DAOs Treasury Management
How to diversify and make DAOs treasury funds productive during a bear market
Decentralized Autonomous Organizations (DAOs) treasury management has been a topic of discussion for quite a long time. Now more than ever, DAOs understand the importance of shielding DAOs’ funds from market volatility and downturns.
The main purpose of any DAO is to efficiently manage and govern its ecosystem. DAO treasury management is a key process as DAOs rely on their treasuries to grow, independently of market conditions. Consequently, treasuries must be resilient while maintaining healthy growth. On top of all that, the logistics of coordinating multiple signers, perhaps across multiple wallets, makes treasury management challenging.
In this article, we will describe strategies that can help ease some of the burdens on DAOs treasury managers’ shoulders. A summary of the risk that treasuries face will be followed by examples of treasury diversification and investment options.
Treasury management challenges
According to DeepDAO data, currently, DAOs’ treasuries hold around $8.1 billion, of which $5.9 billion as liquid funds. One question arises: are these treasuries idle funds or are they bringing any yields to DAOs? If yes, at what cost for DAOs?
Lack of diversification
One of the major challenges that DAOs face in earning a yield on their treasury lies in its composition. The majority of treasuries comprise DAOs’ governance tokens.
Having DAO treasuries in ETH, USDC, and DAI would ease treasury management by hedging funds against risk and asset price volatility. Unfortunately, this is not always the case. As Table 1 shows, treasury diversification is not as spread in the DeFi space as we might think. In the snapshot taken, out of six DAOs treasuries, five hold a significant part of their assets in native tokens.
Setting aside an amount of stablecoins is a very effective way to protect DAOs’ treasuries from future market downturns and offset the DAOs’ operational expenses. Stablecoin is a must-have for DAOs pursuing a steady, predictable source to fund innovation and operations in the long-term. A DAO treasury should be a good mix of stables and native tokens to be prepared for the short-term liquidity and cash needs, as well as set up for the long-term success of the project by holding native tokens.
Lack of long-term planning
DAOs treasury managers can get caught thinking in terms of market cycles, given the fast-paced nature of the DeFi ecosystem growth. The most successful DAOs build their communities for the long term. DAOs should act similarly when managing their treasuries.
DAO treasuries should be as much resilient as possible, so they are actually available to support the function and purpose of the DAO in all market conditions; surviving downturns but also capturing upside during good times. As Larry Sukernik writes, “Bull markets teach bad lessons”. A bull period can push treasury managers to increase the expense allowance and blindly follow prices losing sight of the DAOs’ operational funding needs based on false expectations of never-ending price increments.
As a guiding principle, DAOs should keep their treasury in assets with liquidity profiles that match the DAO’s operational expenses patterns. For example, if a DAO has no visibility on its upcoming operational expenses, it should keep a higher percentage of its reserves in stablecoins or liquid assets. On the other hand, If a DAO has highly predictable expenses, it may prefer to take on more long-term illiquid investments.
Lack of assets management infrastructure
Besides planning weakness, DAOs heavily rely on basic infrastructure to manage their treasuries. The majority keeps track of accounting using in-house solutions based on spreadsheets, and third-party dashboards (such as Dune, or Zapper/Zerion). This approach affects operations efficiency due to the fact that spreadsheets are hard to adjust when DAOs businesses scale. Other than monitoring, regular reporting is of key importance in a decentralized environment like the one of DAOs. A monthly or quarterly report will help DAOs contributors feel part of the project and earn trust in the DAO, through having the same visibility over the DAO’s finances: being able to forecast, and understand the flow of funds and budget.
A proper assets management infrastructure could speed up execution and reporting processes and shield partly DAOs treasuries managers from common daily operations pitfalls. As a starting point, DAOs should pick a treasury and payroll management app, such as Coinshift, that helps organize daily operations and payments to DAOs contributors as well as offers standardized reporting tools.
Treasury management solutions
DAOs have two main sources to generate income: protocol revenue and non-operating income (i.e. investment returns). Ideally, protocol revenues should cover the operating expenses of a DAO, but given the early-stage nature of many protocols and the fixed-kind of costs they face (audits, DAO management, contributors’ salaries), it isn’t always the case.
There exist three main ways to diversify a DAO treasury:
- Over the counter (OTC): OTC sales allow a DAO to exchange tokens directly with its community/partners without going through secondary markets. This method allows DAOs to set vesting schedules and potentially have less impact on token price.
- At market selling: This implies selling tokens at the best available price. Even though this method is fast in execution, it might send negative signals to DAO stakeholders, especially when the size of the sellout is large.
- Using Decentralized Finance (DeFi): Creating a collateralized debt position with variable or fixed rates to borrow operational capital. While this is an innovative solution that makes sense for DAOs operating in DeFi, it also bears a number of risks.
Once treasury is diversified, DAO can leverage the opportunities offered by DeFi protocols to make productive the funds collected. In this scenario, DAOs treasury managers should tend to favour passive and automated strategies. That’s because DAO treasuries are often managed by a multisig and each transaction requires signatures from several contributors, often spread geographically and across time zones.
Alternatively, DAOs should establish smaller working groups devoted to actively manage a given treasury budget or delegate their treasury management to established assets manager as Enzyme. Enzyme is a protocol built on Ethereum that allows users to create, manage and invest in custom crypto asset management vaults. DAOs can import their Gnosis safe multisig and delegate operations to a third-party address — that can freely move within some given investment boundaries. This delegation solution lets DAOs preserve the security of the multisig and add a new layer of flexibility by outsourcing asset management.
Lending protocols
Stablecoin reserves represent a significant opportunity cost for DAOs as they usually remain idle as non-productive assets. Stablecoins lending is one of the most established primitive in the DeFi space to earn single-side yields. In addition to Compound and Aave, new players like Euler are innovating the lending ecosystem by offering a suite of tools automating trading services like short, long, and arbitrage strategies.
Lending protocols offer either overcollateralized or undercollateralized loans.
Collateralization is the act of pledging an asset by a borrower as a means for the lender to recoup initial capital in the instance that the borrower defaults on the loan. Defaulting on a loan or any sort of debt obligation happens when the borrower fails to pay back the loan according to the original agreement.
Given that DeFi empowers open interactions, no one has a credit score or any sort of formal identity associated with the loan they are taking out. Therefore, similar to mortgages, most DeFi lending applications require borrowers to collateralize their loan as an incentive to hold them accountable for repaying the debt. Specifically, Euler will require the borrower to over-collateralize the loan (usually starting at a 130% rate). This means that in order to borrow, the value of the collateral should exceed the loan value.
Overcollateralization has proven to be a reliable mechanism even during the recent market turmoil. Nonetheless, some new protocols are pushing for innovation by offering uncollateralized options in the lending-borrowing markets. Clearpool, for example, lets users lend money to established CeFi groups. Using a creditworthiness rating, the protocol addresses the identification challenge faced by other lending protocols. This feature makes it possible to offer undercollateralized loans improving the overall capital efficiency and generating higher APYs than the average ones.
Lending protocols, both overcollateralized and undercollateralized, share similar risks leading to loss of funds.
- Smart contract: Exploit of a bug in downstream yield protocols’ code
- Governance: Arbitrary changes to protocol parameters, allowance rights and operation rights
- Asset de-peg: The peg of a token against another asset is not maintained
The two lending mechanisms behave differently in case of default. Overcollateralized loans suffer bad debt creation, whereas undercollateralized loans lead to a loss of funds in the event of borrower insolvency.
A possible hedging solution to smart contract risks and bad debt creation has been designed by Idle with the Perpetual Yield Tranches. Perpetual Yield Tranches are a new DeFi primitive that lets liquidity providers choose their risk-return profile. PYTs offer two different yield classes: Senior and Junior Tranches, where the latter cover former funds in case of losses. Senior holders benefit from the built-in protection mechanism and, in exchange, route part of the generated APY to the Junior holders. The innovation introduced lies in the possibility to avoid socialized losses, by shielding DAO funds deployed on the Senior side of PYTs. This solution is already available for the Euler lending market.
Automated market makers
Differently from lending protocols, Automated Market Makers (AMM) let DAOs deposit liquidity and earn a yield. The main difference is that the former enables single-side liquidity lending, whereas the latter asks to deposit multiple tokens based on pool composition.
Balancer is an automated portfolio manager, liquidity provider, and price sensor that empowers decentralized exchange and automated portfolio management of tokens on the Ethereum blockchain. One pool of interest for a DAO in the Balancer ecosystem could be one composed only of stablecoins, such as the one with DAI, USDC and USDT. Alternatively, DAOs can deposit into boosted pools such as the Aave one allowing them to generate some extra yield on stablecoins.
Convex offers as well interesting opportunities for DAOs’ treasuries by providing on-top investment automation to Curve, a leading exchange liquidity pool on Ethereum. On Convex, liquidity providers can receive boosted CRV tokens and liquidity mining rewards with minimal effort. Convex is price agnostic and thus does not require oracles making the protocol protected against price manipulation and flash loan attacks.
Besides the common risks faced by lending protocols (i.e. smart contract, governance and asset de-peg risks), the use of paired tokens in AMMs generates dependencies that can lead to impermanent loss (IL) risk.
Impermanent loss happens when the price of assets locked up in a liquidity pool changes after being deposited and creates an unrealized loss (in dollar terms) versus if the liquidity provider had simply held the assets.
The bigger the change, the higher the impermanent loss, i.e. less dollar value at the time of withdrawal than at the time of deposit. DAOs can limit impermanent loss exposure by favouring stablecoins deposits.
In addition to stablecoins liquidity deployment, DAOs can interact with AMMs to foster liquidity provision on the pairs that involve their governance tokens. Olympus Pro, with its bond-as-a-service strategy, empowers DAOs to retain control of their AMM liquidity, limiting the need to issue additional incentives in the future. In combination with Perpetual Yield Tranches, DAOs can scale the liquidity onboarding phase over the limits imposed by the protocol-owned liquidity (POL). This open model allows DAOs to deposit POL into Senior PYTs built on top of their AMM pair to organically generate outperforming yields on Junior PYTs, incentivizing the market to deploy capital in that class. As a result, PYTs can amplify the outcomes of the Olympus Pro bond strategy, reducing swap slippage and improving the robustness of the price oracle.
Liquid staking solutions
Besides stablecoins lending and AMM deposits, DAOs can diversify part of their treasury in the so-called blue chips assets. Ethereum, for example, is moving towards the Proof of Stake consensus mechanism and lets users and DAOs enter the staking market.
DAOs can lock ETH to sustain the validation activities and receive staking yields. The current main drawback of liquid staking solutions is the inaccessibility to the deposited assets until the actual merge happens. During this timeframe, liquidity providers receive a derivative token representing the staked underlying asset.
Lido is a key player in the DeFi ecosystem offering its staking solution on multiple networks. On the Ethereum blockchain, for example, more than 30% of all the staked ETH are managed by the protocol.
DAOs can leverage the built-in security mechanism of the senior stETH Perpetual Yield Tranches shielding treasury funds from the validator dependencies, such as loss of keys and slashing, linked to liquid staking platforms.
Key Takeaways
We can clearly see that there isn’t a unique way to address DAOs treasuries challenges, but we believe this is a solid (even if non-complete) list of possible resilient treasury management solutions. DAOs treasury managers should find a balance between long-term and short-term investments, always remembering the crucial role of the funds they manage for the DAO collectivity.
Our goal is to let asset managers able to take a passive long-term strategy with minimal exposure to underlying risks and incrementally grow the size of their treasury using the Idle product suite.
We plan to release other follow-up posts going into further details about our approach to treasury management and highlight our feedback and results from our conversations with protocols, DAOs, and institutions using PYTs as a treasury management solution.
We are actively speaking with DAOs and DeFi protocols interested in leveraging our product suite for their treasury management needs. If you’re interested in using Idle for your protocol or DAO treasury, please get in contact on Discord or fill out the Treasury Management Solution form.
