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From the data, is DAO Token swap effective for Treasury diversification?

2022-06-02 22:00

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Are DAO Token Swaps For Treasury Diversification?

By Darsh Patel

Translation: Demo @ DAOrayaki DoraFactory

Diversification into other crypto assets, both stable and unstable, is fast becoming central to DAO's money management agenda, but how to do this is still up for debate. Treasury Swaps represent the latest attempt by the DAO to diversify from its own governance tokens while forming strategic alliances with other protocols. In this article, the DAOrayaki community will explore whether Token swaps really lead to portfolio diversification, and whether governing the exchange of tokens is necessary to strategically coordinate the two projects.

Treasury exchange 101

This is probably the first Treasury swap

The DAO Treasury swap is a proposal that DAOs can integrate with other DeFi protocols by trading local governance tokens with other DAOs' tokens. This allows the DAO to participate in each other's governance and form strategic alliances, using the power it holds to essentially trade influence across the ENTIRE DeFi ecosystem. In the utopian future envisioned by many PROPONENTS of DAO Treasury swaps, including Balancer DAO founder Fernando Martinelli, many DAOs would own small pieces of each other and actively participate in each other's governance processes.

As one of the pioneers of DAO Treasury swaps, the Balancer community has conducted successful swaps with Fei, mStable, PrimeDAO, and GnosisDAO -- most recently proposing a potential swap with another Ethereum heavyweight, Aave. Balancer's first successful Treasury swap with Fei involved swapping 200,000 BAL for equivalent portions of Fei Stablecoin (2,454,000) and TRIBE Governance Token (2,598,000), As of November 2021, when the swap is executed, the total market value is approximately $9 million. This was the first attempt at a "safe" DAO Treasury swap, as Balancer got 50% of its value for a Stablecoin and 50% governance Token, rather than directly swapping the equivalent of its own similar volatility governance Token, Attracting a cash + stock m&a deal similar to TradFi with a direct governance Token exchange will mimic the all-stock transaction. The Balancer community proposed and executed subsequent exchanges with mStable, PrimeDAO, and GnosisDAO, with a public proposal to exchange 14,666,67 AAVE for 200,000 BAL (for those who keep score, FMV is approximately $2.2 million) and provides for the purchase of an additional 100,000 BAL tokens at a price of $1,105,500 compared to the BAL's price of $11. Both Balancer and Aave are "diversifying" their Treasury holdings, Aave is acquiring a new type of yielding asset by depositing its BAL into the BAL:ETH liquidity pool, and Balancer is acquiring additional, and not importantly, LP is one of its most popular pools -- seems like a win-win, doesn't it? Fei did not slack off - proposing a follow-up exchange with OlympusDAO and Tokemak.

Another interesting example of a DAO in a specific ecosystem is the SocialFi Alliance, which takes a proactive approach to diversifying its Treasury assets with governance tokens that resemble consistent DAOs. DHEDGE, a social trading app, and Mask Network, an organization that aims to bring a decentralized app ecosystem to traditional social networks, have made THE DAO Treasury swap an important aspect of their ethos to strengthen the alliance of ecosystem partners. To date, dHEDGE has conducted a $1 million Token swap with Perpetual Protocol and a $500,000 Token swap with Mask Network. MaskDAO even formalized its strategic swaps in the Polygon ecosystem, proposing to allow DAOs to perform swaps at face value, discount, or premium, subject to mutual locking with a linear attribution schedule of at least 12 months, presumably trying to avoid a massive sell-off that would lower the price of masks. MaskDAO further identified its first potential partners from Sushi, dHEDGE, and Gitcoin's SocialFi alliance, as well as countless other candidates, including but not limited to Polygon, Near, Axie Infinity, and Perpetual.

Nothing on this scale has gained much traction in the nascent Solana DAO ecosystem. However, as part of a partnership between Ratio Finance and Sabre DAO, a pending clearinghouse has been proposed. The Ratio and Sabre communities hope this multifaceted proposal is the first step toward a mutually beneficial partnership that will strengthen both agreements. However, it is worth examining whether Token exchanges are a necessary or valid pillar of such partnerships. Will cross-marketing and Sabre LP joining Ratio Finance be enough to generate the required strategic alignment without the hassle of swapping coffers?

Mango Markets also recently vetoed a proposal to buy BTC in favour of using the USDC in its Treasury assets to buy Marinade-Staked SOL. While this rotation into "earning assets" (inflation yields and therefore quotes) is encouraging, does owning SOL rather than USDC offer any diversification or downside protection, or is BTC better off from a risk mitigation perspective?

Diversity or fake diversity?

I believe I've made it clear at this point that DAOs are starting to see Treasury exchanges as an excellent way to get long-term strategic partners with so-called aligned incentives to join a project. However, from a fiscal management perspective, the question remains: does the exchange of governance tokens with another DAO in the ecosystem really provide any asset diversification for DAO finances? Let me answer this question for you: it's not true. We're still in the early days of DeFi, and it's no secret that returns across blue-chip cryptocurrency assets are generally correlated. This handy logarithmic return correlation analysis (portends) by Two Sigma's analysts shows that there is not a single negative correlation between returns of BTC, ETH, XRP, LTC, BNB, etc. -- hinting at common risk within the cryptocurrency space. In addition, there has been a great deal of academic work exploring the correlation of returns between BTC and other blue-chip crypto assets and traditional financial market variables, such as recent declines in tech stocks or interest rate hikes. In short, everything is connected -- but how much? Are these correlations stronger or more pronounced when tokens come from the same ecosystem or manage agreements with aligned incentives or similar products? Let's wait and see.

Case studies using covariance analysis

To examine the relevance of swap assets in a particular ecosystem, we can look at the BalancerDAO and SocialFi alliance cases mentioned above. Daily price data (collected at 11:59:59 PM GST) was fetched for all the tokens in the Balancer portfolio, These tokens are generated as a result of one of the Treasury swaps (and for all governance tokens in the SocialFi consortium that belong to the DeFi protocol), counting all &nbsP in a particular queue; The logarithmic returns of all tokens in 2 years or since the start of the latest protocol in the queue, whichever comes first, and the covariance matrix of the logarithmic returns is calculated for each Token. Readers can find the NBviewer link for the notebook we analyzed here. Special thanks to our friends at Scalyr for providing the cleanest daily price CSV I've ever seen.

Balancer DAO

For Balancer's Treasury swap, we examined daily price data for BAL, MTA, TRIBE, GNO, PRIME and AAVE and compared correlations with logarithmic returns dating back to 2021-04-03. The results are shown in the correlation matrix below:

Source: Castle Finance, Scalyr. Data as of 31 March 2022

There are some interesting observations about the correlation between the assets that exist in Balancer's Treasury and other DAOs in the Ethereum ecosystem: First, there is not a single negative correlation across the entire matrix, and all assets exhibit positive correlations. Pay special attention to the first column in the correlation matrix, as it reveals whether BalancerDAO's money management recommendations for implementing the swaps above resulted in any significant diversification of its native BAL tokens, and we see that it has a positive, statistically significant correlation with the returns of all governance tokens it swapped with BAL, R2 values with MTA, TRIBE and GNO were 0.5663, 0.3763 and 0.6777, respectively. The highest positive return correlation is with AAVE that has not yet been exchanged, from 2021-04-03 to the time of writing, Pearson correlation coefficient is 0.8049.

We can see that for at least the past year, the price of governance tokens exchanged by Balancer in the Ethereum ecosystem has not only moved in sync with BAL, but the returns have also shown a positive correlation, That means none of these individual exchanges offer significant progress in BalancerDAO's attempt to diversify its funds against a sharp market decline, and the black Swan event that worsened BAL's market value could lead to a similar decline in the returns offered by its exchange assets.

Source: Castle Finance, Scalyr. Data as of 31 March 2022

As the above visualization of logarithmic asset returns dating back to August 2021 shows, a number of significant negative return events led to sharp declines in returns across all assets: Late January 2022, early December 2021, late November 2021, and early September 2021 are all notable examples of a sharp decline in the return on one asset, which usually means that the other assets in the basket that BalancerDAO's coffers have also fallen sharply.

For the sake of argument, assume this is just the quality of DAO governance tokens within the Ethereum ecosystem, perhaps due to their mainstream nature -- let's now look at tokens belonging to the SocialFi alliance built on Top of Polygon to see if returns are similarly relevant.

SocialFi Alliance

A basket of governance tokens belonging to the DeFi protocol is selected from the 15-20 Web3 organizations in the SocialFi Alliance. We examined daily price data for MATIC, SUSHI, DHT, MASK, GHST, POOL, REP, QUICK, and DODO and compared correlations in logarithmic returns dating back to 2021-02-18. The admittedly less bad results are shown below:

Source: Castle Finance, Scalyr. Data as of 31 March 2022

Again, we notice that there is not a negative correlation in the whole matrix. All governance tokens belonging to DeFi protocols within the SocialFi Alliance showed positively correlated returns, dating back more than a year. This time, however, there is a string of correlations between assets that are of course not statistically significant. MASK, the governance Token that belongs to MaskDAO, seems to be irrelevant to the rest of the Polygon ecosystem, at least among the governance tokens that belong to daOs within the SocialFi consortium captured in our basket above. So perhaps MaskDAO is doing itself a big favor in facilitating a cascade of Treasury swaps, since its governance tokens seem to lack a clear yield correlation with other assets in the ecosystem. In terms of value, this behavioral bias could be attributed to the inherent characteristics of the Mask network and other projects and protocols in the SocialFi alliance. Mask is more like a social media + data sharing Web3 project, allowing users to encrypt messages for friends, start new projects on Twitter, make social transactions, and create a verified Web3 profile rather than a traditional DeFi application or protocol, It may lead to divergence from the pricing behavior of other governing tokens.

The problem, however, is that basically all the other tokens in this basket have statistically positive Pearson correlation coefficients with the other tokens in the basket. Again, the fact that none of these governance tokens show no or non-zero negative correlation in returns calls into question the effectiveness of the DAO Treasury exchange as a means of preventing significant drawdown or spreading assets across the general Treasury, at least for these protocols in the Polygon ecosystem.

Learn about the Solana ecosystem quickly

Saber < > Ratio

As mentioned earlier, DAO Treasury swaps have not gained much traction in the Solana ecosystem, but there have been several proposals to try to diversify the Treasury that we might have neglected to investigate.

Ratio Finance and Sabre are exploring a proposal based on three pillars: "Sabre LP joining Ratio Finance, [the] Treasury swap between the two agreements and mutual marketing aimed at enhancing the two agreements." The question we are most interested in here is whether a Treasury swap is needed to achieve the desired strategic alignment. Given RATIO Token's relatively new nature, we can only look at price data dating back to 2022-03-26, not including the day it fell, to eliminate any noise from its initial spike. Since then, the correlation coefficient between RATIO and DAILY logarithmic returns of SBR is shown as follows:

Sources: Castle Finance, CoinGecko. Data as of May 10, 2022

Pearson's correlation coefficient is 0.1906, and we cannot conclude that there is a statistically significant positive correlation between the daily logarithmic returns of SBR and RATIO. This is not entirely surprising, as we only used daily price data from more than a month ago at the time of writing. Given all these confusing variables, we'll avoid making a judgment here (for now).

Mango Marinade (yum)

While Mango's recent financial management activities do not really constitute a swap, we believe it is worth examining its decision to purchase Marinade pledged SOL rather than its original plan to purchase BTC in the L1 ecosystem as we answer the question of whether the return correlation is strong. We examined daily log returns dating back to the Mango Token decline (September 2021) to see what correlations existed between BTC, SOL, and MNGO. Correlation matrix with R2 value is shown in the figure below:

Sources: Castle Finance, CoinGecko. Data as of May 10, 2022

As expected, MNGO has a fairly high positive correlation with SOL, with a correlation coefficient of 0.7071, while BTC has a less significant correlation coefficient of 0.4825. If the DAO is looking for portfolio diversification and risk mitigation, it will want to choose assets that are less correlated in the BTC. However, given the collateral returns mSOL has generated, it is encouraging to see Mango putting its spare cash to work.

Stress and testing

This is one reason why we have mentioned several times in this article the main downsizing protection and diversification away from assets that follow a particular return model. Another must-read article for those interested in the DAO Treasury world comes from our friends at Messari. They stress-tested PieDAO's Treasury for a major drop in THE PRICE of BTC (using it as a proxy for the overall cryptocurrency market index due to its popularity, ability to capture the overall sentiment of the industry, and the tendency of the cryptocurrency market to be more correlated with BTC during sharp declines), And showed it was woefully unprepared for a major market correction.

Source: Messari, DeepDAO. Data as of May 3, 2021

Oh dear. Fortunately, PieDAO has diversified into over 50 different crypto assets, according to the latest DeepDAO data, but if their returns are all correlated... Does that matter? Anyway, turning our attention to our portfolio of assets, the product of several Balancer Treasury swaps and the formation of a SocialFi alliance, and noting that the Bitcoin beta isn't too far-fetched, it can be calculated as the variance between the covariance of a particular asset and the return generated by bitcoin divided by the asset, Any Token with a statistically significant Pearson correlation is very similar, as they all have similar covariances and similar variance of returns to Bitcoin. Like the bitcoin beta, which is our intent and purpose "market," swap diversification does not affect the results of the stress test. Balancer's portfolio and any portfolio of agreements in the SocialFi Alliance (mandatory "Not including MaskDAO" disclaimer) are poorly protected against major market declines.

Important points: change or not change...... And how to swap?

As we have repeatedly emphasized, the DAO Treasury does not necessarily achieve the desired diversification by exchanging its native governance tokens with governance tokens that belong to other protocols in a particular blockchain ecosystem. Due to beta, an asset similar to bitcoin, logarithmic returns are statistically significantly positive and do not significantly mitigate losses during market downturns, resulting in limited downside protection against black Swan events. Nevertheless, from a long-term incentive coordination perspective, swaps between the DAO Treasury still make sense: lead to increased cooperation between agreements that have symbiotic or adjacent products/services, and bring in more stakeholders who are invested in the long-term growth of your agreement or DAO.

Such "strategic value" is hard to quantify, however. For long-term incentive adjustments, swaps may not even be needed, and the integration of product offerings and collaboration opportunities may be able to achieve this without the seemingly meaningless financial exchange of local governance tokens.

However, if contributors hosting the DAO repository still choose to move forward with the repository swap, they may want to keep some important provisions in mind. Swaps can occur between DAOs with different Treasury sizes, and smaller DAOs need to be wary of handing nuclear bombs to larger DAOs to lower their Token prices. In a situation where the amount of vested swaps accounts for a significant portion of the total liquidity of DAO Tokens, any large amount of vested tokens may be enough to burst the order book and lower the price in the event of a quick succession of sales. To avoid such disasters, Treasury swaps need to have certain elements built into them, including but not limited to mutual guarantees, such as vesting schedules and cliff periods, to prevent large-scale sell-offs.

Lock-up periods, similar to those offered to venture capital firms that purchase agreements in the form of Token investments, are an absolute prerequisite for any Treasury swap. Other areas to consider when examining the potential of Treasury swaps include streaming payment options that allow the working group to monitor effectiveness and turn streaming on and off, as well as products and vaults in which unattributed swap tokens can be parked to generate passive income.

To sum up: diversification is not necessarily achieved through Treasury swaps. Partnership between project is often hard to quantify the strategic value, and the DAO to exchange with other DAO implementation of "alignment" can be established through integration and collaborative effort, without the need for a shift in financial, some unknown consequences, including liquid bombs, governance effect has not yet played a role in a meaningful way. Daos need to put a lot of thought behind every decision they make, and not act hastily because they have gained popularity within the community.