Are DAO Token Swaps Effective for Treasury Diversification?
Diversifying into other crypto assets, both stable and non-stable, is quickly becoming core to a DAO’s treasury management agenda, but how to do so remains up for debate (see Hasu or our first blog post). Treasury swaps represent the latest attempt for DAOs to diversify away from their own governance token while forming strategic alliances with other protocols. In this piece, we’ll explore whether token swaps actually result in portfolio diversification and whether the exchange of governance tokens is necessary to strategically align two projects.
Treasury Swaps 101
DAO treasury swaps are proposals through which DAOs can integrate with other DeFi protocols by trading native governance tokens for those of other DAOs. This allows DAOs to participate in one another’s governance and form strategic alliances, using the strength of their holdings to essentially trade for influence across a DeFi ecosystem. In the utopian future that a lot of DAO treasury swap proponents, including Balancer DAO founder Fernando Martinelli, envision, lots of DAOs will own little pieces of each other and actively participate in each others’ governance processes.
One of the pioneers of the DAO treasury swap, the Balancer community has conducted successful swaps with Fei, mStable, PrimeDAO, and GnosisDAO — and most recently put up a proposal for a potential swap with another Ethereum heavyweight, Aave. Balancer’s first successful treasury swap with Fei involved exchanging 200,000 BAL for equal parts of the FEI stablecoin (2,454,000) and TRIBE governance token (2,598,000), totaling ~$9M in market value as of Nov. 2021 when the swap was executed. This was a “safe” first attempt at a DAO treasury swap since Balancer received 50% of its value back in stablecoin and 50% governance token as opposed to a straight up swap for equivalent value in a governance token similarly volatile to its own, drawing parallels to cash + stock M&A deals in TradFi versus an all stock deal that a straight-up governance token swap would emulate. The Balancer community proposed and executed subsequent swaps with mStable, PrimeDAO, and GnosisDAO, and have an open proposal to exchange 14,666,67 AAVE for 200,000 BAL (~$2.2M USD in FMV for those keeping score), with a provision to acquire an additional 100,000 BAL tokens for a cost of $1,105,500 with BAL at $11. Both Balancer and Aave are “diversifying” their treasury holdings (more on this later…), Aave is acquiring a new type of yield-earning asset by depositing its BAL into a BAL:ETH liquidity pool, and Balancer is gaining an additional, rather significant, LP for one of its most popular pools — seems like a win-win, no? Fei hasn’t slouched either — proposing follow-on swaps with OlympusDAO and Tokemak.
The SocialFi alliance is another interesting example of DAOs within a particular ecosystem taking a proactive approach to diversifying their treasury holdings with the governance tokens of similarly aligned DAOs. dHEDGE, a social trading app, and Mask Network, a group aiming to bring decentralized application ecosystems onto traditional social networks, have made DAO treasury swaps a significant aspect of their ethos to strengthen an alliance of ecosystem partners. dHEDGE has thus far conducted a $1M token swap with Perpetual Protocol and a $500K token swap with Mask Network. MaskDAO has even formalized its pursuit of strategic swaps in the Polygon ecosystem with a proposal to allow the DAO to execute swaps at par, a discount, or a premium, subject to mutual lockups of at least a 12-month linear vesting schedule, presumably in an effort to avoid large sell-offs that would tank the price of MASK (more on this later x2…). MaskDAO goes further to identify its first potential partners from the SocialFi Alliance in Sushi, dHEDGE, and Gitcoin as well as a myriad of other candidates including but not limited to Polygon, Near, Axie Infinity, and Perpetual.
No such large-scale initiatives have gained much traction in the nascent Solana DAO ecosystem. A pending swap of note, however, has been proposed as a part of a partnership between Ratio Finance and Saber DAO. The Ratio and Saber communities are hoping that this multifaceted proposal is the first step to a mutually beneficial partnership that will lead to the strengthening of both protocols. Worth examining however, is whether a token swap is a necessary or effective pillar of such a partnership (more on this later x3…). Is mutual marketing and the onboarding of Saber LP onto Ratio Finance enough to yield the desired strategic alignment without going through the trouble of a treasury swap?
Mango Markets also recently shot down a proposal to buy BTC in favor of Marinade-staked SOL using USDC from their treasury holdings. While this rotation into a “yield-earning asset” (inflationary yield, hence the quotes) is encouraging, does holding SOL over USDC provide any diversification or downside protection, or would Mango DAO have been better off holding BTC from a risk mitigation perspective (more on this later x4…)?
Diversification or just pretend?
As I’m sure I’ve beaten to death at this point, DAOs are beginning to view treasury swaps as an excellent way to get long-term strategic partners with supposedly aligned incentives onboarded to a project. The question from a treasury management perspective still looms, though: is there really any asset diversification provided to one’s DAO treasury after swapping governance tokens with another DAO within your ecosystem? I’ll answer that question for everyone up front: not really. We’re still in the early innings of DeFi, and it’s no secret that there are widespread correlations in returns between blue-chip crypto assets. This handy log-returns correlations analysis (foreshadowing) done by analysts over at Two Sigma, shows that there is not a single negative correlation between returns in the likes of BTC, ETH, XRP, LTC, BNB, and more — alluding to the common risks within the crypto universe. Further, there’s a breadth of academic work exploring the returns correlations between BTC and other blue-chip crypto assets and traditional financial market variables like the recent drawdown in tech stocks or interest rate hikes. In short, everything is correlated — but just how much? And are these correlations stronger or more evident when tokens come from the same ecosystem or govern protocols that have aligned incentives or similar product offerings? Let’s find out.
Case Studies with Covariance Analysis
To examine just how correlated swapped assets within a particular ecosystem are, we can take a look at the two cases mentioned above in BalancerDAO and the SocialFi Alliance. Daily price data (collected at 11:59:59 pm GST) was scraped for all of the tokens in Balancer’s portfolio accrued as the result of one of its treasury swaps (and same for all of the governance tokens belonging to DeFi protocols within the SocialFi Alliance), log returns were calculated for all of the tokens within a particular cohort over a 2-year period or since inception of the newest protocol in the cohort, whichever came first, and covariance matrices for log returns were calculated for each of the tokens. Readers can find a NBviewer link to the notebook in which we conducted the analysis here. Special thanks to our friends over at Scalyr for the cleanest daily price CSVs I’ve ever seen.
Balancer DAO
For treasury swaps conducted by Balancer, we examined daily price data for BAL, MTA, TRIBE, GNO, PRIME, and AAVE and compared correlations in their log returns dating back to 2021–04–03. The results are pictured in the correlation matrix below:
A few interesting observations from the correlations between assets present in Balancer’s treasury post-swaps with other DAOs in the Ethereum ecosystem: first, there isn’t a single negative correlation in the entire matrix, all of the assets exhibit positive correlations. Paying particular attention to the first column in the correlation matrix, as it sheds light on whether or not BalancerDAO’s treasury management proposals to execute said swaps led to any significant diversification away from its native BAL token, we see that it has positive, statistically significant correlation in returns dating back to 2021–04–03 with all of the governance tokens that it swapped BAL for, with R2 values of 0.5663, 0.3763, and 0.6777 with MTA, TRIBE, and GNO, respectively. The highest positive returns correlation is with AAVE, which it has yet to swap with, with a Pearson’s Correlation Coefficient of 0.8049 from 2021–04–03 to the time of writing.
We can see that in at least the past year, not only have the prices of Balancer’s swapped governance tokens within the Ethereum ecosystem moved in tandem with BAL, but the returns have also shown a positive correlation, meaning that all of these individual swaps offered no significant headway in BalancerDAO’s attempts to diversify its treasury against a significant market drawdown, and a Black Swan event resulting in a deterioration of BAL market cap would likely result in similar decay in returns offered by its swapped assets.
As shown in this visualization of log returns in the above assets dating back to August 2021, many of the major negative returns events saw sharp declines in returns across all assets: late January 2022, early December 2021, late November 2021, and early September 2021 all being salient examples of sharp declines in one asset’s returns usually meaning an equivalently sharp decline in the others in this basket present in BalancerDAO’s treasury.
Let’s say for the sake of argument that this is only a quality of DAO governance tokens within the Ethereum ecosystem due perhaps to its mainstream nature — we’ll now take a look at the tokens belonging to the SocialFi Alliance building on top of Polygon to see if there are similar correlations in returns.
SocialFi Alliance
Out of the 15–20 Web3 orgs in the SocialFi Alliance, a basket of governance tokens belonging to the DeFi protocols were selected. We examined daily price data for MATIC, SUSHI, DHT, MASK, GHST, POOL, REP, QUICK, and DODO and compared correlations in their log returns dating back to 2021–02–18. The admittedly less damning results are pictured below:
We once again note that there isn’t a single negative correlation in the entire matrix. All of the governance tokens belonging to DeFi protocols within the SocialFi Alliance exhibit positive correlations in their returns dating back a little over a year. However, this time, there’s a slew of returns correlations between assets that certainly aren’t statistically significant. MASK, the governance token belonging to MaskDAO, seems to be pretty untethered to the rest of the Polygon ecosystem, at least amongst the governance tokens belonging to DAOs within the SocialFi Alliance captured in our basket above. So perhaps MaskDAO is doing itself a massive favor in terms of brokering a barrage of treasury swaps, as its governance token seems to lack notable correlation in returns with other assets in the ecosystem. For what it’s worth, this deviation in behavior may be attributed to the innate characteristics of Mask Network versus the other projects and protocols in the SocialFi Alliance. Mask is more of a social media + data sharing Web3 project that allows users to encrypt messages for friends, launch new projects on Twitter, trade socially, and create a verified Web3 profile as opposed to a traditional DeFi application or protocol, perhaps leading to diverging price action from the other governance tokens in the fold.
The point remains, however, that essentially every other token in this basket has a statistically significant positive Pearson’s Correlation Coefficient with every other token in the basket. Once again, the fact that none of these governance tokens exhibit no or nonzero negative correlation in returns calls into question the validity of the DAO treasury swap as a means of protecting against a major drawdown or diversifying assets within a treasury in general, at least for these protocols in the Polygon ecosystem.
A Quick Look into the Solana Ecosystem
Saber <> Ratio
As mentioned earlier, the DAO treasury swap hasn’t gained much traction in the Solana ecosystem, but there have been a few attempted proposals to engage in treasury diversification that we would be remiss to not examine.
Ratio Finance and Saber are exploring a proposal that rests on three pillars: “Saber LP onboarding onto Ratio Finance, a treasury swap between [the] two protocols, and mutual marketing in an attempt to strengthen both protocols.” The question that we’re most interested in here is whether or not a treasury swap is necessary to achieve the desired strategic alignment. Given the relatively new nature of the RATIO token, we were only able to take a look at price data dating back to 2022–03–26, excluding the day of its drop to remove any noise from its initial pump. The correlation coefficient between the daily log returns of RATIO and SBR since then is pictured below:
With a Pearson’s correlation coefficient of 0.1906, we can’t conclude that there’s a statistically significant positive correlation between the daily log returns for SBR and RATIO. This isn’t entirely unexpected, given that we’re only working with daily price data dating back a little over a month as of the time of this writing. Given all these confounding variables, we’ll refrain from passing judgment here (for now).
Mango Marinade (yum)
Even though Mango’s recent treasury management activities don’t really constitute a swap, we thought examining its decision to purchase Marinade-staked SOL instead of its original plan to buy BTC was worth examining in our quest to answer the question of whether returns correlations are strong within an L1 ecosystem. We examined daily log returns dating back to around Mango’s token drop (September 2021) to see what correlations exist between BTC, SOL, and MNGO. The correlation matrix with R2 values is pictured here:
As expected, MNGO has a rather high positive correlation in daily returns with SOL with a correlation coefficient of 0.7071 versus a less significant 0.4825 correlation coefficient with BTC. If the DAO was looking for portfolio diversification and risk mitigation, it would have wanted to opt for the less correlated asset in BTC. However, given that mSOL yields staking rewards, it’s encouraging to see that Mango is putting its idle capital to work.
Stressed and Tested
There’s a reason we’ve mentioned major drawdown protection and diversification away from assets that follow a particular return pattern multiple times in this article. Another piece of required reading for anyone interested in the world of DAO treasuries comes from our friends at Messari. They stress-tested PieDAO’s treasury against major drawdowns in the price of BTC (using it as an overall crypto market index proxy due to its popularity, ability to capture the overall sentiment of the industry, and the tendency of the crypto market to grow more correlated to BTC in sharp downturns), and showed that it was very ill-prepared for a major market correction.
Yikes. Luckily, according to the most recent figures on DeepDAO, PieDAO has since diversified into 50+ different crypto assets, but then again if their returns are all correlated…does it matter? Regardless, turning our attention back to our basket of assets that are a product of Balancer’s several treasury swaps and the formation of the SocialFi Alliance, it wouldn’t be too farfetched to note that beta to Bitcoin, which can be calculated as covariance between a particular asset and Bitcoin divided by the variance of the returns yielded by the asset, would be very similar for any tokens that have a statistically significant Pearson’s Correlation Coefficient as they would all have similar covariances to Bitcoin and similar variances in returns. With a similar beta to Bitcoin, aka “the market” for our intents and purposes, swap diversification doesn’t affect the outcome of the aforementioned stress test. Balancer’s portfolio and the portfolios of any protocols in the SocialFi Alliance (obligatory “excluding MaskDAO” disclaimer) are poorly protected against major market drawdowns.
Takeaways: to swap or not to swap…and how?
As we’ve highlighted over and over again, a DAO treasury doesn’t necessarily get the diversification one would expect from swapping its native governance token with governance tokens belonging to other protocols within a particular blockchain ecosystem. Statistically significant positive correlations in log returns and no significant mitigation of losses during a market decline due to similar asset beta to Bitcoin results in limited downside protection from Black Swan events. All that being said, swaps between DAO treasuries continue to make sense from a long-term incentives alignment perspective: leading to an increase in collaboration between protocols that have symbiotic or adjacent product / service offerings and bringing more stakeholders who are invested in the long-term growth of your protocol or DAO into the fold. However, such “strategic value” is hard to quantify. A swap may not even be necessary for long-term incentive alignment, and integrations in product offerings and collaboration opportunities may be able to accomplish this without the seemingly pointless financial exchange of native governance tokens.
However, if contributors presiding over DAO treasuries still choose to push forward with a treasury swap, there are a few important provisions that they may want to keep in mind. Swaps could take place between DAOs with varying treasury sizes, and smaller DAOs need to be wary of handing a larger DAO a nuke to tank its token price. Any large amount of vested tokens in a situation where the vested swap amount is a significant portion of the total liquidity of a DAO’s token may be enough to blow through the order book and tank the price if sold in rapid succession. To avoid such a disaster, certain things need to be built into a treasury swaps product including, but not limited to, assurances on both sides such as vesting schedules and cliffs to protect against a large sell-off. Lock-up periods, similar to the ones offered to venture capital firms that buy into protocols in the form of a token investment, are definitely a must-have in any treasury swap. Other areas to look into when examining the potential for a treasury swap include a streaming payments option that allows working groups to monitor effectiveness and turn the streaming on and off as well as products and vaults within which unvested swapped tokens can be parked to generate passive yield.
All in all: diversification isn’t necessarily achieved via treasury swaps. Partnerships between projects have strategic value that is oftentimes hard to quantify and the “alignment” that DAOs hope to achieve with other DAOs through swaps can potentially be established via integrations and collaborative efforts without the need for a financial move with several unknown consequences including liquidity nukes, governance implications, etc. that have yet to play out in a meaningful way. DAOs need to put deliberate thought behind every decision rather than making moves because they’re gaining popularity within the community.
DP
Twitter | Telegram: @darshrs
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