COMP’s liquidity mining started the Defi bull market in the summer of 2020, which has turned many Defi protocols into monsters with rapid revenue growth. You would think that this puts them in a very comfortable financial situation, and a simple observation of the DAO treasury seems to confirm this. For example, data from OpenOrgs.info shows that the Defi protocol of the head is sitting on hundreds of millions of dollars, and Uniswap is even billions of dollars.
However, as shown in the figure below, almost all of these so-called treasury values are derived from the project’s native tokens, such as UNI , COMP, and LDO:
Although we all agree that the native tokens in the project treasury may be economic resources, counting them as assets on the balance sheet does more harm than good, and is often used as an excuse for poor financial management.
To clarify this point, please allow us to take a quick look at what traditional accounting is like.
Native tokens are not assets
Although Defi tokens are not considered equity in the legal sense, we can still learn from traditional company share accounting methods. Simply put, float (all stocks that can be traded publicly) and restricted shares (shares currently reserved for employees) together constitute the outstanding shares of the company .
These outstanding shares are a subset of authorized shares (a self-set soft cap on total issuance). Importantly, shares that have been authorized but not issued are not included in the company’s balance sheet. How can it be counted? Counting unissued shares allows a company to issue additional assets at will, by only authorizing more shares without selling them.
We hope you can see this connection with the native tokens in the DAO Treasury: these are equivalent to the cryptocurrency version of authorized but not issued shares. They are not the assets of the agreement, but only reflect the amount of tokens that the DAO can “legally” issue and sell to the market.
Therefore, it is meaningless for a DAO to authorize a small or very large amount of tokens into their treasury: it does not indicate its actual purchasing power. To illustrate this point, imagine Uniswap trying to sell as little as 2% of the funds in its treasury. When this transaction is executed through 1inch, it transmits the order to many on-chain and off-chain markets, which will affect the price of UNI by almost 80%.
Real Defi Treasury
Ignoring the authorized but not issued stocks allows us to understand a different and more accurate Defi treasury situation. In order to understand this situation, we further divide non-native tokens into three categories: (1) stable coins, (2) blue chip encrypted assets, (3) other non-stable encrypted assets. Using this new classification, Uniswap has no assets in its treasury, only Lido and Maker have more than 50 million US dollars in assets.
But why is such a large treasury problematic?
First of all, we have seen that simply issuing new shares is not enough, you must also sell on the market. This will affect prices, which will soon limit larger sales. But further, the price that the market is paying for your native token is not guaranteed, but fluctuates sharply.
Second, this price depends on the overall market conditions. The crypto market has gone through several speculative cycles, during which these tokens can reach a gratifying valuation, but they can also plummet by more than 90% and stay there for a long time.
Third, when a Defi project urgently needs liquidity, it may be related to the risk of a specific project: For example, when a project goes through a large-scale bankruptcy due to a loophole or hacking attack, and hopes to compensate users, the token price is often also very high. Downturn-especially if currency holders may initiate stock dilution actions.
Case study: Black Thursday exposed MakerDAO’s treasury
The risks of holding inadequate treasury reserves are real and specific, as MakerDAO experienced firsthand the market crash on March 12, 2020 (commonly referred to as “Black Thursday”). Because of the lack of liquid assets, MakerDAO’s credit system is at risk of collapse. Although the crisis was finally resolved, it still caused serious value losses for token holders. Let’s see how the event develops:
From the launch of MakerDAO in 2018 to March 2020, DAO used net proceeds to repurchase and burn MKR tokens (returning capital to token holders), burning a total of 14,600 MKRs at a cost of more than 7 million DAI . During this period, the MKR token price averaged around US$500.
Then came Black Thursday, due to a sharp decline in prices and Ethernet Square, network congestion, Maker not immediately clear underwater (underwater) positions, resulting in agreements losses of $ 6 million. After deducting the 500,000 DAI in MakerDAO’s treasury at the time, it had to auction MKR tokens on the market to make up for the remaining 5.5 million losses. Maker eventually sold a total of 20,600 MKR at an average price of approximately US$275.
It was not until December 2020 that Maker’s cumulative revenue reduced the token supply to the original 1 million MKR through repurchase, and the total cost of the repurchase exceeded 3 million DAI (the average price of MKR returned to approximately US$500).
The website Makerburn shows the serious token dilution caused by Black Thursday
Summarizing the financial impact of Maker, the $6 million credit loss brought by Black Thursday erased the $10 million accumulated gains over the past three years. If the Maker Treasury reserves hold more stable assets like DAI, the additional loss of $4 million can be avoided because they can use these funds to make up for the inability to repay the loan without the need to sell MKR at a low price. Or to put it another way, by holding a larger treasury, Maker could have gained as much as $4 million in additional value accumulation.
Although it is difficult to assess funding needs in advance, the 500,000 DAI held by Maker before Black Thursday is almost certainly too small. For the negotiated 140 million outstanding loans, it only accounts for 0.35% of the capital buffer, while most traditional financial institutions hold at least 3-4% of venture capital. This does not include operating expenses and wages. If these expenses are not covered by non-native token treasury assets, they may be further forced to sell tokens when the market is down.
Understanding repurchase and dividends
Many Defi projects naively regard their tokens as a treasury asset and may sell them in the worst case. This idea is caused by the lack of a framework for how to do better. Although there are many ways to run a protocol, practitioners may benefit from the following guidelines.
Principle 1: The goal of DAO is to maximize the long-term value of token holders.
Criterion 2: In practice, Criterion 1 means that every dollar that is owned by the agreement or received as proceeds should be converted to the most profitable place today. Options usually include depositing money in a treasury, reinvesting it in growth or new products, or paying token holders through token buybacks or dividends.
Only when the money has a higher return for token holders outside the agreement (after tax), is it correct to pay the money instead of saving or reinvesting it. In practice, we have seen many Defi agreements pay out money that can be used for growth or stored in the treasury for future expenditures. According to our framework, this is a big mistake. In the case of Maker, we have seen how it sold cash in exchange for tokens, but then had to buy back the same cash with tokens at a higher cost of capital.
Generally speaking, we recommend getting rid of the idea of paying dividends or repurchasing tokens to some extent as a “reward” to token holders, while internal reinvestment is not counted. The most rewarding decision for coin holders is to maximize the return on every dollar, whether internal or external.
Principle 3: When complying with the above guidelines, DAO becomes a non-cyclical trader of its own tokens. If the DAO believes that its tokens are overvalued, internal reinvestment will have a good return. It should sell tokens in exchange for cash and reinvest these cash into the agreement. In all bull markets, this should almost certainly be done. When the DAO sees that its token price is lower than its fair value, and it has excess cash without high internal returns, then it can buy back tokens. In all bear markets, this should almost certainly be done.
Achieve better treasury management
Finally, we want to share our views on how DAOs should manage their treasury. We think of the following guidelines:
Principle 4: DAOs should discount the native tokens in their treasury-they are equivalent to the cryptocurrency version of authorized but unissued stocks.
Rule 5: The DAO Treasury needs to survive the next bear market. The bear market may not be next week or next month, or even next year. But in a market driven by speculation like cryptocurrencies, it will happen. Build a financial treasury that can last you for 2-4 years, even if the entire market plummets by 90%, you can still support it for a period of time.
We especially recommend 2-4 years, because you will want to have enough funds to survive the cold winter of the crypto market under the known standards, but not too long to make you rich and lazy, or too distracted to be like a hedge Run your agreement like a fund.
Considering the known operating expenses of large DAOs with large development teams and liquid mining projects, few or none today meet this condition. This means that most or all of them should use the bull market to sell tokens, build a real treasury, and have stable assets. This will not only enable them to survive the upcoming bear market, but also hopefully lead them. Competitors.
Principle 6: DAO treasury should understand the specific liabilities they apply and hedge them. For example, a lending market may plan that a certain percentage of loan positions will fail each year. Although they will not say it explicitly, they secretly understand that the lending market bears the risk. Therefore, bearing economic losses becomes a regular cost on their balance sheets and can be hedged accordingly. At the same time, a more streamlined agreement like Uniswap may not take additional risks, so the financial treasury is much smaller and there is no problem.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/a-new-mindset-for-managing-defi-treasury/
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