The purpose of any DAO is to manage and govern its protocol in perpetuity. One of the most important functions of DAO is naturally to capitalize in such a way that not only ensures that your ongoing operations can continue, but also invests in the future growth and success of the protocol.
This is not very different from how traditional corporations develop in their design, about how to capitalize.
A traditional corporation has several options to finance its ongoing operations and invest in their future. Corporations can sell newly issued shares, go into debt, and also use their retained earnings.
Similarly, the universe of options available for the DAO Treasury protocol can also be classified into analogous categories:
- Operating income: part of the fees goes to the Treasury.
- Non-operating income: investing or lending different Treasury assets.
- Native Token Sale: Sell existing tokens in the Treasury.
- Debt taking: with collateral in its native token, or without collateral.
The need for treasury management
Many DAOs hold almost all of their treasury assets in the protocol’s native token. Since the operating expenses of all DAOs are often denominated in fiat / USD, if another multi-year crypto winter were to come, DAOs could be forced to sell treasury assets at “liquidation” prices to meet their current obligations, which could lead to a further downward spiral in the price of the native token. Consequently, careful cash management by intelligently generating multiple revenue streams (operating and non-operating) and financing the DAO using sales or debt, in addition to retained earnings, is paramount for DAOs, which they hope to adequately support its protocols through bear markets of several years and in perpetuity.
Different models of Treasury
Each DAO has its structure. The idiosyncrasy in the tokenomy of the different protocols means that not all Treasuries have the flexibility to freely use the aforementioned options. For example, certain DAOs currently do not generate any income that flows to the Treasury and therefore it may be better to consider them as a grant-making foundation, rather than being analogous to a corporation, since the income earned is not related to grants main operations of your protocol.
DAO “Corporation”
They have income at the DAO level, as a portion of the fees paid to the protocol flow directly to the protocol treasury.
Yearn
The 2% administration fee flows directly into the protocol treasury, while the 20% performance fee is divided 50:50 between the creator of the vault and the protocol treasury. All fees obtained are paid in kind (i.e. fees are paid in the token of each vault)
Index Coop
The transmission (management) fees of Index products (similar to ETFs) are generally divided between the DAO treasury and the product creator, where the specific amount is negotiated on a case-by-case basis. The rates obtained are paid / denominated in the product from which they are obtained (i.e. the transmission rate in DPI is paid in DPI).
Aave
A small part of all interest paid is reserved by the protocol for funding. A part of the interest paid by borrowers who repay their debt is sent to the Treasury.
DAO “Foundation”
They do not have income under the protocol structure, so their operations must be financed only with the returns generated in the treasury holdings and through the sale of treasury assets.
MakerDAO
The Maker protocol has an internal “Buffer” that accumulates income in DAI from the stability fees (that is, interest) paid by the borrowers, as well as the settlement fees (from the debtor’s guarantee).
Although any DAI balance in the “Buffer” can be spent by the governance as it pleases (for example in operating expenses), the “Buffer” also has the function of providing additional security to the protocol in case of bad debts, where the DAI in it it can be burned (thus helping to reduce the frequency of having to wedge MKR).
Compound
A small part of all borrower interest paid by borrowers accumulates as reserves . Currently, each reserve is used to protect depositors in a given pool against default / settlement failures, with none of them accumulating in the protocol (unlike Aave). Despite this, Compound’s treasury will continue to accumulate a portion of all new COMP issues until the 10 million COMP supply cap is reached.
Uniswap
Uniswap v3 charges traders 0.05%, 0.30% or 1% on each trade . Although its fee change is disabled (as of the article date), the government can choose to assign 10–25% of these fees to token holders. Since the rate change is not activated yet, all the rates generated by the protocol go to the liquidity providers; furthermore, even if it were activated, there is currently no mechanism that allows the Treasury to accumulate anything as income. Despite this, in 4 years, the supply will inflate at a rate of 2% per annum , and all new UNI issues will accumulate in the treasury. Therefore, Uniswap’s DAO Treasury currently has no other income, only this annual inflationary income.
Sushi
Sushi charges a 0.30% fee on all trades , and with 0.05% directly rewards token holders who delegate their SUSHI to xSUSHI through a token repurchase and distribution model (i.e. revenue of punters are named in sushi). Since the protocol itself is not delegating SUSHI that it contains, the DAO treasury has no revenue (however, until token issues end in November 2023, the treasury will also accumulate 10% of all new issues / inflation SUSHI). Therefore, Sushi DAO can only be funded through non-operating income and token sales.
Income diversification
Like traditional corporations, DAOs have primarily two broad “avenues” through which revenue is generated: operational and non-operational.
Specifically, DAOs can choose to extract fees as income from their protocol from their own operations, or choose to use their existing asset base to generate investment returns.
Additionally, with multiple potential revenue streams, DAOs have the additional opportunity to diversify their revenue streams so that total Treasury revenue can consistently meet and exceed operating expenses.
Although most DeFi projects have begun to appreciate the importance of incorporating some type of value accumulation mechanism within the protocol to give value to their tokens, several DAOs have not realized the importance of generating income and staying as “Retained earnings” in your Treasury. Just as it would be unwise for any growing company to distribute all profits (generally operating income) as dividends and retain none of them, DAO protocols, even in their “early” stages, must ensure that they adequately support the growth and maintenance of the protocol by “withholding” part of your income, too.
Since most DeFi protocols charge fees in one form or another, for Treasuries that do not currently receive a portion of these charges as income (SushiSwap, Compound, Uniswap, MakerDAO), the easiest way for these bonds reduce the risk of their balance sheets, would be to assign a percentage of the protocol fees to flow to the DAO’s own Treasury. For example, SushiSwap’s DAO could simply choose to retain a small portion of the fees that the protocol distributes to xSUSHI participants.
Also, for all protocols, it might be beneficial to consider changing the token denomination in which the revenue is paid or received. For example, the government could choose to have revenue flowing to the Treasury from Uniswap / Sushiswap paid in stablecoin rather than SUSHI / UNI (as is the case with stakers). While such a decision could reduce the Treasury’s advantage, given that raising financing (sale of tokens or debt) in bear markets might be ill-timed, using the proceeds from the protocol to help build a ‘cushion’ in the Treasury will likely be It will make the tradeoffs worth it. Doing so would also help match income to expenses more.
Due to the size of DAO Treasuries and the fact that they hold much of their own native token, it is highly likely that a considerable portion of the income that DAOs can generate will be non-operating income from performance, earned in Treasury investments, that is, at least until these protocols reach a mature stage of growth.
Traditional corporations make several different types of investments in non-operating assets that are kept on their balance sheets. These range from risk-free assets such as T-Bills, to lower-risk investments in highly rated long-term debt, to higher-risk investments such as pursuing mergers and acquisitions or providing venture capital.
Financing with Token Sales and Debt
Given that even the largest protocols may not be able to generate enough revenue to cover expenses ( Yearn for example, at the time of writing this article is trading at a loss even after accounting for non-operating income), it is clear that relying solely on Revenue retention might be insufficient for DAOs to fund themselves (especially given how quickly crypto is growing, and how traditional startups often have to raise multiple rounds of equity funding to sustain their growth).
Additionally, having a large enough asset base that can generate significant amounts of non-operating income means having a large amount of reserve assets on the balance sheet, which would be difficult to accumulate quickly while retaining only operating income. As such, DAOs will almost certainly also have to make token sales or take on debt, or both, in order to have a large enough asset base to generate significant amounts of non-operational income.
Token sale
Generally, in crypto, all the tokens that will ever be issued by a protocol are detailed at launch, and often a large majority will go to the treasury.
If the token supply dynamics is modified later, it is usually to stop token inflation (Sushi governance implemented a token supply limit shortly after launch) and it will almost certainly never issue new tokens (the proposed de Yearn Mint was strongly rejected by token holders and was only approved after heated discussion).
Given this, unlike corporations, DAOs will likely only be able to raise funding through token sales, in moderation so that they don’t run out of tokens in the treasury and without having the ability to mint new tokens.
When it comes to selling native protocol tokens to raise capital in a suitable reserve asset DAOs really only have a number of options:
- Market sales at the spot price; however, this is likely to significantly affect nominal prices.
- OTC sales from strategically aligned investors, with negotiated terms that describe a discount. While this option will not affect the price of the token, a poorly negotiated deal could upset the token-holding retailers (i.e. too large a discount, or perhaps not a long enough lock), and care must also be taken to ensure that selected investors are good long-term partners of the DAO. However, a carefully selected set of investors could add tons of value to the protocol down the road.
- Some kind of auction can be held. Not only is this option likely not to affect spot prices, but DAOs may also choose to block buyers. Another option would be to whitelist / shortlist buyers to ensure they will be long-term incumbents who are properly aligned with the project; One way to do this could be to take a snapshot of the existing token holders and see how active they have been. in the governance of the protocol, but such complexity could make it difficult to market the auction. However, the auction will need to be carefully designed to have guarantees on the amount that can be raised (although it will probably still have a small cash discount).
Therefore, DAOs must carefully assess their specific needs to decide which approach would be best for them. For example, a given DAO might ultimately decide to pursue a mix of options, not only to attract a pool of helpful value-added investors, but also to further energize existing token holders and incentivize them to contribute more to the protocol.
Also, since most DAOs have yet to reach maturity, token sales should be viewed similarly to traditional equity financing rounds for startups. After accounting for the protocol revenue and assuming a yield that can be generated (for example, 8% per annum), how many of the native treasury tokens must be sold to provide, for example, 5 years to cover expenses operational?
Use of debt
Debt could be considered as an alternative to token sales, for those DAOs that can generate enough income to meet interest payments.
Capitalizing a DAO’s treasury using debt could end up being a more acceptable option, for token holders to fund the treasury with reserve assets.
Unlike token sales, taking on debt will not put downward pressure on token prices (unless a secured loan backed by native protocol tokens is settled).
The cheapest form of debt a protocol is likely to be able to access would be loans secured by a loan protocol; however, this is only possible for the largest DAOs whose native protocol token is highly liquid and accepted as a collateral asset in major lending protocols.
For most DAOs, whose tokens cannot meet the listing requirements of lending protocols, then an alternative route to using debt, to unlock the liquidity of native tokens, could be to auction zero coupon bonds. with guarantee. An example of a protocol that could be used to create these bonds would be UMA .
Since history can be queried on the full financial performance of any DAO in each new block (with a few caveats, such as knowing which contracts / addresses should be queried, etc.), it is likely that with a sufficient amount of operational history, the health financial statement of any DAO can be easily assessed and some type of “credit rating” assigned to it.
Certain lending protocols are already approving 0-secured protocol-protocol loans by carefully conducting a credit assessment of the interested protocols, and then whitelisting them to borrow from depositors in a segregated loan pool. An example of this is CREAM’s Iron Bank,
Stablecoin Liquidity Pools in AMM
The return generated by the trading fees earned by LPs (Liquidity Pools) in certain Stablecoin Pools in AMM (Automated Market Makers) can be another almost risk-free way that DAOs can obtain returns and diversify their non-operating income. For example, USDC-DAI pools at Uniswap and other AMMs do not expose DAOs to any credit risk or impermanent loss, while allowing them to earn a portion of the trading fees generated by the protocol.
In addition to the risks described below, it will also be important for DAO treasuries to consider the work that will be involved in providing liquidity in certain cases (for example, in Uniswap v3, although UI and “active management strategies” will likely appear), and therefore the opportunity costs in the time that this could entail.
The risks:
- of smart contracts, which can result in loss of capital. This can be mitigated in large MMAs that have been significantly “battle tested” and rigorously audited.
- of depreciation / devaluation of Stablecoin, which can result in a loss of principal. This can be mitigated by providing liquidity only to stablecoin liquidity pools where the underlying stablecoins have a low risk of depreciation.
- variability in returns from liquidity mining. Some AMMs (for example, Curve) have liquidity mining programs, so while there will be the possibility of getting an additional return on top of the base return of LP fees, the price of the AMM native protocol token will significantly affect the amount of returns that can be obtained.
- variability in trading volumes, which can reduce returns. Although the trading volumes for stablecoin pairs on AMM are less volatile than with some other assets, changes in the fee rate by AMM governance, which may reduce returns, AMM governance could choose to reduce the fees charged on certain stablecoin trading pairs, which would consequently lead to a decrease in LP earnings.
Conclusion
Since DAOs are tasked with supporting your protocol in perpetuity, managing your balance sheets according to your income and expenses is a critically important activity.
Most DAOs currently only have their native protocol token on their balance sheets. Given the volatile nature of cryptocurrencies, this could mean that they are forced to sell their native tokens during extended bear markets (and therefore at inconvenient prices) to fund ongoing trades.
Consequently, DAOs should first ensure that they have an ideally denominated revenue stream on a reserve asset, and then if the income is insufficient to cover operating expenses, they should consider raising additional financing on reserve assets using sales or taking on debt.
Doing so provides a large reserve asset base on your balance sheets that can be invested to generate non-operating income as additional investment, to close this gap, or to provide a “cushion”.
Following a well-designed economic and financial strategy gives the DAO a sustainable position to maintain its protocols, even during bear markets, which are frequent, at least at the dawn of this industry.
