How to Manage a DAO Treasury

The following article references the Ethereum ecosystem. Note that some of the specific applications mentioned might not exist on other chains.

The first principle of DAO treasury management - as with any asset management - is not to lose money. This sounds difficult and obvious in equal measure, but it’s important to reinforce because it will help to guide all of the subsequent decisions the DAO makes.

Thankfully, DAO treasury management is the collective responsibility of all DAO members and doesn’t need to fall on any one person’s shoulders. However, a few sensible voices making and commenting on proposals can help to keep everyone grounded, especially in the speculative excitement of a bull market.

Evaluating risk when managing a DAO treasury

“We tend to think of ‘risk’ in predominantly negative terms. However, in the investment world, risk is necessary and inseparable from desirable performance.” - Investopedia.

All investments carry an element of risk. This means that the primary responsibility of the DAO in regards to its treasury is risk management. This can be broken down into four elements: expertise, acknowledgement of risk, risk calculation, and execution.

1. Expertise: Does the DAO want to execute every investment itself or contract out to decentralized applications (dApps) / professional services organizations?
   
   The answer to this will almost always be the latter. The expertise and track records of dedicated management tools and teams is almost impossible to replicate within a DAO unless it has been specifically formed for that purpose, but even then, there is no substitute for experience in the field. This, combined with the fact that the risk of failure by those tools and teams can be mitigated with insurance on platforms such as InsureDAO means that it rarely makes sense for a DAO to try to assess and execute every single investment.
2. Acknowledgement: When faced with a potential investment opportunity, it is human nature to accentuate the upside and avoid investigating the associated risks. DAOs are as human as their members so it is imperative to put in place teams and procedures to transparently assess the risk of each treasury allocation.
3. Risk Calculation: A standard formula used by insurance companies is:
   Risk = Probability of Loss * Loss
   
   Estimating the probability of loss is a huge topic in itself, but there are a few techniques from the worlds of engineering and finance that risk management teams within DAOs can adopt as basic precautions:
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   1. Failure Mode and Effects Analysis (FMEA)
   2.Sensitivity / What-If Analysis
   3.Value at Risk (VaR)
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   The other side of the equation - loss - is a simpler metric to control by scaling investments appropriately with the estimated risk.

1. Execution
   
   ‍Execution risk is another huge topic in the worlds of business and finance. In the context of DAOs, there are a few aspects to pay attention to:
   
   1. Talent: As mentioned, make sure your DAO has people with the skills and experience to research and deploy treasury allocations or work with applications and partners who can do it for you.
   
   2. High signal to noise ratio: With the best will in the world, if the merits and disadvantages of every proposal are lost in unstructured Discord threads then every decision will be slow and your DAO will not be able to properly assess and execute its treasury allocation strategy. Pickle Finance solved this problem by voting in a smaller, dedicated treasury management committee that works autonomously on day-to-day operations and only consults the community on major decisions.
   
   3. Systems: Whichever systems you use for storing and managing your treasury, it is imperative to conduct and document test runs of every operation that will be carried out, accounting for system limitations, gas fees, and human error.
   

Diverse Membership

Before diving into the assets and tools that comprise a healthy DAO treasury, it’s worth emphasizing that your DAO’s greatest asset is the collective intelligence of its members. However you construct your treasury, there will always be hacks, contract vulnerabilities, game theory, and other ‘unknown unknowns’ that are simply impossible to predict.

Your best defense against these is to have thousands of engaged members all over the world who are continuously relaying information back to the DAO so that it can react quickly to sell a vulnerable asset or otherwise avoid danger. DAOs that are cliquey, geographically limited, or culturally homogeneous will always be more vulnerable to attack than diverse DAOs simply because they don’t have access to as much information and have stronger biases.

On the offense side too, having community members in thousands of other Discords and Telegram groups, filtering information and looking for opportunities can be a significant edge in the race for growth.

Therefore, before even thinking about growing your treasury, it’s important to first build a diverse community across all time zones with a healthy ‘immune system’ that can both guard the treasury and help it grow.

Diverse Assets

The biggest mistake that DAOs make is to have most of their treasury in their own token. The right mindset is crucial: your DAO may well be the next web3 giant, but most people don’t know that yet. In a downturn, the market can turn adversarial very quickly: holders often panic and sell their tokens back into more familiar assets like $ETH or fiat, which can quickly devastate the value of an undiversified treasury.

This is especially true for new DAOs that have not had time to nurture a broad distribution for their tokens. In the early days, tokens are usually concentrated in the hands of a few whales who can crash the price if they sell.

Yet, even for well established DAOs, tokens will always be at a disadvantage compared to the base layer (L1) asset, for several reasons:

1. Narrow distributions: tokens are held by fewer people than the native L1 assets.
2. Low liquidity: more challenging and relatively expensive to buy or sell, especially in a downturn.
3. Exchange costs: will incur a fee and spread when purchasing or selling against the L1 token.
4. Legitimacy: takes an investment of time and effort to convince people that a token is worth holding.
   

Asset Classes

For specific ideas of how to diversify, looking at the treasury breakdowns and market fluctuations of the top DAOs on DeepDAO can give a good idea of how various asset combinations perform. In general, a diversified treasury should look to balance exposure across a variety of assets and have at least two years of operating expenses in stable, liquid assets such as stablecoins.

It’s important to remember that in crypto, no asset is perfectly safe so any comparison between them is always relative. With that in mind, the following examples range from passive, relatively low risk assets such as L1s, to more active liquidity provision and riskier ventures.

Stablecoins

Stablecoins are tokens that are pegged to real-world currencies such as the US dollar. They can be used to anchor a treasury in the traditional finance world as a hedge against fluctuations in the crypto market. The most popular stablecoins are $USDC, $USDT and $DAI - all pegged to the US dollar - but there are many more, all using a variety of multi-asset, single-asset, and algorithmic strategies to maintain their pegs.

It’s important to remember that the popularity of any coin is no guarantee of its safety or price stability. And, stablecoins are not regulated like fiat currencies or insured by banks or the FDIC. This was dramatically illustrated in May 2022 when UST - an undercollaterized algorithmic stablecoin - broke its peg and wiped out $40bn of value in a few days. Again, an inquisitive and vocal community is the best defense against these kinds of lurking dangers.

L1s

L1 assets such as $ETH are generally the most stable assets in their respective ecosystems. They perform the same function as gold in a traditional portfolio, which is to provide long-term stability and preservation of value. L1 assets derive their value from their utility in the paying of transaction fees, having the longest track record of security, and being a Schelling Point for traders.

Depending on your perspective, the downside of L1s is that their value - in contrast to stablecoins - fluctuates against fiat currencies. Therefore, your treasury’s desired ratio of L1s to stablecoins will depend on the DAO’s general philosophy and definition of success. For example, if the DAO is committed to being wholly crypto-native and denominating their success in crypto rather than fiat, then L1s will command the larger portion. However, in finance it usually doesn’t pay to be too dogmatic, so having some stablecoins as a pragmatic hedge can give you more options in the long term.

Staking

Staking is sometimes sold as a way for the treasury to earn passive income from its assets by locking them up in aid of the overall network security. In reality, it is no more than a hedge against inflation, but, thinking long-term, keeping pace with inflation will make a huge difference to purchasing power and is a no-brainer in terms of treasury management.

💡 Many L1 networks have a security budget that is paid out to validators via an inflationary issuance of new tokens. For Proof-of-Work (PoW) networks such as Bitcoin and Ethereum, this is the reward given to miners in exchange for securing the blockchain and validating transactions. In Proof-of-Stake (PoS) networks, the rewards are given to validators who are willing to bond some of their tokens as a surety of their honesty while they process transactions.

The Ethereum roadmap includes a transition to PoS, which is projected to bring the network’s security requirements down by 90%, meaning fewer tokens need to be issued to pay for it;  meaning lower inflation. At present, Ethereum staking is available on its experimental ‘Beacon Chain’ with a minimum of 32 $ETH (which cannot be withdrawn until The Merge) or via derivative platforms such as Lido.

After the merge, the staking yield on Ethereum PoS is likely to resemble the closest crypto will get to a ‘risk-free rate’ in traditional finance. If applications are like crypto’s version of stocks, then staking is crypto’s version of bonds, and is likely to become a default holding of well diversified treasuries.

While Ethereum staking is still in its proto stage, other networks are much more advanced. Their ‘risk-free rate’ is likely to be much higher than Ethereum’s, but that likely reflects the lower relative security of those networks. 💡

Applications

The category of ‘applications’ in this case covers everything built on top of the L1. Just as Amazon and Google became more valuable than infrastructure companies such as Cisco and Lucent in the web2 boom, it is likely that web3 applications that find product-market fit (and a way to reward investors - no easy feat) could be an important, high-growth component of a diversified treasury.

Index Tokens

Following the theme of traditional finance, crypto also has its own equivalents to stock market index funds. These are tokens backed by a basket of tokens that reflect the performance of the wider market. One of the most popular of these is the DeFi Pulse Index, which tracks the blue chips of decentralized finance, but there are many others that cover other market sectors with varying degrees of proficiency.

Copy-Trading

The beauty of transparent public ledgers is that it is possible to copy the asset compositions of successful treasuries such as a16z and Paradigm and use them as ad-hoc indices. Companies such as Coinmatics, eToro, and Zignaly have taken this a step further and enable users to deposit funds and then automatically copy the trades of expert traders, who earn a fee for their efforts.

Lending & Liquidity Provision

So far we have only talked about passive investments, but your treasury could also take a more active role and provide utility in the form of lending or liquidity provision (LP). This can be done fairly simply by depositing a single asset into protocols like Aave, which will manage the process of lending it out via collateralized loans and recovering regular repayments with interest.

Alternatively, your treasury could supply a pair of assets such as $ETH and your DAO token or $USDT-$USDC into a pool to facilitate good liquidity for traders. The most popular platform for this is Uniswap. In the first scenario, you are providing traders with $ETH in exchange for $DAO and vice-versa, earning a fee for every transaction.

💡 Uniswap offers two LP platforms: Uniswap V2 offers liquidity along an infinite price spectrum, meaning that a 50/50 asset pair can be deposited and left without active management, albeit for a lower yield. Uniswap V3 also allows LP from 0-infinity, but gives the option to restrict the range for a higher yield.

The risk here is that if one of the pair of assets appreciates strongly against the other, then traders will drain that side of your pool beyond your range, leaving you with 100% of the (relatively) unwanted asset, which might continue to lose value, while not generating any yield. For this reason it is strongly recommended to only provide LP for well-correlated assets so this likelihood is reduced. 💡

Whichever type of LP you choose, it is good practice (and good etiquette) to fund a pool for your DAO token and the L1 asset to earn fees, aid price discovery, and achieve a broad distribution.

Venture

Venture investments in startups, either alone or in partnership with other investors is a much larger topic than can be covered here, but suffice to say that taking equity and token positions in startups can be a good candidate for the smaller, high risk portion of a well diversified treasury.

Funding projects that emerge from the DAO can also be a good way of strengthening the wider ecosystem. A good example of this is BitDAO, which, as well as having one of the best diversified treasuries in web3, has also made several ecosystem investments in projects such as zkSync and PleasrDAO.

Treasury Management Tools

Finally, if your DAO does not yet have the capacity (or desire!) to manage its own treasury, there are a large number of tools built to take the effort and stress out of treasury management, from diversification to reporting to everything in between.

Yearn

Yearn is a set-and-forget tool that provides yield-as-a-service (YaaS) via various back-end yield strategies. Yearn accepts deposits of currencies such as $ETH and $USDC; blue-chips such as $UNI, $LINK and $COMP and an array of Curve LP tokens.

Balancer

Balancer has much less overall liquidity than a protocol like Uniswap or Curve, but it offers pools of up to eight assets, making it suitable for managing diversified treasuries. The ‘balance’ in Balancer is the method of keeping a stable ratio of assets in the pool.

For example, in a three-asset pool of 50% $wBTC / 25% $ETH / 25% $DAI, there would always be enough $wBTC to swap for double the amount of $ETH or $DAI, meaning that if the price of $wBTC goes up relative to the other two, then enough of it would be sold in exchange for a restorative amount of the other two. An added benefit of Balancer is that it pays the liquidity providers for the privilege of managing their treasury in that the fees for these balancing transactions accrue to the pool contributors.

Weezi

Weezi is a CRM for DAO asset management that makes it easy to manage funds across multiple wallets and treasuries. Simply set up your DAO and initiate votes when it's time to add a new asset.

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Exponent

Exponent offers decentralized Capital-as-a-Service, so you can use expert tools to manage your treasury without having to hand over the keys to your crypto. Their tools come with built-in risk monitoring and alerts so you can stay ahead of exploits and threats.

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Hedgey

Hedgey builds plug-ins for DAOs that facilitate every step of the treasury management process, from diversification and yield to Over-the-Counter purchases, DAO-to-DAO token swaps, compensation, vesting, and complex options strategies.

Llama

Offering a more bespoke service, Llama works with DAOs on tailor-made treasury allocation strategies.

Multis

Multis offers standard treasury management tools for DAOs such as payroll, cross-chain monitoring, cashflow visualization, budgeting and financial reporting.

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Try the Aragon App to manage your DAO's treasury

The Aragon App makes it easy for members to see the status of your DAO treasury because it's transparent on the blockchain. You can create proposals to move or purchase assets and set them to automatically execute if the vote passes. This gives your DAO members visibility on what's happening in your DAO treasury.