Navigating Token Buybacks — How MYSO can support DAOs/Treasuries
A look into share repurchase programs in traditional markets and how ZLLs can help DAOs/treasuries optimize token buybacks and push new utility to native tokens
TL;DR
- Companies engage in stock buybacks as part of a remuneration strategy to drive positive value flow towards stock price and thus return value to shareholders
- While open market buybacks are straightforward, synthetic repurchases, which make use of derivatives like options and forward contracts, can oftentimes be more effective in terms of cost, signaling power, and hedging opportunity
- Analogous to stock repurchases, token buybacks are common strategies utilized by DAOs and protocols to acquire additional native tokens for a treasury. Token buybacks are a powerful tool for DAO/protocol capital to be redistributed to token holders
- Most token buyback projects make use of a centralized exchange — however, by using a MYSO Zero-Liquidation Loan market, a DAO/protocol can create additional utility for their native token, gain yield on lent stables, while at the same time participating in synthetic repurchases given a downturn that leads to loan defaults
Stock buybacks in traditional markets
In traditional equity markets, public companies often engage in stock repurchases — this involves a company using its cash to buy shares of its own stock on the open market. A company may do this to drive positive value flow towards the stock price to essentially return money to shareholders, usually when there is idle cash that doesn’t need to fund investments or company operations. This is typically referred to as a shareholder remuneration strategy. In addition, a company may engage in a buyback when they feel that their native stock is undervalued—this action can affect both outside sentiment and internal operations, and there is much discussion over the proper methodology to carrying out these repurchases.
Shareholder remuneration can be performed in ways other than share buybacks — issuing dividends and capital repayments are both popular methods of returning capital back to shareholders. Nonetheless, developments in traditional markets in the past 30 years have led to the incorporation of derivative financial instruments, such as options and forward contracts, to stock buybacks — we refer to these as ‘synthetic repurchases’.
Some of the largest companies in the United States, including Bank of America, Dupont and Lockheed Martin, which operate in diverse industries, have used derivatives in making their stock repurchases more effective in terms of cost, signaling power, timeframe, and to hedge risks involved in the buyback process.
Let’s explore different strategies for stock repurchases and how MYSO’s Zero-Liquidation Loans can be used to optimize token buybacks for DAOs/protocol treasuries! 👇
Stock buyback methodologies
There are a number of different methods that companies utilize for their stock buyback programs. Most frequently, firms engage in open market repurchases by laying out a structure for the buyback in terms of size and time before execution. Other primary methods of repurchases also include fixed-price and Dutch auction tender offers, which involve a firm either offering a single pre-determined price to all shareholders for a specific number of shares or utilizing an auction method that diversifies the repurchase price over time. Open market purchases are typically anonymous, meaning that companies are not usually at risk of being front-run during the buyback process — this stands in stark contrast to typical DeFi proceedings.
While these primary methods are popular tools for companies to implement stock buybacks, synthetic repurchases that make use of derivatives have shown to be effective in both theory and practice.
Derivatives in stock buybacks
Synthetic repurchases are a method of stock buyback that can make use of a wide array of equity derivatives, including options, forward contracts, and other complex instruments to improve repurchase effectiveness. With proper implementation, they have shown to increase the pace of buybacks, minimize the impact on share liquidity, provide a hedge to certain risks, or simply lowering costs.
One way a company can implement derivatives to enhance a share buy-back program is by selling puts. By implementing this options strategy with repurchases, firms can reduce the costs of the share buyback by collecting put premiums upfront. This is particularly useful if the company has a bullish outlook on the native share price. This makes sense implicitly, as a stock repurchase program works to drive up share prices — thus, writing puts and collecting a premium can be effective towards bringing down the net cost of the buyback program. In addition, empirical research has shown that a share buyback through written puts sends out a positive signal to the market as it demonstrates a bullish outlook on a company’s shares. The same research also found that companies writing puts significantly outperform their researched benchmarks, indicated that the strategy works to push a strong signal to market participants.
Another innovative method of share repurchases include purchasing additional calls to enhance a buyback program, which allows the company to acquire its shares below the market price given that the price finishes above the call strike price. If the share price finishes below the strike price, the options will not be exercised — however, the price for repurchase will now be even more attractive and will most likely be perceived as undervalued.
Other forms of buybacks that make use of derivatives include accelerated share repurchases, forward equity purchases, along with various implementations of Transferable Put Rights (TPRs), which give shareholders rights to a free put and can be used as another powerful signaling tool for share price undervaluation.
MYSO ZLLs for token buybacks
Analogous to stock repurchases, token buybacks are common strategies utilized by DAOs and protocols to acquire additional native tokens for a treasury. Token buybacks are a powerful tool for DAO/protocol capital to be redistributed to token holders and we see it serving a key role in token sustainability models for protocols going forward.
In 2018, there were $875 billion worth of stock repurchases among S&P 500 companies —this amounts to around 3.6% of the total market cap of the index. The aggregate treasury size of the 75 largest DAOs and DeFi protocols (excluding the Ethereum Foundation) currently stands at around $85.5 billion. If we were to translate a similar level of buyback activity to the current DeFi space, this would amount to ~$311 million in potential yearly token buybacks!
Having said this, many large token buyback programs are executed through a centralized exchange, typically using a TWAP strategy or other staggered approach. This places the outcome of a program to rely heavily on a centralized actor that may lack transparency in execution and may signal a message that goes against the mantra of decentralized organizations. However, performing buybacks through a decentralized exchange comes with its own problems — high slippage costs, price fluctuations, and gas costs are all limiting factors in optimal repurchase execution. It becomes quite difficult to make on-chain token buybacks efficient, as doing a small amount of large-scale purchases can make the program prone to frontrunning, and executing repurchases in staggered batches leads to high gas costs and slippage over time.
To combat both of these concerns, we can implement the traditional equity market strategy of synthetic repurchases to DeFi by making use of MYSO’s Zero-Liquidation Loans! As discussed in a previous piece, DAOs/protocol treasuries can utilize MYSO to create a non-liquidatable loan market for a protocol native token — for example, this would add further utility to the token by allowing users to essentially take leveraged positions to capture token upside while allowing a treasury to put its stablecoins to use in a way that is contained to its own ecosystem.
With this sort of setup, the treasury is essentially exposed to an in-the-money covered call strategy, or equivalently, a synthetic short put. In the case that a borrower defaults on their loan, a DAO/protocol treasury would reacquire their collateral i.e. native tokens at a discount!
Thus, with a Zero-Liquidation Loan market that makes use of treasury stables, a DAO/protocol can create additional utility for their native token, gain yield on lent stables, while at the same time participating in synthetic repurchases given a downturn that leads to loan defaults. For any treasury that has confidence in the long-term performance of their native token, token repurchases in any regard, especially at an implicit discount, should serve as a key tool in signaling conviction as well as reinforcing and redistributing value to token holders.
Participating in a ZLL market thus provides an avenue for profitable and productive deployment of capital to repurchase native token supply or generate yield on stables (in default or no-default scenarios, respectively).
Driving value back to tokenholders
Stock repurchases in traditional equity markets are a powerful tool for companies to support stock price and return value back to shareholders. While traditional forms of open market buybacks are straightforward and common, companies have implemented synthetic repurchases, which make use of a variety of derivatives, to make the process more effective. These innovative strategies have shown to increase the pace of buybacks, minimize the impact on share liquidity, provide a hedge to certain risks, or simply lowering costs.
Similarly, most token buybacks for DeFi projects are carried out using spot buys on a CEX (which comes with its own tradeoffs) as DEXs are still quite inefficient in practice. By using MYSO’s Zero-Liquidation Loan markets, DAOs/protocols are able to implement a strategy that allows the treasury to to earn yield on lent stables, while at the same time participating in synthetic repurchases of their native tokens in the case of a downturn that leads to loan defaults.
Implementing a MYSO ZLL market creates a new layer of utility for any DAO/protocol token while also signaling conviction and resolve in token repurchases, which at the same time drives value back to token holders. It’s a win-win for any project and their community!
If you are a protocol/DAO and want to create a Zero-Liquidation Loan market for your native token, reach out to the team on Discord and keep your eyes out for new product announcements!
References
L. Zeng and P. Luk. Examining Share Repurchasing and the S&P Buyback Indices in the U.S. Market. March 2020 https://www.spglobal.com/spdji/en/documents/research/research-sp-examining-share-repurchases-and-the-sp-buyback-indices.pdf
E. Luning. Innovation in Corporate Finance: Enhancing Share Buy-Backs with derivatives. June 2007 https://essay.utwente.nl/58053/1/scriptie_E_Luning.pdf
D. Jenter, K. Lewellen, and J. Warner. Security Issue Timing: What Do Managers Know, and When Do They Know It? December 2006 https://www.nber.org/papers/w12724
