DAO Treasury Management
Introduction
The decentralised governance of blockchains, commonly embodied by Decentralised Autonomous Organisations (DAOs), presents unique challenges. This is especially true for the assets they collectively hold and manage, usually referred to as the treasury or community pool. To ensure the DAO’s stability and growth, these treasuries need careful strategic oversight. In the absence of a central guiding authority, it’s up to the DAO’s governance mechanisms to shoulder the responsibility of effective treasury management.
This article highlights common challenges in decentralised treasury management and presents some best practices based on important industry insights to guide DAOs in their asset management endeavours.
The Significance of DAO Treasuries
The treasury is essentially the financial backbone of a DAO, supporting its operations, initiatives, and growth. In the decentralised realm, where traditional oversight mechanisms are absent, the treasury’s management can dictate a DAO’s success or failure.
Especially in bear markets, a resilient and strategically diversified treasury can be a DAO’s bulwark against obsolescence. Having proper treasury management in place is vital to ensure the DAO not only has sufficient funds to cover its long-term operations, but also to allocate towards initiatives that can drive the DAO’s growth and value production.
Challenges in DAO Treasury Management
Navigating the world of DAOs requires a keen understanding of the unique challenges that come with managing a decentralised treasury. While the potential for growth and innovation is vast, DAOs must also grapple with a set of intricacies distinct from traditional financial entities.
From the inherent volatility of the crypto market to the complexities of decision-making within a decentralised framework, treasury management in DAOs is a multifaceted endeavour. Below, we outline some of the most pressing challenges DAOs face in this domain:
- Asset Volatility: The crypto market’s inherent volatility can lead to significant fluctuations in a DAO’s treasury valuation.
- Concentration Risks: Many DAO treasuries are heavily skewed towards their native tokens, exposing them to specific protocol risks.
- Operational Expenditures: With operational costs often denominated in stablecoins, DAOs with treasuries concentrated in volatile assets can face budgeting challenges.
- Market Reflexivity: DAO treasuries, especially those concentrated in native tokens, can be influenced by broader market sentiments, leading to reflexive dynamics where external events can drastically alter treasury valuations.
- Decision-making Dilemmas: Deciding on fund allocation can be contentious, given the diverse opinions within a DAO.
- Regulatory Uncertainties: The evolving regulatory landscape for cryptocurrencies and DAOs can pose challenges.
- Traditional vs. Crypto Accounting: Traditional accounting practices might not always align with the crypto realm, leading to potential misconceptions. For instance, counting native tokens as assets might be misleading, as selling a significant portion could drastically impact the market.
Managing a Pool of Native Tokens
To begin with, it is worth considering how the unique challenges and dynamics of decentralised governance necessitate new perspectives on asset management, especially where traditional financial models often fall short and, in particular, with regards to a blockchain’s native token.
As Hasu (2021) rightly pointed out, the central issue is that although native tokens hold value and could as such be considered a valuable asset, DAOs remain highly limited in their ability to liquidate native tokens due to the correlative negative impact it would have on its value.
Hence, viewing native tokens merely as valuable, liquid assets could give a bloated sense of security.
The financials of a DAO are therefore better evaluated in terms of its “real” treasury, that is, assets that aren’t tied to the DAO’s native token. This includes stablecoins, blue-chip crypto assets, and other non-native crypto assets.
Such a perspective offers a clearer picture of the DAO’s actual financial health, devoid of the potential market impact of liquidating native tokens.
The Capital Coordination Cycle for DAO Treasuries
In traditional finance, a simple investment cycle can be conceptualised as deploying capital, extracting value, and then distributing returns. Adapting this to the DeFi realm and the possibility to leverage blockchain composability, we can think of a “capital coordination cycle” tailored to the unique dynamics of DAOs:
- Strategic Allocation: Deploy capital based on thorough market analysis, risk assessment, and alignment with the DAO’s vision and goals.
- Value Extraction: With investments in place, the DAO (or a dedicated subDAO) should make sure to manage its assets to maximise returns, though always in line with its risk tolerance — which is not necessarily to be confused with actively trading in and out of positions. If, for example, a DAO has invested part of its treasury into an index on EntryPoint, this step would involve actively deploying the Index Tokens on DeFi protocols for yield generation, staking, and other avenues.
- Value Coordination: The interconnected nature of DeFi means DAOs shouldn’t operate in isolation. Collaborating with other protocols, participating in joint governance activities, or entering into strategic partnerships can amplify value.
- Value Distribution: Ultimately, the value accrued should benefit the DAO’s community. Whether it’s through token buybacks, dividends, or reinvestment into the ecosystem, ensuring the community benefits fosters trust and long-term growth.
This cycle isn’t a rigid pathway but rather a conceptual tool that underscores the importance of active treasury management, collaboration in the DeFi space, and the central role of the community in a DAO’s success.
Best Practices and Tools for Effective Treasury Management
Whilst the decentralised nature of DAOs brings its own set of complexities, it also paves the way for innovative strategies and tools tailored for this new paradigm. Ensuring the financial health and sustainability of a DAO is best approached through a blend of traditional financial wisdom and novel approaches specific to the crypto realm. Below, we summarise these through four key areas:
- Market Dynamics and Diversification: DAO treasuries, especially those concentrated in native tokens, are inherently reflexive and influenced by broader market sentiments. To manage this, DAOs should anticipate market dynamics and diversify their treasuries through strategic allocations, for example, a variety of stablecoins or other blue-chip crypto assets to reduce volatility exposure and maintain a more stable reserve for operational expenses. Furthermore, it’s essential to develop a realistic financial model to understand monthly expenses and revenues. By ensuring conservative assumptions, DAOs can avoid overestimating their financial runways.
- Governance and Community Involvement: Establish clear governance protocols for efficient and transparent fund allocation. Foster trust through regular updates and reporting, transparent decision-making, and involving the community in treasury-related decisions. Alongside this, build out operational capacity in the form of secure wallet setups and established governance processes. Engaging with tools and platforms that aid in treasury management can also be beneficial.
- Performance Monitoring and Risk Management: Conduct regular reviews of the treasury’s performance and alignment with DAO objectives. Utilise tools like Dune Analytics for real-time insights and proactive management. Identify financial risks, devise counter-strategies, and establish ongoing risk monitoring systems. Additionally, it’s vital to actively monitor cash positions, update financial projections, and ensure alignment with core treasury management principles.
- Accounting, Budgeting, and Oversight: Re-evaluate traditional accounting practices, especially concerning native tokens’ representation. Implement comprehensive budgeting, monitor adherence, and track project expenditures. Appoint dedicated teams for budget oversight and risk management to ensure alignment with DAO objectives and treasury safeguarding. Projects should ensure they have the appropriate funds to meet their ongoing operational costs and have a solid investment plan in place for excess capital, as long as an appropriate buffer is maintained for the inevitable bear market (reasonably no less than a 2-year runway).
Building on these best practices, DAOs are also exploring specific strategies to enhance their treasury’s value and align with their community’s interests. One such strategy gaining traction is token buybacks, and another is the emphasis on conservative cash management principles to weather economic downturns.
Token Buybacks and Value Distribution
Token buybacks have emerged as a compelling strategy for DAOs to manage their treasuries and distribute value. Instead of distributing protocol revenue as dividends or rewards, some DAOs opt to use a portion of their revenue to buy back their native tokens from the open market. This approach can serve multiple purposes:
- Value Accrual: By reducing the circulating supply of tokens, buybacks can create upward price pressure, benefiting all token holders.
- Stabilising Token Prices: Regular buybacks can introduce a consistent demand for the token, potentially reducing price volatility.
- Reinvestment: Post-buyback, DAOs can choose to either burn the acquired tokens, permanently reducing the total supply, or retain them in their treasury for future use or redistribution.
Altogether, token buybacks are essentially a mechanism that aligns the interests of the DAO with its token holders. By reinvesting in its own token, the DAO signals confidence in its future prospects and provides a tangible mechanism for value distribution.
Yearn Finance as a Case Study
Yearn Finance, a leading DeFi project on Ethereum, provides a practical example of this strategy in action. In a forum post titled “Rethinking Capital Allocation” from a few years back, Yearn’s community discussed the merits of using protocol revenue for YFI token buybacks instead of distributing it as dividends. The rationale was to reinvest in the project’s growth and maximise future cash flows.
This discussion led to the introduction of a “Buyback and Build” strategy, formalised in proposal YIP-56. Here, part of Yearn’s generated revenue was now used to buy back YFI tokens on the open market to be allocated to strategists and contributors.
Incorporating this strategy into the tokenomics of Yearn, the protocol introduced veYFI. By locking their YFI tokens, users could obtain veYFI, allowing holders to boost their vault rewards and empowering them to vote on the allocation of bought-back YFI tokens.
All in all, this approach ensured that those who actively contributed to the protocol’s success were aptly rewarded, either in the form of tokens and/or governance power, aligning their incentives with the broader goals of the project.
Smart Treasuries: Automated Active Management
In the traditional sense, a treasury is a store of value, a reserve to ensure sustainability. However, with the advent of DeFi and the complexities it brings, the concept of a ‘smart treasury’ has emerged.
A smart treasury is an active management tool that leverages DeFi protocols to automate portfolio management, maintain asset ratios, and even generate yield. Platforms like Balancer have been at the forefront of this movement, offering DAOs the ability to create automated portfolio strategies.
For instance, a DAO might set up its smart treasury to maintain a specific ratio of assets. If the value of one asset rises significantly, the smart treasury can automatically rebalance, selling the appreciated asset to buy more of the depreciated one, ensuring the desired ratio is maintained.
Moreover, smart treasuries can also be programmed to generate yield, investing portions of the treasury in yield-generating protocols, and thus adding another revenue stream for the DAO.
While still a nascent technology, smart treasuries present an interesting part of the next evolution in DAO treasury management, offering possibilities for automation, efficiency, and enhanced revenue generation.
Conclusion
As the blockchain landscape matures, the role of DAOs in shaping the future of decentralised governance becomes increasingly pivotal. Central to their success is the effective management of treasuries, which, unlike traditional financial entities, operate without centralised oversight. Recognising the unique challenges they face and adopting best practices is paramount. By harnessing the power of innovative strategies and adhering to these practices, DAOs can ensure not only their financial resilience but also their ability to drive meaningful change in the decentralised ecosystem.
Bibliography
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