Arbitrum Treasury and Sustainability Research: Risk Reduction in DAO Treasuries

We are happy to share a study for the Arbitrum community on the impact of portfolio volatility on DAO treasuries.

Following discussions with the Treasury and Sustainability Working Group, our study focuses on the risk reduction properties of traditional asset classes such as stocks and bonds for a DAO treasury, and highlights the potential impact on portfolio level risk/reward of broadening an investment universe with less correlated assets. In addition, we also provide examples of how allocations could have affected the historical risk profile of a DAO treasury, and also the tradeoffs of using stablecoins as a risk reduction tool, including the potential impact of capacity constraints for large DAO treasuries looking to earn yield on their stables in DeFi.

The data shared in our study includes:

  1. Levels of portfolio concentration within the DAO treasury landscape
  2. Statistical relationships between ARB, BTC, and ETH
  3. Historical volatility of traditional asset classes compared with crypto
  4. How allocations have impacted historical losses
  5. The cross-section of drawdowns experienced across the DAO landscape post FTX
  6. The relationship between time horizon and expected maximum drawdown
  7. Long term historical evidence for returns in traditional asset classes
  8. Correlations between traditional asset classes and crypto
  9. Potential tail risks when using stablecoins as a risk-free proxy
  10. Capacity constraints for earning yield on stablecoins in DeFi
  11. Optimal portfolios including and excluding traditional asset classes
  12. How constraints around portfolio concentration can limit diversification benefits

We hope that by collating and sharing this publicly available data, we can help to demystify and to highlight the ways these important factors relate to the improvement of long term treasury sustainability.

Arbitrum Treasury and Sustainability Research - Demystifying DAO Treasury Risk Reduction

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I see lots of synergies between this & the @Aera research report targeting portfolio volatility in a DAO treasury. Whereas Aera suggests rebalancing according to an assets previous day volatility, Avant Garde makes a compelling case for DAOs move outside web3 into real world assets. On the face of it, I see these 2 approaches being incompatible with one another due to entry and exit fees in real world assets preventing the dynamic rebalancing Aera recommends. These differing approaches assume significance in light of the STEP diversification proposal, as yield bearing stablecoins are compatible with an Aera volatility rebalancing vault whereas whitelisted, tokenized representation of t-bills in our treasury are a more conservative and secure approach that cannot be dynamically rebalanced due to entry and exit feees.

Let’s now look at the substance of their reports & their recommendations

A. Their study of the 25 largest onchain DAO treasuries show 60% hold 90% of assets in their native token. So we are certainly no exception in this regard!

The issues with this are (1) inability of our treasury to act as a countercyclical buffer and (2) higher volatility creating a mismatch between assets and liabilities, resulting in higher crystallized losses and greater net outflows

B. Their specific analysis on ARB showed it had a 1.3 to 1.4 beta on BTC and Eth. However, there is not enough history on ARB so we should treat these numbers with caution.

For the rest of their analysis, they use ETH/BTC as a proxy for ARB when comparing performance and volatility with traditional assets.

C. During the most turbulent crypto periods, the difference in volatility widens from 3x to 20x equities and 40x bonds.

For example in Q4 2022 a third of DAOs saw peak to trough declines of greater than 50%, with 15% seeing their treasury values collapse 90%!

Any liabilities incurred during these bad periods cost the DAO much more than if they had a diversified treasury where we could liquidate traditional assets

D. So now the question turns to, what traditional assets should we hold in the first place? Historically, the answer is equities outperform bonds which outperform bills

Interestingly, t-bills are actually flat or negative after inflation adjustment, indicating these assets should be the first to get liquidated during a downturn to pay for expenses.

E. But what about stablecoins, I hear you ask?

Even if we leave aside de-peg risks , USDC DAI and Tether don’t have endogenous yield unlike t-bills or bonds. Additionally, de-fi yields on these assets are more volatile and suffer from capacity constrains when done on Arbitrum.

A 5 million DAI deposit on Aave on Arbitrum pushes yield from 9% to 5%, while 25 million DAI takes it below 2%. Even for USDC, 50 million halves the yield on Aave from 12%-6%. Their analysis raises an interesting point on whether ArbitrumDAO should ever put its own treasury to work on Aave and swing the market to this extent.

On Mainnet, a 50 million allocation is less than 1% yield reduction, but its an open question over whetehr we want to stake our assets on ethereum rather than arbitrum.

To conclude, a DAO portfolio that includes traditional asset classes improves risk/reward compared to one that has only ETH & Stablecoins

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