Treasury Diversification
Contributors: @dylan @DarkForestCapital @verto0912 @Lavi @MrMadila @AcceleratedCapital @george
Summary
Building on our initial Treasury Management Goals, we would now like to propose a new treasury structure. This new structure would break our treasury into two separate accounts: a long-term investment account focused on capital preservation and an operations account to fund everyday spending. The Investment Account is essentially a pool of capital that serves to preserve the purchasing power of Index Coop. The operations account is just that, a working capital account that covers all of our normal recurring expenses. The operations account will address the growth and sustainment goals outlined in the post cited above.
As funds become available from the vesting contracts detailed in the inflation table, they will be distributed between the Investment and/or Operations accounts. For now, let’s introduce each account.
Investment Account
The investment account preserves capital and acts as a safety net. It gets us through the tough times and ensures we remain well capitalised throughout the market cycle. Keeping in mind we also need to distribute our INDEX tokens to the market, there are multiple things to consider when determining what this account shall contain. The main objectives, mentioned above, are summarised below.
- Deploy capital to generate a total return above a defined hurdle rate
- This account will build a so-called DeFi Citadel and significantly enhance our community’s ability to survive any and all market conditions, eg: crypto winter, competitor attack, contract vulnerability, DAO hack, black swan event
How we achieve these goals will be discussed in a separate post.
Operations Account
The Operations Account captures all our revenue and pays all our expenses. The Operations Account is also the pool of capital that funds all of our initiatives, like liquidity mining and methodologist incentives. Practically, there are multiple accounts that fall under the umbrella of the everyday account. Some examples and ideas being considered are shown below.
- Liquidity mining
- Methodologist incentives
- Governance staking rewards
- Working Groups
- Contributor Rewards
- Smart Treasury Balancer Pool
- KPI Rewards Program
- Contributor Token Ownership Plan
For the purpose of this overview, we bunch everything together and call it the Operations Account which essentially can be considered working capital. There will be a separate post detailing at a very high level a budget estimate of future expenses that shows how all these accounts interact.
Investment and Operations Account Allocation
Now that we have a basic understanding of what each account is and the purpose it serves, we can discuss allocation. Two of the simplest approaches to this are, top down or bottom up. A bottom up approach requires a lot of forecasting and assumptions, so anything we generate using this approach is only as accurate as our assumptions. By using a top down approach, we avoid the inherent risks of trying to forecast in an unpredictable environment and simply outline a goal and then determine what is needed to fund it. The question then pivots from how much do we need, to where does it come from.
A good starting point is to think in terms of income. What is the yearly income needed to sustain Index Coop during a bear market? We spent $40K, $63K and $149K on community rewards across December 2020, January and February of 2021 respectively. If investment account income is used to cover community rewards alone, then our other income streams can be invested back into growing the protocol. For simplicity, let’s assume the following:
- Team Size 10
- Salary $150K USD per annum
- Community Rewards $1.5M per annum
We have 9 gold owls and the equivalent of 12 people (at $150K p.a) working for Index Coop based on $150K of community rewards being paid out for February 2021. Based on this a team of 10 people is a realistic assumption. Using these simple assumptions, Index Coop should target a $1.5M income per annum from the Investment account. What would the Investment look like to achieve this:
It is important to note that the risk profile of a treasury is normally low, diversified, insured and should err on the side of being conservative in terms of expected APR. Also, during a bear market, trading volumes, fees and other productive means of generating yield are likely to be less than what is currently available.
Market cycles, hacks and smart contract vulnerabilities are just some of the risks that exist in DeFi. Our treasury / DAO is no different. Either directly or indirectly, the DAO will be exposed to these risks. Our job is to mitigate against them as best we can. Hedging against a black swan event, by its very nature, is hard to achieve. What we do know is that during downturns in the market, assets prices fall dramatically. From the 2017 highs to December 2018 lows, ETH lost over 90% of its value and many micro cap projects went to zero. For comparison, the below chart shows a variety of other asset classes during that time period:
The bear market of Jan 2018 to Dec 2018 is shown above.
We should not forget what bear markets are like and, during the good times, ensure enough is put away for the bad times. Everyone can do great during the bull market, but it’s what we do to prepare and plan for the downturn that will make us outperform our competitors. Contingency planning during the bull market will be a defining feature during the next bear market and we intend to create a competitive advantage for Index Coop.
At the end of a bear market Index could emerge with a stronger competitive advantage having retained the core team, continued to focus on its core operations and be sufficiently well capitalised to capture the upturn in market conditions. This means we try to get through a bear market of any length whilst trying to avoid drawing down on our principal capital.
What can we afford to allocate to the treasury?
As of today (29/03/21), the community treasury has a market value of $59M. Here is a breakdown of the treasury’s growth since October of last year:
One thing is immediately apparent: growth has been very strong.
Looking forward, by excluding the current treasury balance, using a $15 per INDEX, we anticipate 34% of all vested tokens to be surplus to our needs. In doing so, we assumed zero income from our products and excessive spending levels. Why? Well this estimate becomes incredibly conservative and gives us a place to start the discussion. This estimate shows that we have sufficient capital to fund an Investment Account while maintaining operational stability.
Given this, we propose initially funding the Investment Account with 50% of the current treasury (~$29.6M). In addition, we propose that 25% of funds withdrawn from vesting contracts flow into the Investment Account for diversification purposes. This leaves 75% of vesting contract income along with any income generated from the products we create available for reinvestment back into the ecosystem. At this funding level, a diversified Investment Account would be capable of sustaining a team of >10 people at $150k per year with a 5% growth rate in perpetuity. Actual goals and targeted growth rates will be decided in a future proposal. Our goal here is to illustrate how the Index community Investment Account would be able to sustain operations indefinitely if funding ever had to come solely from it.
The intent of this post is to outline at a high level the two main account types Index Coop will have and to agree to the allocation between the Investment and Operations Account. Upon agreeing how the funds are to be allocated, we will then proceed to determine how the capital is to be invested for the benefit of Index Coop.
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