A Guide to DAO Treasury Diversification Sales
Introduction
According to OpenOrgs.info, the largest DAO treasuries have amassed billions of dollars in assets under management. These inventories are primarily concentrated in the native governance token of the protocol, posing a variety of challenges, such as:
- Diversifying the treasury while minimizing market impact
- Managing protocol-specific risks while holding a concentrated position
- Funding workstreams and paying contributors with a highly volatile asset
Many DAOs are starting to acknowledge these challenges, resulting in a shift in sentiment toward more sophisticated asset management strategies.
This post is the first in a multi-part series examining these strategies and providing recommendations on how to effectively govern a collective DAO inventory.
In this first post of the series, we discuss the treasury diversification sale as a means of reducing concentration in the native DAO token, and we provide guidance on structuring the sale in a positive-sum way. Throughout the piece, we draw on our experience as lead investors of two DAO treasury sales (Index Coop, Forefront) and as participants in an additional sale (Visor).
The Benefits of Diversification
Before diving into the specifics, let’s review why a DAO should consider partial diversification into stablecoins in the first place.
An allocation to stablecoins can:
- Dampen total portfolio volatility
- Offset future operational expenses
- Increase the resiliency of the DAO during periods of market disruption
Since DAO treasuries concentrated in the native token are naturally reflexive, stakeholder outlook can significantly alter treasury valuations. If an external event or negative future outlook drives a dislocation in price, the DAO will lose access to its purchasing power when it needs it most. Diversification into non-speculative assets can bolster capital reserves and allow the DAO to sustain operations during bear markets.
In addition, as Hasu recently pointed out, native tokens held in a DAO treasury are effectively the unissued authorized shares of a traditional company. Instead of being considered assets, these shares instead signal only the total potential supply available to the protocol or company. A DAO could realize some purchasing power from selling these unissued tokens, but it would likely amount to significantly less than the quoted market value. In other words, we should focus primarily on the diversified allocation of a DAO treasury when analyzing the available purchasing power it has.
But acquiring a stablecoin allocation will ultimately require the DAO to sell its native token and thus involves some nuance. Ways to raise stablecoins can include, but are not limited to:
- Over the counter (OTC): This is a selling strategy where tokens are directly exchanged for another asset without flowing through the secondary market. This can be a direct deal between institutional investors and/or the community, has the least direct impact on price, and offers additional flexibility in regards to token lockups and vesting schedules. We are focusing on this particular method in this post.
- At market selling: This is the most immediate way to raise stablecoins but also the most detrimental to price. At market selling can signify to stakeholders a negative outlook on the current valuation. Additionally, selling into an illiquid market or selling large amounts in short periods of time can result in downward price pressure.
- Conditional order strategies: This is an alternative to selling at market that utilizes condition-based orders to divest over time. This can include calendar-based rebalancing, TWAP/VWAP strategies, limit orders, and more.
- Financial derivatives: Derivative strategies can include creating a hedged collateralized debt position, using novel financial primitives such as UMA’s range token, implementing liquidity management programs to rebalance via protocols like Visor, or employing other income generating strategies like Ribbon’s Treasury vaults. These are oftentimes sophisticated, or as in the case of range tokens require sufficient marketing by the DAO to sell the issue, and are typically a more hands-on way of raising capital.
Before initiating any of the above strategies, it is important to reach consensus within the DAO since treasury rebalancing will impact all stakeholders. We recommend creating and voting on a governance proposal to ensure everyone is aligned on both the need for a stablecoin allocation and the means of acquiring it. It would also be good at this stage to review goals and plans for what to do with the proceeds.
Executing the Sale
1. Designing and Scoping the Raise
Before you go out and raise capital, identify your specific needs as a DAO. Ask yourself how much capital you ideally want to raise and what the minimum acceptable raise amount would be. Think both in terms of stablecoins and the native DAO token — become comfortable with a range of possible sale amounts and ensure you know the maximum amount of native tokens you would be comfortable selling. Finally, identify a target date to finish the raise; ideally, it should be an expedient process so that you can get back to building.
Once you do all of this, gather community consensus on the raise. Community consensus upfront will help prevent issues like what was seen with the Sushi Phantom Troupe — Strategic Raise proposal from SushiSwap. This was a proposal to divest ~51mm SUSHI tokens from the community treasury in order to onboard a variety of institutional investors. For reference, the deal terms included a 6-month cliff followed by 18 month linear vesting with a 20–30% discount to the 30-Day TWAP. Proceeds were to be deployed into productive assets, such as Yearn, stable pool LPs, and Kashi markets.
The proposal was met with discontent from the community. Concerns were raised around the size of the deal relative to the overall treasury assets, the number of strategic investors being brought onboard, the large discount during a period of time when the SUSHI token price was already depressed, and more.
By gauging consensus upfront and ensuring key stakeholders are onboard, your DAO can prevent a similar episode from occurring.
Deal Sizing
Selling tokens from the community treasury is ultimately an optimization problem with multiple constraints. The project must maximize capital raised and minimize the number of tokens sold while attracting the highest-quality investors who are also optimizing for their own economic constraints. All of this must be done as quickly as possible so the DAO can turn its attention back to its actual goals.
If a DAO sells too many tokens for too little capital, it damages the longevity of the project. High quality investors will understand this, pushing for the fairest price rather than the lowest price. For example, when ForeFront approached us for a treasury raise, they initially valued their project at a $3mm fully diluted network valuation (50% discount to spot) and were raising $800k, which was roughly 30% of their treasury. We realized that $800k wouldn’t have offered much runway for the project, and they were selling a lot of tokens at such an early stage of the project’s life. In consideration of this, we offered a $10mm valuation to the community (it was subsequently raised to $20mm to match demand) because it benefited both us and the DAO. Our investment would’ve done more harm than good if we followed through at the lower price.
A simple goal for your first treasury diversification sale might be to raise enough stablecoins to adequately fund operational expenses for a 1–2 year period. This frees up resources to focus on the DAO’s goals without having to be concerned with the ongoing pressure of funding operations. You can tweak this number higher or lower given the constraint optimization problem mentioned above, but this provides a starting place for internal discussions.
Discounts and Vesting
DAOs should create appropriate vesting terms to ensure long-term alignment with partners. Terms can vary in length and should account for both how deep the discount is and investor appetite.
A typical term for a vesting period is 1–2 years. More than this is doable and signifies a greater long-term alignment between strategic partner and DAO, but an extension in vesting period should be balanced with demand.
A discount to the current price is often offered when a vesting period is included in the deal. The discount takes into consideration illiquidity. An easy way to understand this is a simple thought experiment: if you had two tokens available on the secondary market, with one having a 1 year lock and the other having no such lock, which would you as an investor choose to buy assuming they were trading equally? The rational choice would be to select the more liquid option since the illiquidity brings with it no net benefit.
Now, assume the more illiquid token is 30% cheaper than the more liquid option. You know that regardless of the token price action over the 1 year period, you will make 30% more after 1 year than just buying at spot. Suddenly, you will be considering which is rational to buy. Thus, if the deal terms include a lock-up period, it’s important to provide a sufficient discount to incentivize taking the illiquidity risk.
The discounted token price for the sale will need to be committed to for a couple of months as the deal progresses, and market fluctuations over the period can result in large discounts/premiums to spot. However, constantly adjusting the price with volatility in the market is disconcerting for all parties involved. Instead, execute with a steady hand, making changes only when absolutely necessary.
Delegating Negotiation Power
Once you’ve designed the scope of your treasury raise, determined your constraints, and created community consensus around the need for the sale, identify delegates from the DAO to lead the efforts of engaging investors.
Due to both the complexity and sensitivity of the negotiation process, it makes sense to delegate DAO negotiations either to a team of contributors, as Index Coop did with their BD working group, or to the core team itself depending on how far along the project is in the decentralization process. Ideally, this team will comprise members that have had previous experience in business development or finance, but it is generally understood that not all DAOs will have these types of members available. The important point is to ensure negotiations are handled by a select few to enable both speed and responsibility during the negotiation process.
2. Composing the Round
Selecting the participants in your sale is one of the most important components of a treasury raise. The best investors in a project are both its users and its community contributors, but strategic investors can also complement your project’s strengths and weaknesses.
Strategic Investors
Some DAOs pursue investments from strategic partners to help them grow the protocol. These strategic investors can include Investment DAOs (e.g. MetaCartel, Seed Club), Institutional Investors (e.g. 1kx), or Angels, and can bring with them experience and expertise that can help guide a project from idea to execution.
The DAO should carefully consider if they would prefer having a lead investor or not, and, if so, who leads the round. Benefits of having a lead can include:
- Helping the DAO fill the round with investors. Additional investors are selected for their specific attributes, experience, or network, that when combined with others in the round, maximizes the value-add to the DAO. The lead can help in constructing the round in a way that could help reach the community’s goals.
- Serving as a connection between the DAO’s negotiating team and the group of investors. Oftentimes, a lead will negotiate on behalf of the entire group of investors, minimizing time spent negotiating between all involved parties.
Since the lead investor plays a crucial role, the DAO would do best to select a lead that shares a similar ethos or vision. If the DAO is looking to expand into a specific vertical, finding a lead that has done something similar for other DAOs will bring the most amount of value to the project. Consider the DAO’s biggest risks and find parties that can help de-risk those areas.
Usually lead investors (typically venture funds) have token network ownership targets due to their fund’s economics and thus may demand a significant portion of the funding round. This is up to the community to decide whether the value of the fund would result in a net benefit to the community versus going with a more diverse group of investors. Sometimes, however, greater diversity of investors may also be counterproductive to the project since you may instead want a highly focused handful of investors with significant skin in the game. We generally recommend giving more skin in the game to a few investors as opposed to a wider distribution that usually leads to investor apathy where no investor feels accountability towards the project.
A lead is not always necessary though. Think of a lead as another tool in the toolkit to help the DAO accomplish its mission. If the DAO would prefer a more diverse round or have more hands-on control over the negotiation process, then it is perfectly acceptable to not have a lead. Choose what is best for your circumstances and constraints.
If the DAO intends to pursue investment from an institutional investor, they should consider the reporting requirements. These requirements will vary depending on the investor, their 3rd party service providers (auditors/administrators/accountants), as well as jurisdiction and structure. The investor would benefit greatly from additional verification and information about the investment, which could include:
- Details of the smart contract/vesting terms (also beneficial to have a written confirmation of the distribution mechanics from the smart contract auditor).
- Either instructions on how to query the smart contract to view the locked/claimable tokens, or a basic front-end UI which allows the investor to connect their wallet and view their position.
- A memorandum of understanding or a term sheet, which is not a legally binding agreement, that outlines everyone’s understanding of the mechanics and provides a contact person for the investor’s audit (signed by a core contributor from the DAO and the investor).
A major concern for institutional investors is around their own audits. Unfortunately, auditors are currently not sophisticated enough to verify the mechanics of a smart contract. In the traditional world, if assets are held in custody with a 3rd party an auditor will reach out to a contact person to verify that funds are held securely in custody and they are owed back to or in control of the investor. With a smart contract this is not possible, so providing as much information as clearly as possible will benefit the investor.
Community Investors
Keep in mind, your best strategic partners are your own community members. A successful treasury diversification sale should include an allocation with similar terms to the community. Both Forefront and Index Coop did this during their latest treasury sale rounds.
In the Forefront sale, the DAO reserved a max allocation of 200k $FF of the 1M $FF (20%) for the community, prioritizing Forefront contributors that had measurably contributed to the DAO. Allocations were capped at $10k max with a $5k minimum contribution.
Index Coop similarly offered an allocation to the community. Eligibility was determined by reviewing which members had received contributor rewards over a three month period prior to the sale. Those members were allowed to purchase on the same terms as the strategic investors, including the 6 month linear vesting period and discount to market price, with a total cap of $100k per contributor.
3. Creating the Final Proposal
All DAO members should have a voice when determining the final deal terms. Community consensus is an ongoing process that should be managed in an open and transparent manner to the best of the DAO’s ability. For this reason, we recommend drafting a proposal and having the DAO vote before finalizing the sale. Sometimes it is the founder creating the proposal (Forefront), sometimes it is the community (Index Coop), and sometimes it is the lead VC. Regardless, it is always done in order to create agreement among stakeholders.
Through a deliberative process that takes place on the forum, the community will be able to properly discuss and revise the proposal to ensure it aligns with the goals of the DAO. The proposal should highlight the goals of the capital raise, the specific terms of the deal (e.g. discount, vesting period), and the ways in which the community can participate. Additionally, it should be posted with enough time for the community to thoughtfully engage before closing the round.
Treasury diversification will unlock a new chapter for many DAOs, providing them with the ability to focus on their specific mission without being constrained by the constant fear of sustaining operations. Treasury diversification sales are a means to both securing a stablecoin allocation for the inventory without substantial price impact and onboarding new stakeholders with an incentive to coordinate with the DAO on its goals.
If you are thinking about doing a treasury diversification sale for your protocol or DAO, please reach out.
Resources
Treasury Diversification Proposals Examples
