[RFC] - Hop Treasury Management Framework

Bernard · October 12, 2023, 5:07pm

[RFC] - Hop Treasury Management Framework

Author Comment

web3 Studios (“w3s”) is a digital assets investment banking firm exclusively focused on companies building an open economy. Founded by Blackstone and McKinsey alumni, the group facilitates M&A, capital raising, and strategic projects for DAOs.

The group is leading an ecosystem initiative for Uniswap, doing Strategic and Treasury Management Work for Gro DAO, has previously been engaged with Zerion, and conducted research work together with leading web3 firms such as Polygon, The Sandbox, and DappRadar.

Summary

This RFC seeks to establish a benchmark for Treasury Diversification by introducing the Treasury Management Framework (TMF) and offering an OTC token sale to strategic partners.
The TMF represents a robust, adaptable framework designed to ensure the financial stability of the DAO while preserving its decentralized governance principles.
After implementing the framework, our proposal includes conducting an OTC token sale to strategic partners. This initiative aims to bolster Hop DAO’s expansion and extend Hop’s financial runway.

Rationale

A few weeks ago, @cwhinfrey posted a Treasury Diversification RFC, proposing to sell part of the $ARB received for USDC to help cover the ongoing DAO expenses.

After contributing to the original discussion post, we drafted an initial idea, which has been thoughtfully adjusted thanks to the invaluable feedback received thus far from the community.

In light of considering research on Treasury Diversification, we are exploring various avenues for the sale of HOP, including the possibility of an OTC Partnership deal, to provide a planned and strategic approach to stabilizing and improving the DAO’s financial viability.

Current State of HOP Treasury

HOP’s treasury currently holds a substantial $24.2 million, but it is exclusively exposed to HOP tokens, constituting a 100% allocation. This concentration has posed challenges, particularly as the HOP token’s price has experienced declines.

YTD Treasury Value ($). Source: DeFiLama

Hop DAO faces challenges accentuated by the fact that their monthly expenses are primarily denominated in HOP. This specific denomination makes it difficult for Hop DAO to maintain a precise grip on operational costs. To address this, there’s a pressing need for Hop DAO to establish a diversified treasury, which includes stablecoins. Such a strategic move in diversification is not just a financial necessity but also a strategic imperative. It ensures the smooth functioning of daily operations and provides the Hop DAO team with the bandwidth to focus on broader strategic growth initiatives.

Hop DAO’s revenue model is intricately tied to the protocol fees, which serve as the primary source of protocol revenue. These fees, in turn, are significantly influenced by the number of active users. It’s a model that leans heavily on user engagement and adoption. To put things into perspective, since the onset of this year, the protocol has been successful in generating a commendable $2.9 million solely in fees.

However, a deeper dive into Hop DAO’s financials reveals a concerning trend. Operational expenses, unfortunately, have overshadowed the revenue. Hop DAO is currently operating at a burn rate of $169.3k per month. This financial trajectory underscores the urgency and the absolute necessity for Hop DAO to revisit and optimize the treasury strategy. It’s not just about sustainability anymore; it’s about positioning for future growth.

Monthly YTD Protocol revenue. Source: TokenTerminal

Addressing these challenges, there are several avenues to improve the treasury allocation, one of which will be elucidated in the upcoming chapter.

Treasury Stats

Monthly Net Burn Rate

The average monthly net burn rate is $169.35k.

	Expenses	Revenue	Treasury (YTD Change)
Monthly average (2023)	$484.6k	$315.3k	−46.9%

Hop Protocol YTD data

	Token Incentives	Operational Expenses	Total Expenses	Revenue	Profit
January	-$177.3k	-$207.7k	-$385k	$177.3k	-$207.7k
February	-$252.9k	-$272.3k	-$525.2k	$252.9k	-$272.3k
March	-$467.8k	-$501.6k	-$969.4k	$556.3k	-$413.1k
April	-$315.7k	-$465.6k	-$781.3k	$547.8k	-$233.5k
May	-$191.4k	-$290.4k	-$481.8k	$534.2k	$52.4k
June	-$179.4k	-$218.3k	-$397.7k	$191.9k	-$205.8k
July	-$108.1k	-$166.7k	-$274.8k	$213.1k	-$61.7k
August	-$97.4k	-$179.4k	-$276.8k	$232.4k	-$44.4k
September	-$105.8k	-$160.9k	-$266.7k	$131.5k	-$135.2k
October (ongoing)	-$10.1k	-$144.8k	-$154.9k	$15.8k	-$139.1k
YTD	-$1.9m	-$2.6m	-$4.5m	-$2.9m	-$1.7m

HOP Token

	HOP ATH	HOP ATL	As of 05.10.23
Price	$0.2972	$0.0366	~$0.0371

– Source: TokenTerminal, etherscan

YTD HOP token price. Source: TokenTerminal

Treasury Management Framework (TMF)

To effectively tackle the issues at hand, we propose the establishment of a Treasury Management Framework (TMF). This encompassing framework is meticulously designed to cater to the unique needs of Hop DAO and address various facets of treasury management. The primary objective of this framework is to furnish the DAO with lucid and well-defined treasury guidelines, all while maintaining the decentralized essence of the DAO governance process.

It’s worth emphasizing that the primary focus lies in the initial stages, where it is crucial to establish clear principles and objectives. However, once this foundation is in place, the governance process becomes transparent and readily adaptable to evolving market conditions and financial needs.

Treasury Management Framework

Let’s delve into the key components that form the bedrock of this framework:

Treasury Management Principles: The foundation is laid with a clear articulation of fundamental principles that underpin effective treasury management. These principles serve as guiding pillars, aligning the decision-making process with the overarching objectives of the DAO, all while taking into account the risk appetite.
Treasury Management Operational Model: This central component defines the nitty-gritty of the treasury management process, creating alignment among all stakeholders and ensuring clarity in the entire treasury management workflow. It outlines the procedures, policies, and tools employed to enable efficient cash flow management, robust risk mitigation, and well-informed decision-making within the DAO.
Liquidity Management and Budgeting: The spotlight here is on the critical aspects of cash flow forecasting and liquidity management within the context of DAO treasury management. We need to explore strategies aimed at ensuring an adequate liquidity buffer to meet operational needs while harmonizing budgeting practices with the DAO’s financial objectives.
Treasury Asset Allocation: The efficient allocation of treasury funds takes center stage here. This involves the selection and allocation process for deploying the DAO’s financial resources, encompassing diversification, periodic rebalancing, and investment strategies. The aim is to secure Hop’s financial stability while carefully considering risk management objectives.
Risk Management: Risk management is a paramount consideration at every juncture of the Treasury Management Framework. This section underscores the significance of identifying, assessing, and mitigating various risks associated with treasury operations, investment decisions, and market volatility. It offers clear guidelines for implementing robust risk management practices within the DAO.
Governance: As governance lies at the heart of decentralized operations, we will delve into how the Treasury Management function operates in a decentralized fashion of Hop DAO. It underscores the need for transparent decision-making processes, active community involvement, and rigorous accountability in managing the DAO’s financial resources.
Reporting Tools: Transparency is the linchpin of any DAO’s success, and this section hones in on the reporting tools and mechanisms employed to ensure complete transparency in treasury management. It underscores the significance of timely and accurate reporting, providing all stakeholders with crystal-clear visibility into the DAO’s financial activities.

By implementing the Treasury Management Framework, HOP DAO has the opportunity to establish a robust, sustainable, and adaptive approach to managing its financial resources. This framework acts as a trusted compass, guiding every aspect of treasury management, from fundamental principles to governance practices. Ultimately, it empowers DAOs to make informed decisions, achieve their financial goals, and maintain unwavering transparency while effectively mitigating risks. The result is a well-oiled financial engine that supports the DAO’s long-term vision and objectives.

Treasury Diversification through Strategic Partnerships

To achieve a diversified treasury, the first proposed step is to convert HOP tokens into different assets. Given the current market conditions and our priority of maintaining operational stability, it makes logical sense to convert a portion of the HOP treasury into stablecoins.

Rather than conducting open-market sales that could disrupt market prices, we suggest pursuing OTC sales with strategic partners. This approach ensures a more controlled asset disposition. There are multiple great cases of successful partnerships like Lido and Paradigm, PoolTogether with a pool of investors (ParaFy, Galaxy Digital, Dragonfly Capital 7, and Nancent), and a recent TrueFi X partnership.

Hop stands as a top-5 bridge on Arbitrum and Optimism, boasting a monthly transaction volume exceeding $50 million. It enjoys a strong product-market fit and has a robust community. This sale not only enables the protocol to concentrate on development but also provides an opportunity for strategic partners with extensive networks and expertise to contribute to the project’s growth and business development.

We propose selling an amount ranging from $1-5 million worth of HOP tokens to strategic partners. The final deal size will depend on the agreement between the DAO and a future partner, as well as on the risk preferences DAO set up to ensure a sustainable runway.

Web3 Studios will help conduct benchmarking studies and internal Due Diligence to determine an appropriate valuation and lockup/vesting schedule. We will then compile a comprehensive pitch deck containing all protocol information for potential buyers. Utilizing our network of investors, we will pitch HOP to identify the right candidate. If a suitable buyer is found, we will summarize the deal and create a governance proposal for the community to decide on the sale.

Web3 Studios is actively engaged in over $200 million worth of secondary offers in leading web3 projects, aiming to unlock liquidity for founders and investors. We utilize our broad institutional network to stay informed about investor activity and token launches. Some of the notable projects we’re involved in include Scroll, Sui, LayerZero, and zkSync, among others.

Next Steps

As we kick off this RFC, it marks the inception of a broader conversation within the community. In the event that this initial RFC receives significant feedback, our plan is to proceed with a more detailed proposal, laying out specific deliverables, budget, and timelines. Your valuable insights and thoughts are essential to us, and we eagerly anticipate your contributions to the ongoing success of HOP.

Together, we chart the path forward!

Voting Options

Move the discussion forward
No action
Abstain

Move the discussion forward
No action
Abstain

0 voters

dybsy · October 13, 2023, 3:26am

i won’t be voting for any token sale without reviewing a legal opinion on Howey status with associated risks.

jengajojo · October 13, 2023, 7:57am

Thanks @Bernard

Can you please help us understand the treasury runway according to your analysis?
Can you offer examples or testimonials of your services from other DAOs?

Bernard · October 18, 2023, 4:57pm

Disclaimer: To assess the actual runway, we need input from all core members. This is our goal if the topic gains traction. If any numbers are missing or our assumptions are too strong, please let us know so we can refine our calculations.

Answering your first question @jengajojo, the current burn rate is based on historical data and prices, while the runway depends on various factors, such as:

Expense Dynamics and HOP Token Volatility. Hop DAO’s expenses are partly denominated in USD but paid out in HOP tokens. This creates intricate budgeting challenges. For instance, when volatile assets like HOP experience sharp price declines (over the last 180 days, the HOP token’s price has seen a significant 78% decrease), it can unexpectedly inflate the cost of liabilities denominated in other currencies, like USDC.
Liquidity Risks. Swapping a sizable amount of HOP tokens, say $100k, on SushiSwap can result in a substantial 39% price impact. This highlights the risk associated with the thin liquidity of HOP, which can jeopardize both the Treasury and Market Cap.
Revenue Streams. Based on our observation, there are no USDC revenue streams that could bolster the DAO’s financial runway.

Preliminary scope:

To tackle these issues effectively, the following process will be done by us (with the help of the community, of course):

A financial model of expenses and revenue will be built (structured by sources & token denomination).
Net cash burn and runway in months will be estimated. Ideally, we’ll focus only on cash (like stablecoins) and cash equivalents (such as Compound cTokens), excluding native assets.
Sensitivity analyses will be conducted, and plans for actions to be taken in scenarios where certain thresholds (like Allocation in stables, or cash ratio) are crossed will be formulated.
Following the definition of a target runway and stablecoin allocation based on the analysis conducted in the previous steps, the initiation of OTC deal structuring will occur. This includes internal Due Diligence, preparation of marketing materials, and sourcing.
If/Once the OTC deal is closed, the remainder of the Treasury Management Framework will be implemented, and an investment process will be established.
Monthly cash/stablecoin balances will be regularly maintained to achieve a target cash ratio exceeding a certain level, and Treasury and Budgeting reports will be posted on Hop’s community forum. Here’s an example of this result, specifically created for Gro DAO.

Our ultimate objective is to ensure that there is always cash on hand. In this context, a better metric to consider right now is the Cash ratio, which measures how many months’ worth of cash/stablecoins you have to cover your spending needs if token prices were to plummet to zero. Ideally, this ratio should be between 1 and 1.5 (12 and 18 months, respectively).

Assuming that the average operational expenses nominated in USD remain at $112k ($160k of three-month average operational expenses minus the $48k, according to HIP-37), and the treasury holds $686k from the Arb allocation sale (HIP-38), the cash ratio stands at 0.51 or around 6 months. This is significantly lower than the desired 1.5 threshold. However, it’s important to note that these numbers may evolve as we gather more information on budgeting and cashflows. Hopefully, we have answered your first question, @jengajojo .

w3s background:

In terms of prior experience, here are a couple of bullets:

Strategic Finance and Treasury Management: Held key roles at different projects like Gro DAO, overseeing Finance, Strategy, and Risk, leading the Treasury Management Initiatives (the monthly report can be accessed here).
Strategic Mandates: Led Strategic Paths Report at Gro DAO.
Risk: Implementation of the Risk and Rebalancing Framework for their core protocol.
Our Strategic Finance team comprises professionals with backgrounds in Crypto Investment, Risk Management, and Treasury Management, all of whom have significant experience at leading firms (TradFi: Blackrock, JP Morgan; DeFi: Coinpanion, Idle Finance).

takeabreath · October 19, 2023, 7:56pm

I believe that the issue of treasury management should be discussed further as it could enhance Hop DAO’s operational efficiency and competitive stance among other bridging solutions.

While the decision to diversify Hop’s treasury was a step in the right direction, it happened when $ARB was nearing its all-time low. My expertise is not in finance, but I think most would agree that this decision was reactive.

A proactive approach to treasury management could enable Hop to:

Cover operational costs
Allocate more capital to R&D
Hire additional service providers that add value to the DAO

The latter two points directly contribute to Hop DAO’s competitiveness with other solutions.

I believe that if W3S are willing to periodically report their progress to the DAO, the risk of moving forward is relatively low, given the proposed amount of HOP.

Furthermore, I do not find the solutions described in this RFC (especially through Strategic Partnerships) controversial. However, I would appreciate hearing from those who oppose this RFC or are at least sceptical.

Bob-Rossi · October 25, 2023, 3:09am

I probably share sentiment with others that while I agree with the ARB sell, it was also something that felt reactive then proactive. I’d personally like to see a more proactive approach to the treasury. My concern being mid to long term funding of the project, as we are currently funding fixed costs with tokens that fluctuate at the whim of the market.

Specific to the proposal, I think there is a lot of good info / things to think about. Some form of a treasury framework I believe should be considered. And I think there would be stability to having ‘x’ number of months / years guaranteed to be funded through stable coins. This is a growing project that isn’t even fully completed yet, so net outflows isn’t super concerning… yet… but that doesn’t mean we have to 100% rely on HOP tokens and airdrops. Which given recent price action can be concerning if the trend doesn’t reverse.

I discussed some ideas in the other RFC ([RFC] Treasury Diversification - #14 by Bob-Rossi), as ultimately, I wonder if the end goal may be somewhere between reactive sell-offs and a full-on coordination with an outside company. We are ultimately a small project, and we may still be able to get away with a high-level framework that is monitored periodically.

With that in mind, I have voted for moving the discussion forward. As while I’m not 100% sold on the entire idea due to HOP’s size, I do still believe this discussion is worth continuing and would like to hear other input. We are small enough I’m undecided if we need an entire outside consultation versus a framework, but I’d be curious enough to at least encourage the conversation to continue.

Bob-Rossi · October 25, 2023, 3:23am

@dybsy - plucking this thought out and moving it outside this specific RFC…

My thought would be this might be worth a separate discussion on what this looks like. As IMO there will come some point where that will need to happen, and it would be best to get ahead of that while we have some runway to do so. From discussions going back to the ARB sale, it seems the thought of at least keeping a runway of stables is desired, and if this type of determination takes months to get to it’s best to start sooner than later. And if there is a Howey issue it’s best to know our options in advance.

I know that falls into 100% easier said than done, but even in the most basic of frameworks (i.e., say we decide on something as simple as keeping a 1 year runway of expenses in stables) we would probably need that.

I wouldn’t even know where to start with something like that - maybe people here have experience from other DAOs / connections - but I can’t imagine it would be that large of an expense all said and done. Would just need coordinated.

dybsy · October 25, 2023, 3:29am

I’ve brought it up several times in different calls. Whenever I suggest the DAO needs to explore legal retainers and/or opinions related token issuance given the nebulous regulatory landscape and, specifically, open liability questions related to acting in a DAO vis-a-viz general partnership liability, I get handwaved about whatever the corporate structure is as between Hop Labs and the treasury and this community DAO. Since I don’t know how everything operates, and since I can’t get any answers or momentum, I am simply going to refrain in participating in anything I feel exposes us, the DAO, and me, personally, to unneeded liability. Voting on whether to refill a treasury or issue GMC grants is fine a good; operationalizing liquidity via token sale is another matter.

fourpoops · October 26, 2023, 2:28pm

Although I think treasury management is still sorely needed, I’m just not sure if the value proposition makes sense here. As far as I understand, the Hop Labs team could also facilitate a raise on their own. Also, I think the timing of this is not necessarily the best.

On the one hand, for every week that goes by without a HOP sale, we fail to capitalize on the fact that the market is valuing Hop Protocol at $40M. On the other hand, for every week that gets closer to v2 testing/rollouts, it may be silly to capitalize on the fact that the market is only valuing HOP at $40M.

In an ideal world, treasury diversification would look like this imo: 1) stay lean until v2 rolls out and some new low liquidity price discovery can happen, 2) do a private sale and/or do a Bond Protocol “public” sale, 3) use proceeds for expenses and for protocol owned liquidity, 4) begin a longer discussion on how longer term treasury diversification across different assets should look.

With the recent ARB proposal, I believe the DAO has enough runway to stay lean and wait for a better environment to capitalize.

takeabreath · October 27, 2023, 1:03am

From my understanding of the RFC, the framework implies a more (pro)active approach to treasury diversification, “under the right market conditions.” However, I would also suggest considering the legality of any proposed action before execution (to address concerns expressed by @dybsy, this could be outlined in the “policies” explained in the “Treasury Management Operational Model”).

If this proposal is approved, it would not necessarily require any immediate action from Hop DAO. The proposed HOP should be sold “when appropriate”. Maybe you can add some clarity on this @Bernard but that is how I understood this RFC.

I think this makes the risk of this current RFC relatively low, especially if Hop DAO specifies that any OTC deal should undergo a vote first.

Since Hop DAO has already secured itself for a while financially, there is no need to rush the proposed OTC deal. For good reason too since any OTC trade conducted should be with a “strategic partner” committed to participating in governance and adding value to the DAO with their contributions.

Lastly, I would like to emphasize that the selection of “strategic partners” should be in line with the Mission Statement. The selected “partner” should be familiar with it as well. Probably a bit verbose mentioning this but I think it’s an important criterion for any prospective partner and delegate.

Bernard · November 3, 2023, 12:12pm

@dybsy @Bob-Rossi @fourpoops @takeabreath Thank you all for sharing your valuable insights and concerns regarding Hop DAO’s treasury management. It’s clear from the discussion that there’s a consensus on the importance of transitioning from a reactive approach to a more proactive one.

Indeed, being reactive, especially when it comes to operational liquidity, can pose challenges. Both the Treasury Management setup and any potential token sale require preparation. Waiting until we have only a one-month runway could complicate matters and force the DAO to accept whatever price is in the market at that point. Instead, it might be a better idea to be financially and operationally prepared for the v2 launch ahead.

As mentioned by @takeabreath , the idea behind this RFC is not to force immediate decisions or create unnecessary structures. Instead, it aims to establish a comprehensive framework that aligns with Hop’s values and strategic goals. This framework could be divided into multiple parts, initially setting up treasury management guidelines that correspond to Hop’s values and goals. By doing so, when the conversation about a capital raise or token sale becomes even more relevant, Hop DAO will already have a well-defined plan and execution steps in place.

I suggest we continue this conversation at a deliberate pace, taking into consideration the poll results. We will create a list of questions for the community and delegates to formalize different aspects of our RFC and ensure that the final proposal fully aligns with the DAO’s needs.

Given that both the core team and ambassadors are currently busy with the new release and operational improvements, we should allow ourselves until mid-December to receive critical feedback from other delegates, as well as from @cwhinfrey and @shanefontaine . The timeline could be moved to earlier dates if there’s a desire to expedite the process.

Thank you again for your feedback and we look forward to continuing the discussion!

francom · November 3, 2023, 5:14pm

Thanks for the additional post @Bernard. If i’m understanding your proposal correctly, there are two components to it.

One is to help the DAO establish a comprehensive risk management framework and the other component is to provide investment banking type services to help the DAO sell tokens to an aligned VC. Regarding the latter, I believe it makes more sense for the DAO to wait for the Hop V2 launch which will hopefully give the DAO more leverage in Hop sale negotiations. Additionally, I find it hard to justify the 5% fee that was mentioned in the community call because I believe Authereum Labs is best positioned to help the DAO execute a token sale given their extensive investor network and deep understanding of the core product and competitive landscape. And I believe they wouldn’t charge a fee as high to execute.

Therefore, from my perspective I think it makes sense to continue discussing the creation of a comprehensive risk management framework with your help through a grant proposal. But,for now I think I would vote against using your services for a Hop sale.