This article will take the maximization of the interests of all governance token holders as the goal of DAO governance, and briefly discuss DAO from six aspects: risk-free interest rate, potential financing channels, governance structure, optimal capital structure, valuation level, and mergers and acquisitions finance.
Edited by: DAOrayaki & THUBA DAO
Definition of the current stage of the DAO
DAO basics
Decentralized Autonomous Organization DAO (Decentralized Autonomous Organization) generally refers to an organization based on blockchain technology, developed through smart contracts, and safeguarding the interests of all parties by a well-designed token economy. Participants are connected by a common goal and collaborate through the network . Different from the traditional corporate hierarchical structure design, DAO does not have a central node and hierarchical structure, and all decisions are made by DAO members. Since the concept of DAO was first proposed in 2014, DAO has grown rapidly. At present, it has differentiated into multiple types of DAOs such as funding type, investment type, protocol type, collection type, media type, and social type.
According to DeepDAO data [1] , as of April 7, 2023, a total of 12,353 DAOs in the world have assets of 25.3 billion US dollars. The top five DAOs are Optimism Collective, Arbitrum One, Uniswap, BitDAO, and Polygon. The total assets are about 16.5 billion US dollars, and CR5 is as high as 65%. At the beginning of January 2023, there were only 10,752 global DAOs with assets of 8.8 billion US dollars. The top five DAOs were Uniswap, BitDAO, ENS, Gnosis, and Wonderland, and CR5 accounted for about 63%. DAO is still in the stage of barbaric growth, and the number of organizations, asset scale, and competition pattern are still in the stage of rapid iteration.
Due to the imperfect organizational structure of DAO, many organizations currently adopt the dual structure of company + DAO, and the company acts as the developer, operator, asset custody and owner of the DAO underlying protocol. A typical case is that Uniswap labs is responsible for the development of the Uniswap underlying protocol, and Uniswap is an open and free DAO.
Figure 1 Brief description of the development process of DAO
The basic framework of corporate finance and DAO financial research
DAO is considered to be a form of resource organization comparable to the corporate system and the basic production unit of the future Metaverse. Compared with companies with hundreds of billions of assets at every turn, the development of DAO has a long way to go. The rapid development of the asset scale under the corporate system is partly due to the accelerated operation efficiency of capital operations such as equity and debt investment and financing, mergers and acquisitions and reorganizations. In the future, the expansion of high-quality DAO assets will require equity and debt investment and financing, and non-performing DAOs may face problems such as bankruptcy restructuring and debt restructuring.
A simple framework of traditional corporate finance theory is to start from ① market risk-free interest rate, externally analyze ② potential financing channels (including primary PE/VC/IPO and secondary stock issuance/bond issuance), and internally analyze company ③ internal Entrusted agency governance structure, ④ optimal capital structure (equity and debt ratio under MM theorem), so as to measure ⑤ company valuation level (DCF/PE/PS and other methods), and provide valuation for further analysis of inter-company ⑥ mergers and acquisitions Base. The development of basic corporate finance theory has been relatively perfect, and the goal of corporate governance is to maximize the interests of shareholders, not to maximize the interests of companies or creditors.
Although it is quite different from the corporate system, the research framework of traditional corporate finance can also be applied to DAO, providing theoretical reference for DAO governance and possible future capital operations. Analogous to the analysis of corporate finance, a basic framework of DAO financial analysis is to start from ① the risk-free interest rate in the cryptocurrency market (although this interest rate may not exist), externally analyze ② potential financing channels, and internally analyze ③ the governance structure of DAO (Voting mechanism, organizational structure), ④ optimal capital structure (equity debt ratio, initial distribution ratio of tokens), so as to measure ⑤ DAO valuation level, and provide a valuation basis for ⑥ mergers and acquisitions among DAOs. Comparing with corporate finance, the goal of DAO governance should be to maximize the interests of all holders of governance tokens, but this conclusion has not yet reached a consensus in the market and academic circles. To maximize the size of DAO assets, all holders of governance tokens and utility tokens Maximizing benefits, maximizing DAO valuation, etc. may also become the goals of DAO governance. It remains to be seen where the market consensus will go. This article will take the maximization of the interests of all governance token holders as the goal of DAO governance, and briefly discuss DAO finance from six aspects: risk-free interest rate, potential financing channels, governance structure, optimal capital structure, valuation level, and mergers and acquisitions. .
Six Financial Dimensions of DAO Research
The risk-free interest rate faced by the DAO
The risk-free interest rate in the financial market usually takes the yield of government bonds or stock index yields. The government guarantees the repayment of funds for treasury bonds, and there will be no default except for extreme factors such as war. There is no government guarantee in the cryptocurrency market, and there are always risks in market institutions. For example, FTX, the world's second largest cryptocurrency exchange, will go bankrupt within a week at the end of 2022; in addition, there are risks such as account hacking, so the cryptocurrency market does not There is a completely risk-free rate, but there is a low-risk rate as an opportunity cost of investing in the crypto market. Investors "denominated in BTC/ETH" and investors "denominated in U.S. dollars and other fiat currencies" face two different types of opportunity costs. The former are usually emerging cryptocurrency funds, which are raised and invested through BTC/ETH; the latter Usually, traditional financial investment institutions and individual investors need to bear additional exchange rate risks of cryptocurrencies and currency issuance.
Table 1 The lending rate of each token on the Compound platform
Source: Compound official website, data as of April 7, 2023
Figure 2 Compound platform ETH lending rate
For investors denominated in Bitcoin/Ether, the low-risk interest rate can refer to the Defi lending rate. There are many cryptocurrency exchanges and institutions that provide DeFi (Decentralized Finance) loans. Due to differences in transaction costs and liquidity, prices of the same currency often vary between different exchanges. This article takes the Compound project, which is the first echelon of liquidity in the industry, as an example to introduce low-risk interest rates. First, a rough introduction to Compound’s deposit and loan mechanism. Compound sets up a separate fund pool for each type of loan asset. The depositor deposits 1 ETH, and the Compound platform issues 10 Compound tokens as a deposit certificate (exchange rate 0.1). Assuming that the exchange rate rises to 0.12 when the user redeems, the user can get 1.2 ETH, corresponding to a 20% return . Borrowers need to pledge certain assets to borrow money. For example, by pledging 1 bitcoin, you can borrow ether equivalent to 0.75 bitcoin (pledge rate 0.75).
The pledge rate is usually between 0 and 0.75. When the price of the pledged asset fluctuates too much, the borrower will be required to cover the position, otherwise the position will be liquidated. This mechanism guarantees the safety of the depositor's funds to a certain extent. It is worth noting that the low-risk interest rate on the Compound platform is not static, but determined according to the relationship between capital supply and demand. Take ETH as an example: the deposit rate is between 0%-12.75%, and the loan rate is between 0%-16.18%. [2] . Compared with the risk-free interest rate of traditional finance (usually between 2% and 10%), the low-risk interest rate of cryptocurrency fluctuates in a larger range, which means that the valuation of cryptocurrency assets is naturally characterized by large fluctuations.
For investors who calculate investment income based on the US dollar, the low-risk interest rate can be the yield of treasury bonds in the traditional financial market, the pledged ETF index of the cryptocurrency market, and the hedging arbitrage yield of buying and selling cryptocurrencies at the same time. The national bond yield method is not applicable to some directional funds in the cryptocurrency field, and LPs also disagree with a high probability; the cryptocurrency market pledge ETF index method is the most ideal method, but considering that there are very few tradable cryptocurrency ETFs, there is currently no Not applicable, the effectiveness of this indicator is expected to increase in the future; hedging arbitrage yield includes cross-exchange arbitrage in space and futures and spot arbitrage in time, which requires a large capital capacity and stable yield for hedging strategies, otherwise it cannot be used as a general sexual interest rate.
① Cross-exchange arbitrage means that the price gap between different exchanges is too large. Taking Bitcoin as an example, if you buy it on A exchange and sell it on B exchange, even considering the handling fee, there is still a positive return. Take Bittrex, Exmo and other six Taking the closing price data of major exchanges from 2015 to the end of 2022 as an example, the daily trading price difference is about 1%, up to 13.65%, but it has declined in recent years, that is, as the liquidity increases, the prices of various exchanges converge, and arbitrage opportunities disappear. ② Futures-spot arbitrage refers to arbitrage by using the price difference between the futures contract price and the spot price. Investors can buy a certain amount of spot goods and sell the same amount of futures, and can obtain profit from the difference on the delivery date. If the exchange supports the payment of the margin for selling futures in the form of purchased spot, lower-risk arbitrage can be achieved, otherwise there is a risk of liquidation due to a sharp rise in prices and insufficient margin. Both cross-exchange arbitrage and futures-spot arbitrage strategies have problems of limited capital capacity and potential risks. The former has the risk of transaction failure due to insufficient liquidity and insufficient transaction speed, while the latter has a greater risk of liquidation when the margin cannot be paid in the form of spot. Therefore, for investors denominated in US dollars, long-term effective low-risk interest rates still need to be found.
Figure 3 BTC price difference of major exchanges
Source: Cryptodatadownload
Potential Financing Channels
Primary market: The sources of venture capital for DAO mainly include VC institutions denominated in traditional legal currency, VC institutions denominated in cryptocurrency, and DAO funds denominated in cryptocurrency. The top ten crypto funds for 2022 are all US funds. Except for Sequoia, which is a traditional VC, all others are newly established funds focusing on the field of cryptocurrency. Only the top funds such as Paradigm and a16z have a capital scale of more than 2 billion US dollars, and the capital scale of other funds such as Pantera and Sequoia are mostly less than 1 billion US dollars. VC institutions denominated in traditional legal currency/cryptocurrency still adopt the traditional VC structure, which is limited to high-net-worth individuals or high-risk groups in specific countries or regions. The investment goal is to obtain financial returns or strategic advantages. DAO funds refer to community members. To raise funds or raise funds from LP, members initiate investment proposals and investment resolutions through governance tokens.
DAO funds currently mainly include three types: ① DAO venture capital funds raise funds through LP, adopt a management fee + commission profit model, which is more in line with the current legal framework; ② Syndicate DAO is composed of parent DAO and sub-DAOs, parent DAO conducts due diligence, sub-DAOs are established by the parent DAO for each investment, and generally have no more than 99 members. Sub-DAOs members can obtain investment income and bear investment risks; ③ Service DAO provides consulting services to third-party funds in exchange for project equity or fixed services fees, but not directly involved in investment decisions.
Table 2 Top 10 Cryptocurrency Funds in 2022
Source: Web3 VC Database
Primary Market: Another financing channel for DAOs in the primary market is Initial Crypto-Token Offering (ICO), which generally refers to blockchain start-up projects issuing encrypted tokens to raise Bitcoin, Ethereum and other common Digital currency, the issuance of tokens (tokens) can be used as payment tokens to use the functions developed by the platform in the future, and can also be exchanged for other encrypted currencies on the exchange. There is no consensus method in the token valuation industry. Valuation of currency liquidity, future lifting time, future supply and demand relationship and other factors [5] 。
Compared with the traditional IPO model, ICO has obvious differences in the issuer, issuer, and institutional services. ① The IPO issuer is a mature enterprise that has established a relatively complete organizational framework, business model and relatively complete historical financial data. A limited liability company after the share reform; while ICO is usually in the early stage of the development of blockchain start-up projects, entity legal person/non-entity team/individual/DAO organization can issue. Some projects even have white papers but no actual products can also carry out ICO. For example, Ethereum raised 18.4 million US dollars of bitcoin within 42 days in 2014 under the condition of only releasing white papers. Most projects issued tokens at a price of less than 1 US dollar. Size less than $500,000.
② Compared with a limited company, the tokens issued by ICO may adopt two types of mechanisms: fixed amount and unlimited design. For example, the total amount of Bitcoin is only 21 million, while the total amount of Ethereum has no upper limit. Taking Polygon as an example, its white paper stipulates that the total supply chain of the token MATIC is 10 billion pieces, and 1.9 billion MATIC pieces were sold in the ICO in exchange for 5 million US dollars of BNB tokens. ③ Shares of a joint stock company represent rights such as ownership, dividend rights, and voting rights, while blockchain start-up projects may adopt a dual-token mechanism, that is, governance tokens are limited in supply, have investment value, and are similar to stocks, while game tokens are unlimited Supply, generation and consumption only within the platform, for a specific discussion on the dual-token mechanism, please refer to Appendix 1: Token Economic Model. ④ There is no mandatory intermediary agency for ICO issuance. Although there are three-party agencies such as UD Blockchain that provide consulting services for token issuance, it is not mandatory, but IPO must hire brokers, accountants, lawyers and many other intermediary agencies.
Figure 4 2019-2022 ICO Issuing Price (USD)
Figure 5 2019-2022 ICO Fundraising Scale (USD)
Source: Coinmarketcap
Table 3 The total amount of the top ten blockchain tokens at the end of 2022
Source: Coinmarketcap, as of December 31, 2022
Secondary market: After listing, a joint stock company can raise funds in the secondary market through additional stock issuance/bond issuance, while DAO may raise funds in the secondary market through token selling or bond financing. The former means that the DAO project party usually only sells part of the tokens during the ICO, and stores the tokens needed for the future development of the project in the treasury (for the concept of the treasury, please refer to Appendix 1: Token Economic Model), so proposals are initiated and voted in the community After approval, you can quickly raise funds by selling tokens directly to the secondary market. Debt financing means that DAO applies for short-term (less than 1 year) or long-term (several years) token loans from the lending market, and issues bonds to the traditional capital market to obtain legal currency loans. Due to the lack of long-term token loan products, DAO does not have the legal entity qualifications to issue bonds, loans need to be repaid but token financing does not need to be repaid, etc., DAO's secondary financing has not yet formed a significant volume. However, for a DAO with a stable organizational structure and good future profit expectations, the cost of debt financing is much higher than the cost of token financing, so the scale of debt financing will continue to grow with the development of the DAO scale.
Token-based governance structure
The same share, same rights, and same benefit of a joint stock limited company are mandated by law. Except for the special AB share structure, one share represents one vote for governance, and the one share, one vote model effectively protects the interests of all shareholders. The tokens issued by DAO do not naturally represent governance rights, but only represent the right to use tokens to obtain the functions developed by the platform in the future. The model of one token, one voting right is no longer applicable, and the distribution of governance rights is determined by each community.
Considering the large number of community members, it is difficult for all community members to participate in voting and reach a consensus, so some innovative governance rights distribution mechanisms have been proposed [6] . ① The quadratic voting mechanism allows a single voting subject to vote repeatedly for the same option, but the voting cost is the square of the number of votes. This mode weakens the control of users with a large number of tokens and enables projects supported by a large number of users to pass. Typical applications are Gitcoin, but because forged identities will invalidate the voting mechanism, social accounts need to be bound, which makes voting impossible to achieve anonymity. ② Weighted voting and reputation voting link voting influence with holding time and lock-up time to avoid the risk of large-scale borrowing of funds to manipulate project voting, but a large amount of fund lock-up inhibits project liquidity. The typical application is Polkadot.
③ Knowledge extractable voting means that proposals are divided into different themes, and different topics correspond to different knowledge certificates. Those who own certain types of knowledge certificates can obtain higher voting influence, which solves the investment problem in the professional field, but knowledge certificates The reasonable distribution of needs to be studied, and the typical application is Dit protocol. ④ Anger withdrawal mechanism means that any member can withdraw the corresponding share of funds in DAO at any time and withdraw from the DAO organization. The typical application is DAOhaus. In theory, voting cannot harm the main interests of any member, but the stability of the organization under this mechanism is limited.
The design of DAO governance mechanism is still evolving, trying to find the optimal solution between voting efficiency and member consensus. The solution to the optimal DAO governance mechanism is not only a financial problem, it needs to be further explored in practice, which will be a key factor in determining whether the DAO asset scale can grow exponentially.
Optimal Capital Structure
The purpose of optimal capital structure planning is to maximize the value of DAO, and it is necessary to focus on two aspects: token and debt capital ratio, token distribution and release.
Under certain conditions, the tax-free MM theorem holds that the proportion of equity financing or debt financing used by enterprises does not affect the total value of the enterprise, so it is impossible to increase the value of the enterprise by changing the capital structure. The MM theorem with tax holds that under certain conditions, the tax shield effect of debt financing increases the value of the enterprise, but the bankruptcy cost reduces the value of the enterprise accordingly, and the value of the enterprise rises first and then decreases with the increase of the proportion of debt financing. The formula of the MM theorem is expressed as follows:
The holding income of DAO token includes the capital gains of the token price increase and the corresponding dividend right of the token. As long as the token dividend right is consistent with the principle of traditional stock one profit, the MM theorem can be transferred to the DAO field. Conversely, if DAO dividends violate one share one profit, the MM theorem does not apply. However, since dividend distribution will cause tokens to be classified as securities, DAO currently tries to avoid paying dividends to token holders as much as possible, but to benefit all parties through capital gains.
In general, under the premise of one token for one benefit, the value of DAO can be increased by appropriately increasing the ratio of creditor's rights. The increase in value mainly comes from the tax shield effect; the increase in the ratio of creditor's rights also leads to an increase in the capital cost of tokens.
The initial token distribution refers to the distribution of the total amount of fixed tokens in the single currency or dual currency model among the founding team, marketing, investors, ICO, treasury and other parties. There is no unified view on the basic principles of token distribution and release. There are two basic points that can be summarized through numerical simulation: ① The token release cycle should match the user growth cycle; ② The treasury should hold more tokens to stabilize token price fluctuations .
Yash Agarwal once proposed a framework for DAO community valuation [7] , analyzed the indicators and dimensions that DAO valuation should focus on, but did not propose a quantitative model method. Kristof Lommers once proposed a preliminary quantitative idea for the valuation of DAO token [5] . Valuation methods are divided into relative valuation method and absolute valuation method. The relative valuation method refers to the benchmarking of a certain indicator and the DAO with a recognized valuation, so as to obtain the valuation of the target DAO. Kristof initially proposed that indicators such as TVL, protocol transaction volume, token transaction volume and speed, and user net present value can be used as benchmark indicators for relative valuation. However, since few DAOs have stable and recognized valuations, the relative valuation method is currently applicable Scenes are limited.
In terms of absolute valuation method, Kristof proposed that the value of DAO token can be split into the discounted value of the expected cash flow of the token, the discounted value of the implied value of governance rights, and the discounted value of the expected pledge reward of the token. The essence of this method is that the token value is equal to the capital gains, governance rights income, dividends and pledge income that can be obtained by holding tokens. Among them, the benefits of governance rights are difficult to measure and token holders with different holdings enjoy different benefits of governance rights, so different holders will get different valuation results.
Kristof's absolute valuation method has important reference significance in token investment pricing, but it is not fully applicable to the DAO merger and reorganization scenario. The DAO merger valuation should be based on all tokens with voting rights, neither all circulating tokens nor all Tokens, mainly means that as long as they control all the tokens with voting rights, a certain DAO can have full control over another DAO. Therefore, DAO Valuation is equal to Total Voting Tokens* Token Valuation.
Key points of DAO merger and reorganization
DAOs are moving from barbaric growth to orderly growth. Small DAOs with poor management can go through bankruptcy liquidation, and large DAOs with poor management may revitalize their assets through acquisitions. Well-run DAOs may also achieve rapid growth through mergers and acquisitions. On December 8, 2021, the proposal to merge xDai and Gnosis was approved, 1 xDai token STAKE was exchanged for 0.032 Gnosis token GNO, and xDai Chain was renamed Gnosis Chain [8] . On December 22 of the same year, the merger proposal of Rari Capital and Fei protocol was approved by the votes of their respective DAO members, and the Rari token RGT was converted into TRIBE [9] , the total lock-up value after the merger is 2 billion US dollars. According to the terms of the merger, RGT token holders can exchange RGT for TRIBE at a ratio of 1:26.7 (RGT: TRIBE) within 180 days; those who disagree with the merger can exchange TRIBE for a certain share of the Fei Protocol treasury within 3 days.
In the stage of DAO merger and reorganization, we need to pay attention to the merger of organizational structure and transaction consideration. In terms of organizational structure merger, if the organizational structure of the merger target is the same and belongs to the same public chain, the technical difficulty of the merger is limited. How to avoid the loss of KOL caused by the merger is the key issue; It is much more difficult to determine whether to adopt a new structure or one side to integrate into the other's structure in terms of strategy. No matter which method is used, it is much more difficult than the former; wait and see. In terms of transaction consideration, logically there are cash and equivalent payment, token replacement payment, creditor’s rights loan payment and several types of fusion payment. Considering the difficulty of operation, token replacement payment will still be the mainstream method in the short term. Token replacement payment ratio can be determined by the valuation method mentioned in (5) DAO valuation method.
references
[1] DeepDAO
[2] ETH Interest Rate Model
[3] Cryptodatadownload
[4] Web3 VC Database
[5] A Framework for DAO Token Valuation
[6] 7 common voting mechanisms of DAO
[7] How to value a community? — DAO Valuation Frameworks
[8] xDai / Gnosis Merger AMA
[9] DAO mergers: the future of M&A?
[10] Tokenization and token economy solutions
[11] Single and Dual Currency Model Comparison
Thanks
DAOrayaki, a decentralized media protocol, publicly funded THUBADAO to conduct independent research and share results publicly. The research topics mainly focus on Web3, DAO and other related fields.
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DAOrayaki & THUBA DAO｜Application of traditional corporate finance theory in DAO field
Edited by: DAOrayaki & THUBA DAO
Definition of the current stage of the DAO
DAO basics
Decentralized Autonomous Organization DAO (Decentralized Autonomous Organization) generally refers to an organization based on blockchain technology, developed through smart contracts, and safeguarding the interests of all parties by a well-designed token economy. Participants are connected by a common goal and collaborate through the network . Different from the traditional corporate hierarchical structure design, DAO does not have a central node and hierarchical structure, and all decisions are made by DAO members. Since the concept of DAO was first proposed in 2014, DAO has grown rapidly. At present, it has differentiated into multiple types of DAOs such as funding type, investment type, protocol type, collection type, media type, and social type.
According to DeepDAO data [1] , as of April 7, 2023, a total of 12,353 DAOs in the world have assets of 25.3 billion US dollars. The top five DAOs are Optimism Collective, Arbitrum One, Uniswap, BitDAO, and Polygon. The total assets are about 16.5 billion US dollars, and CR5 is as high as 65%. At the beginning of January 2023, there were only 10,752 global DAOs with assets of 8.8 billion US dollars. The top five DAOs were Uniswap, BitDAO, ENS, Gnosis, and Wonderland, and CR5 accounted for about 63%. DAO is still in the stage of barbaric growth, and the number of organizations, asset scale, and competition pattern are still in the stage of rapid iteration.
Due to the imperfect organizational structure of DAO, many organizations currently adopt the dual structure of company + DAO, and the company acts as the developer, operator, asset custody and owner of the DAO underlying protocol. A typical case is that Uniswap labs is responsible for the development of the Uniswap underlying protocol, and Uniswap is an open and free DAO.
Figure 1 Brief description of the development process of DAO
The basic framework of corporate finance and DAO financial research
DAO is considered to be a form of resource organization comparable to the corporate system and the basic production unit of the future Metaverse. Compared with companies with hundreds of billions of assets at every turn, the development of DAO has a long way to go. The rapid development of the asset scale under the corporate system is partly due to the accelerated operation efficiency of capital operations such as equity and debt investment and financing, mergers and acquisitions and reorganizations. In the future, the expansion of high-quality DAO assets will require equity and debt investment and financing, and non-performing DAOs may face problems such as bankruptcy restructuring and debt restructuring.
A simple framework of traditional corporate finance theory is to start from ① market risk-free interest rate, externally analyze ② potential financing channels (including primary PE/VC/IPO and secondary stock issuance/bond issuance), and internally analyze company ③ internal Entrusted agency governance structure, ④ optimal capital structure (equity and debt ratio under MM theorem), so as to measure ⑤ company valuation level (DCF/PE/PS and other methods), and provide valuation for further analysis of inter-company ⑥ mergers and acquisitions Base. The development of basic corporate finance theory has been relatively perfect, and the goal of corporate governance is to maximize the interests of shareholders, not to maximize the interests of companies or creditors.
Although it is quite different from the corporate system, the research framework of traditional corporate finance can also be applied to DAO, providing theoretical reference for DAO governance and possible future capital operations. Analogous to the analysis of corporate finance, a basic framework of DAO financial analysis is to start from ① the risk-free interest rate in the cryptocurrency market (although this interest rate may not exist), externally analyze ② potential financing channels, and internally analyze ③ the governance structure of DAO (Voting mechanism, organizational structure), ④ optimal capital structure (equity debt ratio, initial distribution ratio of tokens), so as to measure ⑤ DAO valuation level, and provide a valuation basis for ⑥ mergers and acquisitions among DAOs. Comparing with corporate finance, the goal of DAO governance should be to maximize the interests of all holders of governance tokens, but this conclusion has not yet reached a consensus in the market and academic circles. To maximize the size of DAO assets, all holders of governance tokens and utility tokens Maximizing benefits, maximizing DAO valuation, etc. may also become the goals of DAO governance. It remains to be seen where the market consensus will go. This article will take the maximization of the interests of all governance token holders as the goal of DAO governance, and briefly discuss DAO finance from six aspects: risk-free interest rate, potential financing channels, governance structure, optimal capital structure, valuation level, and mergers and acquisitions. .
Six Financial Dimensions of DAO Research
The risk-free interest rate faced by the DAO
The risk-free interest rate in the financial market usually takes the yield of government bonds or stock index yields. The government guarantees the repayment of funds for treasury bonds, and there will be no default except for extreme factors such as war. There is no government guarantee in the cryptocurrency market, and there are always risks in market institutions. For example, FTX, the world's second largest cryptocurrency exchange, will go bankrupt within a week at the end of 2022; in addition, there are risks such as account hacking, so the cryptocurrency market does not There is a completely risk-free rate, but there is a low-risk rate as an opportunity cost of investing in the crypto market. Investors "denominated in BTC/ETH" and investors "denominated in U.S. dollars and other fiat currencies" face two different types of opportunity costs. The former are usually emerging cryptocurrency funds, which are raised and invested through BTC/ETH; the latter Usually, traditional financial investment institutions and individual investors need to bear additional exchange rate risks of cryptocurrencies and currency issuance.
Table 1 The lending rate of each token on the Compound platform
Source: Compound official website, data as of April 7, 2023
Figure 2 Compound platform ETH lending rate
For investors denominated in Bitcoin/Ether, the low-risk interest rate can refer to the Defi lending rate. There are many cryptocurrency exchanges and institutions that provide DeFi (Decentralized Finance) loans. Due to differences in transaction costs and liquidity, prices of the same currency often vary between different exchanges. This article takes the Compound project, which is the first echelon of liquidity in the industry, as an example to introduce low-risk interest rates. First, a rough introduction to Compound’s deposit and loan mechanism. Compound sets up a separate fund pool for each type of loan asset. The depositor deposits 1 ETH, and the Compound platform issues 10 Compound tokens as a deposit certificate (exchange rate 0.1). Assuming that the exchange rate rises to 0.12 when the user redeems, the user can get 1.2 ETH, corresponding to a 20% return . Borrowers need to pledge certain assets to borrow money. For example, by pledging 1 bitcoin, you can borrow ether equivalent to 0.75 bitcoin (pledge rate 0.75).
The pledge rate is usually between 0 and 0.75. When the price of the pledged asset fluctuates too much, the borrower will be required to cover the position, otherwise the position will be liquidated. This mechanism guarantees the safety of the depositor's funds to a certain extent. It is worth noting that the low-risk interest rate on the Compound platform is not static, but determined according to the relationship between capital supply and demand. Take ETH as an example: the deposit rate is between 0%-12.75%, and the loan rate is between 0%-16.18%. [2] . Compared with the risk-free interest rate of traditional finance (usually between 2% and 10%), the low-risk interest rate of cryptocurrency fluctuates in a larger range, which means that the valuation of cryptocurrency assets is naturally characterized by large fluctuations.
For investors who calculate investment income based on the US dollar, the low-risk interest rate can be the yield of treasury bonds in the traditional financial market, the pledged ETF index of the cryptocurrency market, and the hedging arbitrage yield of buying and selling cryptocurrencies at the same time. The national bond yield method is not applicable to some directional funds in the cryptocurrency field, and LPs also disagree with a high probability; the cryptocurrency market pledge ETF index method is the most ideal method, but considering that there are very few tradable cryptocurrency ETFs, there is currently no Not applicable, the effectiveness of this indicator is expected to increase in the future; hedging arbitrage yield includes cross-exchange arbitrage in space and futures and spot arbitrage in time, which requires a large capital capacity and stable yield for hedging strategies, otherwise it cannot be used as a general sexual interest rate.
① Cross-exchange arbitrage means that the price gap between different exchanges is too large. Taking Bitcoin as an example, if you buy it on A exchange and sell it on B exchange, even considering the handling fee, there is still a positive return. Take Bittrex, Exmo and other six Taking the closing price data of major exchanges from 2015 to the end of 2022 as an example, the daily trading price difference is about 1%, up to 13.65%, but it has declined in recent years, that is, as the liquidity increases, the prices of various exchanges converge, and arbitrage opportunities disappear. ② Futures-spot arbitrage refers to arbitrage by using the price difference between the futures contract price and the spot price. Investors can buy a certain amount of spot goods and sell the same amount of futures, and can obtain profit from the difference on the delivery date. If the exchange supports the payment of the margin for selling futures in the form of purchased spot, lower-risk arbitrage can be achieved, otherwise there is a risk of liquidation due to a sharp rise in prices and insufficient margin. Both cross-exchange arbitrage and futures-spot arbitrage strategies have problems of limited capital capacity and potential risks. The former has the risk of transaction failure due to insufficient liquidity and insufficient transaction speed, while the latter has a greater risk of liquidation when the margin cannot be paid in the form of spot. Therefore, for investors denominated in US dollars, long-term effective low-risk interest rates still need to be found.
Figure 3 BTC price difference of major exchanges
Source: Cryptodatadownload
Potential Financing Channels
Primary market: The sources of venture capital for DAO mainly include VC institutions denominated in traditional legal currency, VC institutions denominated in cryptocurrency, and DAO funds denominated in cryptocurrency. The top ten crypto funds for 2022 are all US funds. Except for Sequoia, which is a traditional VC, all others are newly established funds focusing on the field of cryptocurrency. Only the top funds such as Paradigm and a16z have a capital scale of more than 2 billion US dollars, and the capital scale of other funds such as Pantera and Sequoia are mostly less than 1 billion US dollars. VC institutions denominated in traditional legal currency/cryptocurrency still adopt the traditional VC structure, which is limited to high-net-worth individuals or high-risk groups in specific countries or regions. The investment goal is to obtain financial returns or strategic advantages. DAO funds refer to community members. To raise funds or raise funds from LP, members initiate investment proposals and investment resolutions through governance tokens.
DAO funds currently mainly include three types: ① DAO venture capital funds raise funds through LP, adopt a management fee + commission profit model, which is more in line with the current legal framework; ② Syndicate DAO is composed of parent DAO and sub-DAOs, parent DAO conducts due diligence, sub-DAOs are established by the parent DAO for each investment, and generally have no more than 99 members. Sub-DAOs members can obtain investment income and bear investment risks; ③ Service DAO provides consulting services to third-party funds in exchange for project equity or fixed services fees, but not directly involved in investment decisions.
Table 2 Top 10 Cryptocurrency Funds in 2022
Source: Web3 VC Database
Primary Market: Another financing channel for DAOs in the primary market is Initial Crypto-Token Offering (ICO), which generally refers to blockchain start-up projects issuing encrypted tokens to raise Bitcoin, Ethereum and other common Digital currency, the issuance of tokens (tokens) can be used as payment tokens to use the functions developed by the platform in the future, and can also be exchanged for other encrypted currencies on the exchange. There is no consensus method in the token valuation industry. Valuation of currency liquidity, future lifting time, future supply and demand relationship and other factors [5] 。
Compared with the traditional IPO model, ICO has obvious differences in the issuer, issuer, and institutional services. ① The IPO issuer is a mature enterprise that has established a relatively complete organizational framework, business model and relatively complete historical financial data. A limited liability company after the share reform; while ICO is usually in the early stage of the development of blockchain start-up projects, entity legal person/non-entity team/individual/DAO organization can issue. Some projects even have white papers but no actual products can also carry out ICO. For example, Ethereum raised 18.4 million US dollars of bitcoin within 42 days in 2014 under the condition of only releasing white papers. Most projects issued tokens at a price of less than 1 US dollar. Size less than $500,000.
② Compared with a limited company, the tokens issued by ICO may adopt two types of mechanisms: fixed amount and unlimited design. For example, the total amount of Bitcoin is only 21 million, while the total amount of Ethereum has no upper limit. Taking Polygon as an example, its white paper stipulates that the total supply chain of the token MATIC is 10 billion pieces, and 1.9 billion MATIC pieces were sold in the ICO in exchange for 5 million US dollars of BNB tokens. ③ Shares of a joint stock company represent rights such as ownership, dividend rights, and voting rights, while blockchain start-up projects may adopt a dual-token mechanism, that is, governance tokens are limited in supply, have investment value, and are similar to stocks, while game tokens are unlimited Supply, generation and consumption only within the platform, for a specific discussion on the dual-token mechanism, please refer to Appendix 1: Token Economic Model. ④ There is no mandatory intermediary agency for ICO issuance. Although there are three-party agencies such as UD Blockchain that provide consulting services for token issuance, it is not mandatory, but IPO must hire brokers, accountants, lawyers and many other intermediary agencies.
Figure 4 2019-2022 ICO Issuing Price (USD)
Figure 5 2019-2022 ICO Fundraising Scale (USD)
Source: Coinmarketcap
Table 3 The total amount of the top ten blockchain tokens at the end of 2022
Source: Coinmarketcap, as of December 31, 2022
Secondary market: After listing, a joint stock company can raise funds in the secondary market through additional stock issuance/bond issuance, while DAO may raise funds in the secondary market through token selling or bond financing. The former means that the DAO project party usually only sells part of the tokens during the ICO, and stores the tokens needed for the future development of the project in the treasury (for the concept of the treasury, please refer to Appendix 1: Token Economic Model), so proposals are initiated and voted in the community After approval, you can quickly raise funds by selling tokens directly to the secondary market. Debt financing means that DAO applies for short-term (less than 1 year) or long-term (several years) token loans from the lending market, and issues bonds to the traditional capital market to obtain legal currency loans. Due to the lack of long-term token loan products, DAO does not have the legal entity qualifications to issue bonds, loans need to be repaid but token financing does not need to be repaid, etc., DAO's secondary financing has not yet formed a significant volume. However, for a DAO with a stable organizational structure and good future profit expectations, the cost of debt financing is much higher than the cost of token financing, so the scale of debt financing will continue to grow with the development of the DAO scale.
Token-based governance structure
The same share, same rights, and same benefit of a joint stock limited company are mandated by law. Except for the special AB share structure, one share represents one vote for governance, and the one share, one vote model effectively protects the interests of all shareholders. The tokens issued by DAO do not naturally represent governance rights, but only represent the right to use tokens to obtain the functions developed by the platform in the future. The model of one token, one voting right is no longer applicable, and the distribution of governance rights is determined by each community.
Considering the large number of community members, it is difficult for all community members to participate in voting and reach a consensus, so some innovative governance rights distribution mechanisms have been proposed [6] . ① The quadratic voting mechanism allows a single voting subject to vote repeatedly for the same option, but the voting cost is the square of the number of votes. This mode weakens the control of users with a large number of tokens and enables projects supported by a large number of users to pass. Typical applications are Gitcoin, but because forged identities will invalidate the voting mechanism, social accounts need to be bound, which makes voting impossible to achieve anonymity. ② Weighted voting and reputation voting link voting influence with holding time and lock-up time to avoid the risk of large-scale borrowing of funds to manipulate project voting, but a large amount of fund lock-up inhibits project liquidity. The typical application is Polkadot.
③ Knowledge extractable voting means that proposals are divided into different themes, and different topics correspond to different knowledge certificates. Those who own certain types of knowledge certificates can obtain higher voting influence, which solves the investment problem in the professional field, but knowledge certificates The reasonable distribution of needs to be studied, and the typical application is Dit protocol. ④ Anger withdrawal mechanism means that any member can withdraw the corresponding share of funds in DAO at any time and withdraw from the DAO organization. The typical application is DAOhaus. In theory, voting cannot harm the main interests of any member, but the stability of the organization under this mechanism is limited.
The design of DAO governance mechanism is still evolving, trying to find the optimal solution between voting efficiency and member consensus. The solution to the optimal DAO governance mechanism is not only a financial problem, it needs to be further explored in practice, which will be a key factor in determining whether the DAO asset scale can grow exponentially.
Optimal Capital Structure
The purpose of optimal capital structure planning is to maximize the value of DAO, and it is necessary to focus on two aspects: token and debt capital ratio, token distribution and release.
Under certain conditions, the tax-free MM theorem holds that the proportion of equity financing or debt financing used by enterprises does not affect the total value of the enterprise, so it is impossible to increase the value of the enterprise by changing the capital structure. The MM theorem with tax holds that under certain conditions, the tax shield effect of debt financing increases the value of the enterprise, but the bankruptcy cost reduces the value of the enterprise accordingly, and the value of the enterprise rises first and then decreases with the increase of the proportion of debt financing. The formula of the MM theorem is expressed as follows:
The holding income of DAO token includes the capital gains of the token price increase and the corresponding dividend right of the token. As long as the token dividend right is consistent with the principle of traditional stock one profit, the MM theorem can be transferred to the DAO field. Conversely, if DAO dividends violate one share one profit, the MM theorem does not apply. However, since dividend distribution will cause tokens to be classified as securities, DAO currently tries to avoid paying dividends to token holders as much as possible, but to benefit all parties through capital gains.
In general, under the premise of one token for one benefit, the value of DAO can be increased by appropriately increasing the ratio of creditor's rights. The increase in value mainly comes from the tax shield effect; the increase in the ratio of creditor's rights also leads to an increase in the capital cost of tokens.
The initial token distribution refers to the distribution of the total amount of fixed tokens in the single currency or dual currency model among the founding team, marketing, investors, ICO, treasury and other parties. There is no unified view on the basic principles of token distribution and release. There are two basic points that can be summarized through numerical simulation: ① The token release cycle should match the user growth cycle; ② The treasury should hold more tokens to stabilize token price fluctuations .
Figure 6 Token inflation simulation calculation table
DAO Valuation Method
Yash Agarwal once proposed a framework for DAO community valuation [7] , analyzed the indicators and dimensions that DAO valuation should focus on, but did not propose a quantitative model method. Kristof Lommers once proposed a preliminary quantitative idea for the valuation of DAO token [5] . Valuation methods are divided into relative valuation method and absolute valuation method. The relative valuation method refers to the benchmarking of a certain indicator and the DAO with a recognized valuation, so as to obtain the valuation of the target DAO. Kristof initially proposed that indicators such as TVL, protocol transaction volume, token transaction volume and speed, and user net present value can be used as benchmark indicators for relative valuation. However, since few DAOs have stable and recognized valuations, the relative valuation method is currently applicable Scenes are limited.
In terms of absolute valuation method, Kristof proposed that the value of DAO token can be split into the discounted value of the expected cash flow of the token, the discounted value of the implied value of governance rights, and the discounted value of the expected pledge reward of the token. The essence of this method is that the token value is equal to the capital gains, governance rights income, dividends and pledge income that can be obtained by holding tokens. Among them, the benefits of governance rights are difficult to measure and token holders with different holdings enjoy different benefits of governance rights, so different holders will get different valuation results.
Kristof's absolute valuation method has important reference significance in token investment pricing, but it is not fully applicable to the DAO merger and reorganization scenario. The DAO merger valuation should be based on all tokens with voting rights, neither all circulating tokens nor all Tokens, mainly means that as long as they control all the tokens with voting rights, a certain DAO can have full control over another DAO. Therefore, DAO Valuation is equal to Total Voting Tokens* Token Valuation.
Key points of DAO merger and reorganization
DAOs are moving from barbaric growth to orderly growth. Small DAOs with poor management can go through bankruptcy liquidation, and large DAOs with poor management may revitalize their assets through acquisitions. Well-run DAOs may also achieve rapid growth through mergers and acquisitions. On December 8, 2021, the proposal to merge xDai and Gnosis was approved, 1 xDai token STAKE was exchanged for 0.032 Gnosis token GNO, and xDai Chain was renamed Gnosis Chain [8] . On December 22 of the same year, the merger proposal of Rari Capital and Fei protocol was approved by the votes of their respective DAO members, and the Rari token RGT was converted into TRIBE [9] , the total lock-up value after the merger is 2 billion US dollars. According to the terms of the merger, RGT token holders can exchange RGT for TRIBE at a ratio of 1:26.7 (RGT: TRIBE) within 180 days; those who disagree with the merger can exchange TRIBE for a certain share of the Fei Protocol treasury within 3 days.
In the stage of DAO merger and reorganization, we need to pay attention to the merger of organizational structure and transaction consideration. In terms of organizational structure merger, if the organizational structure of the merger target is the same and belongs to the same public chain, the technical difficulty of the merger is limited. How to avoid the loss of KOL caused by the merger is the key issue; It is much more difficult to determine whether to adopt a new structure or one side to integrate into the other's structure in terms of strategy. No matter which method is used, it is much more difficult than the former; wait and see. In terms of transaction consideration, logically there are cash and equivalent payment, token replacement payment, creditor’s rights loan payment and several types of fusion payment. Considering the difficulty of operation, token replacement payment will still be the mainstream method in the short term. Token replacement payment ratio can be determined by the valuation method mentioned in (5) DAO valuation method.
references
[1] DeepDAO
[2] ETH Interest Rate Model
[3] Cryptodatadownload
[4] Web3 VC Database
[5] A Framework for DAO Token Valuation
[6] 7 common voting mechanisms of DAO
[7] How to value a community? — DAO Valuation Frameworks
[8] xDai / Gnosis Merger AMA
[9] DAO mergers: the future of M&A?
[10] Tokenization and token economy solutions
[11] Single and Dual Currency Model Comparison
Thanks
DAOrayaki, a decentralized media protocol, publicly funded THUBADAO to conduct independent research and share results publicly. The research topics mainly focus on Web3, DAO and other related fields.