Published in · 8 min read · Jun 15, 2022
Treasury management can be a very overlooked aspect of the crypto space, but is nevertheless one of the most important. Recent months have proven that to be the case for many DAOs and protocols with countless new projects being put on hold due to cashflow reasons. A founder we recently spoke with estimated that 80% of projects launched on their platform have seized operations and estimates 50% will not make it past 6 months. This was before Ethereum dropped another 40% to current levels of ~$1050.
No one really knows the exact cumulative size of crypto treasuries (protocols, DAOs, foundations, holdcos, etc.), but it is not something to be underestimated. Deepdao points us towards the $9.5bn mark for DAO treasuries alone, with a peak of around $13–$14bn last year. Gnosis Safe (an industry standard for treasury storage) points us to the $40bn mark, with a peak of 3–4x that amount last year. In reality, the total size of crypto treasuries likely far surpasses that. After all, venture capital alone put in $33bn last year…and that is without taking into account the 98% CAGR the crypto industry experienced over the last 8 years ending 2021.
Despite this growth, fundamental treasury management issues persist across the ecosystem. Most projects fundraise in their native tokens and the voting rights associated with those tokens cause unique complications that traditional markets either don’t have or have already solved via mechanisms such as Class A vs Class B shares. Predominantly, this leads to concentration risk that causes death spirals in times of high market volatility and an inability to balance across what Fyde Treasury has identified as the Four Pillars of Crypto Treasury Management:
Diversification, Liquidity, Cash Flow, and Governance.
Diversification is one of the most important elements of a treasury, and although it can be expressed through different methods, the primary objective for diversification remains the same: to gain exposure to assets with different performance cycles, thereby mitigating volatility in a given portfolio. Studies have consistently shown (both empirically and through out of sample testing) that diversified portfolios have less volatility and downside risk than concentrated positions — an important feature for ensuring operational longevity over time.
When looking at the top 50 DAOs and protocols however (including Uniswap, Lido, etc.), nearly 80% have treasuries concentrated in less than 3 assets with most consisting of only their own native token and a small allocation to a stablecoin. To put it into traditional finance terms, this would be the equivalent of Ford’s treasury being almost 100% invested in Ford’s own stock — something that’s prohibited by regulation. Traditional corporate treasury teams are legally required to manage risk in their portfolios to ensure that day-to-day operations of the company can be met.
A treasury consisting largely of one’s own tokens creates a level of idiosyncratic risk that undermines the stability of the organization, and due to the scope of this problem, undermines the stability of the entire crypto ecosystem (as can be seen from recent events).
There are reasons why this level of concentration exists. As mentioned earlier, one of the primary reasons why treasuries are concentrated has to do with the fact that fundraising often occurs in a project’s native token. Philosophically, having a treasury hold the same token as the community / users aligns incentives between users and creators. However, having a diversified treasury would increase the likelihood of preserving that incentive alignment since builders would preserve capital in volatile market conditions. True treasury diversification is difficult - if not impossible - with existing solutions. Concentration of one’s treasury in the ecosystem creates a prisoner’s dilemna as unlocking illiquidity of that treasury comes at a great cost, leading to most protocols and DAOs completely excluding their own native token from the calculation of their treasury assets. This brings us to the second pillar of crypto treasury management.
Liquidity in the crypto space is often discussed in relation to token liquidity while the topic of treasury liquidity is often a sideline discussion. In the trad-fi space, treasury liquidity enables assets to simultaneously be put to work (e.g. generate income or asset appreciation) and be spent for liability matching (e.g. paying employees). When taken from this perspective, a billion-dollar treasury won’t do anyone any good if it’s locked up in private investments that can’t be sold. Even endowments that are large enough to have a investable time horizon into perpetuity only allocate a small portion of their assets into long-term illiquid strategies.
However, this often remains the case for crypto treasuries. Due to the lack of diversification, any selling of treasury assets (which are invested predominantly in the native token) will have a direct and substantial impact on the price of said token. A recent example of this relationship can be seen with COPE on the Solana ecosystem. To meet development expenditures, the team was forced to sell a large portion of their treasury that equated to 11% of their overall token supply resulting in the price plummetting by 77%. The arguably greater cost was the subsequent loss of faith from the community.
In addition to this dynamic, protocols and DAOs lack the Class A and Class B equity structure that traditional companies employ. Therefore, voting remains intrinsically linked to native tokens and the selling of these assets from their treasuries typically results in a reduction of their own voting power (more on this later). The combination of these two dynamics creates a situation where the DAO or protocol becomes a forced holder of their treasury. They can’t sell it because of the impact it will have on price and voting power, and using it for yield harvesting also has similar repercussions on voting power. Therefore, due to this illiquidity, not only are crypto treasuries unable to employ diversification strategies -as a traditional treasury should), it also becomes difficult for them to generate cash flow.
Treasuries need cash flow (i.e., yield) to meet the operational expenditures that are incurred (e.g., employees, audits, software licenses, etc.). To this extent, many crypto treasuries have deployed their assets to generate some form of yield. After all, the rapid growth of the DeFi space was due to the introduction of yield harvesting. AAVE for example generates yield via the accumulation of a basket of aTokens (tokens generated via AAVE Protocol on deposits and that identify wallets for yield accumulation) and through staking across other protocols. Lido generates a portion of its yield through options vaults such as Ribbon, where weekly covered calls strategies on stEth are run, and from Curve farming pools.
However, whereas a traditional treasury could have an allocation upwards of 80% in yield generating assets of varying degree (bonds, stocks, money market funds, etc.), most crypto protocols are bound again by the illiquidity of their assets and fall far short of that. In addition, while traditional treasuries often follow a target yield or a liability matching approach, this strategy has not typically come to the forefront in the crypto space. MakerDAO’s recent announcement is the first notable mention of this approach.
Lack of specification around a target yield could lead to asset / liability mismatches where outflows exceed inflows that could result in a rapidly draining asset base if not careful. Protocols and DAOs have operational overhead just as traditional companies and thus, a target yield or asset / liability management approach should be considered. And of course, one must also consider the right mix of assets to generate that yield.
And finally, Governance rounds out the fourth pillar of crypto treasury management. As mentioned earlier, the concept of Class A and Class B shares don’t exist in crypto to the same extent they do in the traditional equity space. Since price action and voting rights are commingled into one, the selling of tokens in a treasury also results in the loss of voting rights. From larger projects like Curve and ENS to smaller projects like Build Finance DAO, governance attacks have become an increasingly persistent worry. As projects mature in the development life cycle and as governance voting grows as a part of decision making, maintaining proper control over governance rights becomes an ever-important aspect to consider when projects embark on the journey of fully decentralizing.
Currently, tools like Snapshot and Tally can help DAOs and protocols manage governance more holistically, and the recent proliferation of veTokens allows for a more “cash flow -esque” monetization of governance rights. However, protocols that use veTokens are still far and few in between (with veCRV being the most prominent). The vast majority of native tokens still suffer from relinquishing their governance rights when diversifying or employing yield generation strategies.
Very few projects (if any) have solved for all four pillars of crypto treasury management: diversification, liquidity, cash flow, and governance. With the tools available in the market, it remains nearly impossible for treasuries to have the liquidity to successfully diversify, which subsequently prevents them from accessing proper cash flow. And wrapped around all of this is the conundrum of ensuring that governance remains with the dedicated community instead of lost through the process of improving treasury health. With the many issues that crypto treasuries face today, it’s not difficult to see why so many projects fail in a bear market. To prevent the mass dereliction of projects and to ensure the stability of the industry, it will be imperative for there to exist better treasury management solutions than what we currently see today.
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