A detailed analysis of DAO strategy, allocations and direction of travel.
In this update the team wanted to discuss with the wider community our thoughts about the strategic direction of the DAO and the levers that we have at our disposal to effect change. The following post contains an assessment of the many moving parts of the DAO’s current strategy and a summation of our approach to improving its performance and resilience. This assessment centers around four core elements of our current activities:
1. TREASURY MANAGEMENT
2. LIQUIDITY PROVISION
3. LIQUIDITY MINING
A thorough understanding of these elements is key to unlocking greater performance from the DAO and will strengthen our long-term stewardship of the DAO’s capital assets, intellectual property and social capital. This article is based upon figures from the recent treasury review and will form the basis for discussions around implementation of items 3, 7 & 8 of the recent roadmap.
1. TREASURY MANAGEMENT:
Our recent treasury review (https://build-finance.medium.com/build-finance-treasury-update-october-2021-78fd17035bc9) showed the DAO treasury to hold around $1.6M in assets, broadly broken down as follows:
NET TOTAL ASSETS: 187,841 DAI; 16,496 BUILD; 155,582 METRIC; 106,689 BCRED; 371,347 UPDOWN; 487 BAL.
NET $ EQUIVALENT: $1,611,889.
The bulk of these assets were held within the treasury contract (~59%), and a substantial portion in two Balancer pools (~19% & ~18% respectively). The assessment also showed that the DAO treasury’s total capital assets consisted of nearly 16% BUILD tokens themselves, nominally used for liquidity provision and for ecosystem development.
2. LIQUIDITY PROVISION:
BUILD token is available from two principle liquidity sources, Balancer and Uniswap, and from three pools (BUILD-METRIC-DAI, BUILD-METRIC-bCRED-UPDOWN-DAI & BUILD-ETH):
BALANCER 3 ASSET ~$318k liquidity (100% DAO)
BALANCER 5 ASSET ~$408k liquidity (~78% DAO)
UNISWAP ~$69k liquidity (0% DAO)
It can be seen that the DAO currently provides around $640k liquidity, or around 80% of the total liquidity for all of BUILD ecosystem tokens. There are some additional sources of liquidity for METRIC on L1 and it is expected that some METRIC liquidity will migrate away from L1, but that is outwith the consideration of this assessment for the time being.
As the BUILD token represents a pro-rata share of the DAO assets it is clear that the primary obligation of the DAO is to maintain and grow the pool of assets it holds. This may appear self-evident but the actions of the DAO to date do not appear to necessarily hold this as truth. Key takeaways:
- The DAO holds an over-large proportion of its assets in BUILD ecosystem tokens.
- The DAO holds an over-large proportion of its assets in Balancer pools on L1
- The DAO is under-weight on diversified and interest-bearing assets
It should not be regarded as a negative connotation that the DAO should be interested in diversifying its treasury, as protection of treasury capital under all market environments should be seen as a key priority. Furthermore, and being respectful of the fact that the DAO should maintain the ability to offer ecosystem tokens as part of a range of developer incentives, it makes little sense for the DAO to retain such a large proportion of it’s treasury in the BUILD token itself.
Therefore a high-level interim summary might conclude that a sensible course of action would involve reducing the amount of ecosystem tokens whilst increasing the number of diversified and interest-bearing assets in the treasury; in this way the pro-rata claim of each BUILD token holder would be strengthened.
3. LIQUIDITY MINING:
As can be seen approximately 40% of the DAO assets are held in two Balancer pools on L1, providing much needed liquidity to the market and earning swap fees from trading activity. These pools have proven broadly adequate this far but the heavy allocation to these specific pools raises issues of systemic risk, and also leaves the DAO very exposed to changes in market condition and sentiment. There are also regular complaints that these pools do not provide deep enough liquidity to service all market participants adequately. However, without additional layers of incentive there is very little reason for other market participants to add to the existing liquidity, particularly in light of the enhanced offerings elsewhere.
It is therefore proposed that the DAO offers a range of liquidity mining rewards to BUILD LPs on L1 as a way to increase overall liquidity, whilst reducing the DAO’s overall liquidity provision and enabling the DAO to diversify its LP activity to other pools, and potentially to other chains.
If the community are in favor of adopting this strategy then the quantum of change in both regards is of key importance. As we are seeking to increase overall liquidity whilst reducing the DAO contribution then the provision of LP rewards and associated incentivization must be carefully considered.
If it is considered desirable to implement a liquidity mining protocol then the DAO must secure a funding source for the rewards. As the DAO treasury currently holds a substantial quantity of BUILD tokens that it is actively looking to reduce it would seem sensible to use some of these tokens as short to medium term funding for the proposal. However, depending upon then desired quantum of DAO LP reduction and increase in overall liquidity then it is clear that the treasury funds would be unlikely to be sufficient for the long term, providing adequate funding for between 6 to 18 months perhaps. Therefore a sustainable long term strategy is likely to require an inflationary model for BUILD token.
Indeed, this eventuality was considered by the team at the inception of the DAO and was anticipated to take an ad-hoc approach to funding activities as required. To enable this the BUILD token minting keys are controlled by the on-chain governance module, and the minting of further tokens beyond the 130,000 currently circulating will require a formal vote. What this proposal seeks to set out is that the setting of a modest target inflation rate would be useful in allowing the DAO to plan for funding in the medium to long term, whilst giving DAO holders a clear picture of what emissions will look like, and to plan for the impacts of debasement accordingly. It will also enable the forthcoming streamlining of project governance a series of bounds within which to operate.
If it is considered desirable to increase overall liquidity by 50% (to ~$1.2M) whilst reducing DAO supplied liquidity by 50% (to ~$320k) it can be seen that liquidity provided by market makers and other participants must increase from $160k to $880k, or an increase of 450%. Whilst this seems very large it must be noted that the current model provides no incentive for LPs or mitigation against IL. It is hoped that a range of reasonable incentives in addition to a slowly increasing total supply will catalyze a change in behavior from hoarding to active market participation for many DAO token holders. In the above example the required additional liquidity provided by the market would be in the region of $700k and (excluding pool swap fees) if the DAO was to incentivize this at a rate of even 25% APY it would require approximately $150k of funding from the DAO, approximately 10% of the total treasury. If the DAO wanted to double the existing overall liquidity to $1.6M, this funding would increase by another 60% to $240k per annum. There is also no guarantee that 25% APY would be a high enough number to achieve such increased rates of liquidity provision from the market.
For the purposes of illustration however let us assume that the above first case was implemented and the BUILD DAO provided the $150k in LP rewards to the participants in the programme. Once the DAO has removed 50% of its liquidity from the pools it would hold approximately 11.1k BUILD tokens, which at current prices equals around $169k. Therefore the BUILD DAO treasury would have enough to fund a runway of just 13.3 months of LP rewards at the above rates, not including any tokens required for other purposes such as ecosystem development, dev ops, marketing, etc. This is clearly not a sustainable situation. Were the LP rewards in the example to be funded solely through inflation it would require an inflation rate of approximately 10k BUILD per annum, or an annualized rate of 7.6%. Even accounting for an increased rate of funding for LPs and some allocation towards ecosystem funding it is proposed that inflation could remain below 15%. This level of inflation would lead to an overall increase of BUILD supply from 130k to approximately 260k over the course of the next five years.
It is clear that the present model of funding and liquidity provision operated by the BUILD DAO has a number of issues, in particular a tendency towards lack of participation, hoarding of assets, high-risk allocation of resources and constitutional inertia. The above article sets out a case for the reduction of DAO LP allocation whilst implementing a programme of market participant LP rewards funded through a low-inflation policy. It is proposed that a working group be formed to model a wide range of outcomes in order to develop a thesis as to the most efficient means of incentivization, and that fully developed proposal is brought before the DAO members for a formal vote in December 2021. We welcome all comments and thoughts at this stage — please join in the conversation in our Discord governance channel.