DAO Treasuries: A Balancing Act
Building a treasury to survive a crypto winter
DAO Treasuries are lying to you. The billions of dollars locked up in their treasuries aren’t real. Capital allocation in a DAO treasury is a delicate balancing act, get it wrong and you might not survive the winter.
Messari 2022 Report
I recently read the DAO chapter from Messari’s 2022 Crypto Theses Report (Page 154) and was surprised to see just how many DAO’s have almost 100% of their treasury allocated to their native token.
A Trip Down Memory Lane
It’s 2017 and the ICO boom is in full swing, projects were raking in millions of dollars worth of ETH and in many cases keeping it in ETH.
Crypto winter hit and the ETH price collapsed.
Project treasuries that were still denominated in ETH saw their runways shrink from 2 years to 6 months.
Many of these projects died while liquidating their ETH at the market bottom to pay staff.
DAO Treasury Allocation
While being exposed to one asset shows the purest form of faith in your token, it isn’t the smartest move for longevity and protecting against unforeseen future events. Ryan Selkis puts it best in his Messari Report.
Black Swan events leave protocol treasuries at the mercy of the market and that’s before you consider the idiosyncratic risk of each specific asset: smart contract failures, hacks, oracle deficiencies, and coding errors can tank a token’s price
DAO treasuries made up of only their native token also says nothing about its real purchasing power. Hasu illustrates this point in his Mental Models for Defi Treasuries.
Imagine that Uniswap tried to sell as little as 2% of its treasury. When executing this trade via 1inch, which routes the order to many on- and off-chain markets, the price impact on UNI would be almost 80%.
So what should DAO’s do, let’s draw from methodologies already used within crypto & TradFi to try and create a framework.
Caveat, the best approach would be to employ a professional financial manager to reduce treasury risk while maximising long-term token holder value. However, for now the nature of DAO governance, underlying smart contracts and lack of tooling make this extremely hard to implement.
Instead will look at a broad stroke structure of what a treasury could look like. We’ll start by looking at potential treasury categories, % split of assets have been included but have been arbitrarily picked and would likely be decided via a governance vote.
I’m going to use Aave as an example.
Native Protocol Token: AAVE — 40%
A protocol should definitely hold its native protocol token and in most cases will be the largest holding of the DAO.
It signals the team/DAO has skin in the game of how the protocol performs. It is the easiest token for the DAO to acquire & the hardest to exchange without impacting price.
It can be deployed to provide liquidity depth on AMM’s while earning fees. Buy backs can be conducted if LPing results in loss of the native token (impermanent loss).
Stable Coins: USDC, DAI etc. — 35%
A protocol should also have stables in their treasury and in most cases it should be the second largest holding.
Stables provide a buffer if a crypto winter comes, protecting against having to liquidate crypto assets at market bottoms, it can be used for grants, team payments etc.
Having a variety of stables makes sense for the same idiosyncratic risks mentioned above.
L1/L2 Tokens: ETH, MATIC, AVAX — 20%
The DAO should own L1/L2 tokens of the networks its protocol is deployed on. Their combined total should equate to the third largest holding of the DAO.
Take Aave for example, they are currently deployed on Ethereum, Polygon & Avalanche. As a result the DAO should own some ETH, MATIC & AVAX and their ratios should be determined by their TVL on each network.
This helps diversify the DAO treasury, support the network (relative to the amount of usage on that network) and moves capital into more stable assets (This isn’t guaranteed but we would expect ETH to have smaller drawdown than AAVE in a bear market).
These Assets could be used for LPing with the protocols native token or could be staked to help support the networks, both would earn fees for the treasury.
Strategic Partners: MKR — 5%
A small allocation could optionally be used with strategic partners. For example Aave have recently partnered with MakerDAO.
Aave may be interested in acquiring MKR tokens primarily to have a voice in governance decisions with their strategic partner.
This again helps diversify the DAO treasury. The tokens could also be put to work in DeFi protocols while retaining the ability to vote on governance proposals with element finance’s voting vaults.
The Path to Treasury Diversity
Obviously a DAO that is currently 100% exposed to their native token needs to be extremely careful when liquidating /moving assets. Communication to the community about what is being done and governance voting on the categories / % splits are essential.
Large selling would likely see the native token price crash, if a DAO is to restructure its treasury it must do so very slowly. This could be implemented at the smart contract level over a set period of time/blocks. This could be percentage based or in absolute $ terms using an oracle.
Gradually the treasury would transform into the desired split.
DAO governance votes would control how often the rebalance occurs & the maximum amount of assets that can be transformed. Governance will also decide which assets are included and their % splits.
It will ultimately be DAO members who decide what is done with the treasury.
Above are some ideas on how a treasury can be diversified to a variety of assets. There are still many questions to answer on how something like this would be implemented and the risks involved. Constant sell pressure, AMM slippage etc.
In the future large DAO’s will employ real financial managers to help protocols diversify intelligently and ensure they are well capitalised under all sorts of market environments.
For smaller DAO’s this won’t be possible so hopefully we as a community can come together and find the correct balance for DAO treasuries to protect both the token holders and the protocol itself.