Title: Stablecoin Runway Analysis
Status: Discussion
Author(s): @Matthew_Graham, @ElliottWatts, @Hammad1412 and @prairiefi
Created: 15.06.2022
Simple Summary
Finance Nest has performed an analysis of the stable coin runway. The model is built to best reflect the current status of the DAOs finances. There are a number of variables considered in the model that span future Core Hires, amount of productive / unproductive stablecoin holdings, cost base inflation in both expenses and contributor wages.
We present some suggestions for discussion on how to improve/maintain the runway, but ultimately we want to encourage community discussion rather than present recommendations at this point in time. We recommend the next step be a community call where Finance Nest can answer questions and we can discuss other topics which feed into the community deciding what the runway should be. We would like to extend a very warm welcome to any investor, founder etc… to join us on the community call.
Runway Model - here - this is read only but feel free to save a copy and play around with the inputs and see how it impacts the runway.
Analysis
With all forward looking financial analysis there are limitations, there exists the need to make assumptions about the future market conditions along with the internal landscape of the Index Coop business. Within the model, we have incorporated the best available information to us at the time of publication, along with making broad high level assumptions. The assumptions are intended to be challenged and critiqued, scenarios detailed below serve the purpose of providing insight that we can utilise as a basis for further discussion. We have tried to include as many variables as we can where practical to support conversation around how best to optimise the DAOs financial runway.
Key Assumptions
Within this section we outline the key assumptions we have made within the model coupled with reasoning behind inclusion/exclusion coupled with details of thinking behind each assumption.
- Product Revenue - Excluded from the model
The business until recently directed all revenue to Protocol Owned LIquidity (POL) and now also, uses revenue to cover rebalancing expenses. For the purpose of this analysis, revenue is assumed to cover the DAOs rebalancing costs and POL needs, and not feature in supporting the DAO’s runway.
The Return on Investment (ROI) on POL is very heavily skewed towards asset prices and market sentiment. During periods of volatility, asset price correlations converge to 1 and this has the effect of reducing the market value of POL considerably. Virtually all POL positions to date have been loss making and we don’t envisage the financial performance of POL decoupling from the broader asset market environment.
The DAO has a budget of $5m for POL, to date we have made available ~50% of this budget and we are a long way short of funding the full amount. Based upon current monthly revenue figures, we do not foresee within the next 12 months any change to how revenue is allocated. This combined with the need to fund product rebalancing costs means the DAO’s revenue is not contributing to the runway unless a conscious decision is made to redirect how capital is allocated.
- Remuneration Structure - Remains as is
The current remuneration structure is reflected in the model. We have been informed that changes to core hire salaries and DSM could be implemented as part of the roll out of season 2. However these details are not yet known to Finance Nest. Once this is public knowledge we will be able to incorporate this into the model.
- Wage Inflation - 8% Annually
Typically each year wages normally change to account for inflation and reflect the health of the overall business. The headline Consumer Price Index, a measure of inflation, was announced as 8.3% and 7.8% in the USA and UK respectively, during April 2022. This model assumes an annual inflation figure of 8% which is the rounded average of both economies. As the business is not currently economically viable, Finance Nest has opted to assume wage increase is likely to be inline with inflation and not above this.
- Future Hires - 2 Senior Developers
As there are plans to hire additional headcount in the future, for the purpose of this analysis we have assumed Two Senior Developer hires. One hire is to replace @ncitron and the other is a new addition to the Engineering team. The model includes a July 2022 and December 2022 start date with an assumption that 25% of the Senior Developers wages are received in INDEX. Ie: remaining 75% being denominated in stablecoins. The Senior Developers are to receive Band 9 which is equivalent to a Base Salary of $350,000 before the Fixed and Variable component of the DSM program that is paid out in INDEX.
- Investment Account Revenue - Included in Runway
The model includes revenue generated from the Investment Account within the runway calculation. We have built into the model the ability to adjust how many months of runway is held unproductive, we consider the impact of 6 months and 18 months. The ROI on the Investment Account is also a variable that can be changed to reflect the communities views. Having these parameters as variables enables different scenarios to be forecasted and the sensitivity of the changes to be easily understood. Initially we have assumed an ROI of around 12% on the Investment Account, which we believe to be conservative based upon past performance of the account.
The model uses April’s actual stablecoin spend on expenses as it was the highest of the last three months. Built into this we have also applied a 1% increase in spend each month. These other expenses, in addition to contributor rewards, over time are significant. We do however note the monthly expenses in stables are notably more variable than what this model implies. An average of previous months’ stablecoin spend on expenses would have yielded a lower initial spend, we opted for using the largest monthly spend figure to generate a more conservative model.
- INDEX / Revenue - Used to Support Runway
The model calculated the effect of selling a dollar value of INDEX each month. This parameter is a manual parameter. The model also shows what dollar value of INDEX/assets must be sold on market INDEX to support the runway annually to maintain a 12 month unproductive stablecoin runway. This can also be thought of as a proxy for redirecting revenue from POL to the stablecoin runway.
Scenario Forecasting
For the purpose of providing a flavour for how different parameters affect the model, we included 4 scenarios as detailed below.
- Scenario 1 - 100% Unproductive Stablecoins and No INDEX Selling
The most conservative estimate of the runway includes assuming the DAO does not deploy any of its stablecoins to generate yield or support growing the business in any way. Coupled with this there is no selling of any assets in an attempt to extend the runway. Under this scenario the DAO has a stablecoin runway of 21 months, February 2024. If the DAO was to perform a Series B raise with 12 months runway remaining, the raise would need to occur during Q1 2023, around February.
- Scenario 2 - Productive Stablecoins and No INDEX Selling
This scenario assumes that the DAO holds 6 months of unproductive stablecoins and invests the balance to earn 12% ROI. In this scenario, no INDEX is sold to extend the runway and the stablecoin runway is extended by 2 months to 23 months, April 2024. The Series B raise would also be delayed until Q2 2023.
- Scenario 3 - Productive Stablecoins and INDEX Selling
This scenario assumes that the DAO holds 6 months of unproductive stablecoins and invests the balance to earn 12% ROI. $35K of INDEX is sold each month to support extending the runway. With the addition of $35K of INDEX selling each month, the runway is extended by 2 months to 25 months, June 2024. The Series B raise would also be delayed until Q2/Q3 2023.
If $70K of INDEX was sold each month, the runway would extend to 27 months and would seek to commence the raise around late Q3 2023.
- Scenario 4 - Productive Stablecoins and INDEX Selling To Maintain 12 month Runway
Scenario 4 is the most active approach which includes selling INDEX monthly in order to retain a 12 month runway target. The DAO has a choice to periodically sell INDEX to maintain the runway, or the more preferred scenario is to perform a Series B raise. This chart shows the minimum account balance profile the DAO needs to have in order to maintain a 12 month runway at any point in time post the inflection point in August 2023. This can be thought of as the annualised USD value of INDEX that would be sold on the market if the runway was supported by selling into the spot market.
Do note, as the DAO spends stablecoins to cover the DAO expenses, the productive stablecoins are made unproductive and transferred from the Investment Account to the Operations Account to maintain the unproductive runway. This rebalancing is modelled to occur on a monthly basis.
Comparing Scenario 1 through 4, we can see from the chart below the most conservative use of capital mode, effects of earning a modest yield on the Investment Account and Market Selling $1k of INDEX each day.
Core Hires
The chart below shows the effect of hiring four Band 4 Core Hires during May, a Senior Developer in both July and December 2022. Immediately after Noah left, the runway extended until August 2024, which is the right most arc shown in the image below…
With the 4 Core Hires in May, stablecoin spend increased from $232.6k to $280.5K per month and reduced the runway by 3 months to May 2024. We note some contributors receive products as part of the salary and this model assumes that this is paid from the USDC balance.
With the addition of 2 Senior Developers, 1 in July and 1 in December 2022, the runway reduces from May 2024 to February 2024 (Scenario 1). This is the leftmost arc shown in the chart below.
The red line represents Index Coop’s annualised USDC spend. Where this line intersects the arc is roughly when Index Coop will need to give consideration to performing a Series B raise. Based upon this simplified analysis, the model estimates this to be around March 2024 when the DAO has around $4.4m of USDC remaining. Do note this assumes no stablecoins are deployed productively and no INDEX is sold to offset the runway burn rate.
Productive v Unproductive Stablecoins
The chart below shows the difference between holding all unproductive stablecoins, 6 months of stablecoins unproductive and 18 months of stablecoins unproductive. The model assumes an ROI of 12% which we expect to be conservative and assumes all yield is sold to stablecoins to extend the runway. Currently, the assets being farmed are being utilised to build ownership in the Balancer and soon the Arrakis communities.
The 18 month unproductive stablecoin would extend the runway by less than 1 month and generate $187k of revenue for the DAO. A 6 month unproductive runway would extend the runway by 2 months and generate $717k of revenue. A 6 month unproductive runway combined with $35k of funds from either selling INDEX or from revenue scenario is estimated to generate $773k.
If the ROI was 15% on the Investment Account and the unproductive runway was 6 months the total revenue would be $921k over a 20 month period. Assuming $35k of INDEX is sold each month, the Investment Account would generate $996k over a 22 month period before all the assets are sold and held unproductively. This scenario is not shown in the chart above.
Potential Ways To Extend The Runway
Finance Nest views it is in the best interest of the DAO to delay the need for a future raise and provide the business with as much time as possible to find product market fit. To this end, the below lists out several initiatives the community could consider to extend the runway.
- Offset Monthly stablecoin expenses with Selling INDEX
When Index Coop first launched grants and Working Groups, all third party payments were funded through the market selling of INDEX with the exception of the occasional private sale. The model assumes a certain amount of expenses are paid in stablecoins and it also shows how market selling INDEX extends the runway. If Index Coop was to fund USDC expenses (~$35k/month) from either revenue or selling INDEX, then the runway would be extended by 2 months. This represents around $1k per day and less than 1% of trading volume. This is a sensitive topic and something to be discussed as an option during a community call.
An alternative way to achieve this, or an additional initiative, is for the DAO to put aside $35k of revenue each month to support extending the runway. If both $35k of INDEX was sold on the market and $35k of revenue was put aside, then this would lead to the same outcome as selling $70k of INDEX each month.
- Deploy Stablecoins To Earn A Yield
Unproductive capital has an opportunity cost and concentrated investments creates the potential for a large loss of funds. It is therefore rational to make funds productive amongst a variety of strategies. With a diversified portfolio, the DAO would only have systemic risk exposure to Gnosis Safe and Ethereum network itself. The diversification and sizing of positions, would eliminate risk concentration and would ring fence potential loss of funds via a smart contract exploit.
This option considers the DAO deploying stablecoins to earn a yield in a responsible manner by allocating a large portion of the funds to low risk holdings, Balancer, Aave, Uniswap or Compound in stablecoins. Spread the investments across several smart contracts to reduce risk exposure. This will maximise the utilisation of assets to be productive whilst having a spread of low risk investments achieving a lower ROI but investing in the safest names in DeFi. Index Coop intends to build products on Balancer and Aave, has built on Compound and uses Uniswap for POL.
An alternative philosophy would be to increase the unproductive holding which minimises Smart Contract risk to Gnosis Safe exposure. To balance out the overall risk profile, the risk profile within the Investment Account can be increased such that a reasonable yield on the entire stablecoin holding is achieved. This would be something similar to a barbell strategy, lowest possible risk and medium risk, to average out to an overall low risk.
- Encourage Contributor To Be Rewarded With INDEX Over Stablecoins
The largest USDC spend is Contributor Rewards. If we are able to encourage contributors to receive their wage in INDEX we would be able to reduce the stablecoin burn rate. When discussing this idea amongst the Finance Nest, we were not able to find a means of delivering this that was a) easy to implement and b) not gameable. We considered a 15% incentive for contributors to receive INDEX and some minimum holding period. This would need monitoring which is easy enough, but policing it would be challenging. In other words, if contributors prefer stablecoins over INDEX, then paying more INDEX is likely to result in immediate dumping once the tokens are available, putting the same type or worse selling pressure on the token versus strategic sales of INDEX to raise stablecoins. If there is a strong community appetite for this option we can explore this further.
A viable solution is to not pursue any of the measures above and move towards a Series B raise sooner. General thoughts around this topic is the DAO would move to initiate a raise with around 12 months of runway remaining and have the round closed with more than 9 months of runway remaining. With no ROI on the Investment Account, no spot selling of INDEX to fund expenses, the DAO would be looking to kick off a raise around May 2023. This assumes no growth to the existing headcount. Given the potential of a bear market, this would likely lead to selling a generous portion of equity which would need to be factored into any future tokenomics revamp and potential Series C raise if there was a need for further funding at a later date.
An alternative to conducting a rather large raise would be to participate in several smaller raises on adhoc basis over an extended time period. This would be linked to partners who wish to attain equity in the business and do contribute to growing the business prior to being able to purchase INDEX from the community. The opportunity here for the potential investor is to contribute to growing the business and be rewarded with the ability to buy into the business. It would be like validating the promises of an investor before exchanging INDEX for stablecoins. This represents a viable alternative to spot selling INDEX and can be performed on an adhoc basis.
Conclusion
This post intends to support conversation around how our stablecoins are utilised and also factor in how various actions impact the runway. We encourage comments on this post and look forward to crowdsourcing ideas from the community at large.
