.20%.

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2. Deriv Spread (Market Sentiment)

While the Base Rate moves slowly, the demand for leverage moves in milliseconds. To capture this, we measure the Deriv Spread ($S_{deriv}$).

The system analyzes the Derivatives Tier (e.g., Hyperliquid funding rates, Ethena basis yields) to calculate the aggregate secured yield ($R_{deriv}$).

The Deriv Spread is simply the difference between the fast-moving synthetic rate and the slow-moving spot rate:

$S_{deriv} = R_{deriv} - R_{base}$

Interpreting the Spread:

• Positive Spread ($S_{deriv} > 0$): The market is "Risk-On" (Greedy). Traders are willing to pay massive funding rates to maintain leveraged long positions. The cost of synthetic leverage exceeds the cost of spot borrowing.

• Negative Spread ($S_{deriv} < 0$): The market is "Risk-Off" (Fear/Neutral). Demand for long leverage has collapsed, or shorts are aggressively paying longs.

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3. Risk Premium

If we added the raw Deriv Spread directly to the Base Rate, the ISFR would be too volatile to serve as a reliable benchmark. A 10-minute flash crash on a single exchange could distort the rate by 50%.

To solve this, ISFR v2 introduces the Risk Premium (Prisk), utilizing an alpha scalar to dampen extreme noise.

$P_{risk} = S_{deriv} \cdot \alpha$

• Alpha scalar: A governed parameter (currently set to 0.25). This acts as a shock absorber. It ensures that the ISFR captures the trend of the derivative market without being hijacked by short-term wicks.

Example: If the Deriv Spread is aggressively negative at -86.9 bps, applying the 0.25 alpha dampens the shock, resulting in a calculated Risk Premium of -21.7 bps.

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4. Final ISFR Calculation

The final ISFR v2 is computed by combining the slow-moving Base Rate with the real-time, dampened Risk Premium.

$\text{ISFR} = R_{base} + P_{risk}$

Or, fully expanded:

$\text{ISFR} = R_{base} + \alpha(R_{deriv} - R_{base})$

Live Example Calculation

Based on the live dashboard parameters:

1. Base Rate (R_base): 1.97% (Anchored by Aave/Compound)

2. Deriv Spread (S_deriv): -86.9 bps (Derivatives are cheaper than spot)

3. Risk Premium (P_risk): -21.7 bps (Dampened by alpha = 0.25)

Final ISFR: 1.97% + (-0.217%) = 1.75%

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Index Goals

1. Manipulation Resistance: To manipulate the ISFR, an attacker cannot just spoof a single orderbook. They would have to simultaneously manipulate billions of dollars in Aave spot liquidity and the funding rates across major perpetual exchanges.

2. TradFi Compatibility: By separating the "Risk-Free" component from the "Credit Spread" component, the ISFR structurally mirrors how traditional finance calculates SOFR and LIBOR.

3. Mean-Reversion: Because the alpha scalar dampens extreme volatility, the ISFR naturally mean-reverts, making it the perfect benchmark for pricing fixed-rate loans and yield swaps within the Nunchi ecosystem.