Arbitrum Treasury and Sustainability - Working Group

[thedevanshmehta]

Now that all deliverables have been completed, we are able to engage in some comprehensive self-evaluation of our WG in Season 1. This will also help keep context for any other leads of the Treasury WG that are selected over time.

Let’s begin! We’ll start with KPIs for measuring our group;

@thedevanshmehta

Productive engagement on this thread

This thread didn’t see widespread engagement - maybe we framed the KPI too narrowly. Even if we widened it to discussions we’ve driven across the DAO (Twitter spaces, Telegram groups and the forum), we’d rate our progress as “can do better”.

We’ve learnt that its better to put something out frequently rather than keep finessing and have only a few releases. In the next season, we will aim for more and frequent communication. Our goal is not to provide definitive answers but to spur discussions.

@thedevanshmehta

• Number of proposals brought to an onchain vote

1 proposal brought to a vote: STEP 1.

We are proud of this as our 1st season was intended to be research oriented more than action based. We did not expect to diversify 1% of Arbitrum’s treasury in the first season itself.

@thedevanshmehta

Number of service providers engaged

Ah this was a good one. May have missed some but the answer is 27 !!!

We would give ourselves a pat on the back here, speaking with one provider every 3 to 4 days is more than we anticipated.

We got a fair amount of inbound as many projects didn’t know who to speak with when they wanted something from Arbitrum DAO; here’s a list of those we engaged in the context of our WG

1. Myso
2. Revest
3. Backed Finance
4. Angle Protocol
5. Flowdesk
6. Mountain Protocol
7. Superstate
8. OpenEden
9. Ondo
10. Wintermute
11. Fortunafi
12. BlockTower
13. Acumen
14. The Standard
15. Chainflip
16. Fractal
17. Matrixport
18. Hashnote
19. RWA . XYZ
20. GFX Labs
21. Nethermind
22. North Lakes Legal
23. Karpatkey
24. Steakhouse Financial
25. Avant Garde
26. Aera
27. Centrifuge

Let’s now go to the taskboard and see how we did here

@thedevanshmehta

• Taxonomy of all ways to mitigate price impacts
• Deep dive into over collateralized debt positions as a strategy to provide alternatives to liquidations

Very broadly, the 2 ways to mitigate price impact from ARB liquidations are through DAO owned execution and increasing onchain liquidity.

Methods for DAO owned execution

1. A Balancer pool that auto adjusts to maintain a fixed total value of ARB/Stablecoin/ETH, so we can pay out in stables (page 70 Karpatkey report)

2. Aera vault that auto adjusts ARB/Stable/ETH based on volatility of these assets. These are ideal for grant programs as it follows a minimax strategy, where upside is limited but downside is minimized. More details in this post by @Aera

@thedevanshmehta

The steps for such a strategy include:

1. Define a target between 5% and 20% annualized volatility for non-governance token portion of the treasury
2. Calculate volatility of each asset
3. Assign weights to each asset by current portfolio allocation
4. Keep target fixed and rebalance weights according to actual volatility of an asset

3. 3. A DAO owned CDP. Instead of liquidating positions when ARB deposited as collateral for grantees falls below a threshold, the DAO injects more ARB from the treasury to cover the shortfall. When price increases, the CDP strategically liquidates ARB to sqaure off open debt positions. This offers a significant time alpha compared to other DAO owned executions.More details in forthcoming post by @sids2000

4. Teams request funding in USD and conversions done via OTC or centralized exchange by an intermediary before handing over to grantee. This is important as there is much more liquidity in a CEX/OTC compared to onchain

@karpatkey

• Of this trading volume, 75% occurred on Centralised Exchanges (off-chain CEXs), while the remaining 25% occurred on Decentralised Exchanges (on-chain DEXs).

5. The current situation of paying in ARB is disadvantageous to the DAO both ways: if ARB increases we are overpaying, if it decreases the project we funded is affected.

@Aera

For instance, this grant intended to send 5500 USD for one of its payments. At the time of proposing this transaction in the multisig, 4,166.67 ARB was worth roughly 5500 USD. However, at the time of the transfer’s execution nearly two days later, it was worth 6233.70 USD, a whopping 13% premium that the Arbitrum DAO paid. In this case, the recipient received more ARB than they were entitled to, which is unlikely to cause complaint, but this just as easily could have gone the other way.

They also make a compelling case for the DAO to own its execution to mitigate price impact from grants made by our treasury

@Aera

Put another way, a grant recipient who receives 1000+ ARB and who decides to sell that ARB on Uniswap will on average move the entire market down by 5.5bps with their sale. Given that ARB’s circulating supply is roughly 1.3B, that’s quite the move. This is all the more reason for the Arbitrum DAO to own more of its ARB execution (we discuss this in more detail in the Protocol-Owned Execution)

Methods for Increasing onchain liquidity

1. Use sequencer revenue in the DAO owned liquidity, buyback and make strategy detailed in Karpatkey’s report (page 69 in Karpatkey report)

2. Diversify assets from treasury to bolster ARB onchain liquidity

@JoJo

going into the discussion that increasing liquidity on dexes could be key to enhance the stability of $ARB as asset in light of sells from grant programs, why don’t we try to solve for both the problems (diversification of treasury, enhancing liquidity to avoid fluctuations from grant programs)

We have only recently come to know of the poor state of ARB onchain liquidity and have not dug deep into methods for ameliorating the situation, which we would need to explore further in S2.

Aera uncovered some eye popping statistics on what happens with onchain ARB liquidations

@Aera

It turns out that significantly more ARB could actually have been sold on Dec 15 (750k ARB) than could have been sold on Jan 4 (190k ARB), before hitting a 2% slippage threshold. In September 2023, a swap as small as 113k ARB could have moved the price down by more than 2%, whereas a month later, you could have sold 1M ARB and not moved the market nearly as much.

They propose some general strategies for mitigating price impact

@thedevanshmehta

• Spread out grants over a time period rather than all at once (such as with hedgey)
• Spread out distribution based on external parameters such as grantee achieving milestones or upon ARB price/liquidity
• Greater rewards to those locking up their tokens for a particular amount of time
• Encouraging limit orders by grantees
• Incentivizing market makers to provide liquidity during large distribution periods

We also have karpatkey’s own taxonomy on strategies for mitigating price impact

@karpatkey

To reduce the potential market effects of ARB liquidation, several measures can be considered, including but not limited to:

• Diversifying the funding currency for initiatives;
• Implementing payment streams to regulate the flow of ARB;
• Optimising the frameworks for grants and incentives;
• Increasing ARB’s on-chain liquidity;
• Enhancing ARB’s use cases within the DeFi ecosystem;
• Adding more utility features to the ARB token; and
• Considering ARB buybacks using the DAO’s revenue.

@thedevanshmehta

• Lit review of how other chains are using their sequencer revenue

Many thanks to Karpatkey for diving into sequencer revenue use at Optimism, Metis and Base in their report (page 53-63).

@karpatkey

• Optimism directs its sequencer revenue towards the Retroactive Public Goods Funding program (RPGF). So far, three funding rounds have been exclusively financed with OP tokens. However, at least in part, future rounds are anticipated to incorporate ETH funding.
• Optimism’s total on-chain net revenue is around 9,422 ETH as of the time of this writing.
• Base, an L2 built on the OP Stack in collaboration with Optimism, contributes 2.5% of total sequencer revenue or 15% of net on-chain revenue (whichever is higher) to the Optimism Collective as part of the collaboration agreement.
• Since Base Chain’s launch, the sequencer has accrued 3,493 ETH in net revenue.
• Metis is the only rollup with a clear commitment to decentralising its sequencer.
• Metis has recently introduced a staking mechanism requiring METIS token stakes for operating a sequencer node, aimed at attracting more sequencers and reducing METIS’s circulating supply.

@thedevanshmehta

• Categorising sentiment on Arbitrum for planned use of sequencer revenue

Thanks once more to Karpatkey for digging deep into forum activity and undertaking this task (page 63-65)

@thedevanshmehta

Methods or case studies for how DAOs can diversify treasury holdings to traditional instruments like stocks/US bonds. Example: avantgarde finance or Centrifuge Prime

I appreciate Centrifuge and Avantgarde for their report on RWA diversification at DAOs.

It’s exciting that these are the first research artifacts to be converted into a proposal (STEP 1), currently on Snapshot!

@thedevanshmehta

• Methods or case studies for treasury management . Example: how ENS or Gnosis manage their treasury with the help of Karpatkey

Thank you Karpatkey, your case studies on how you work with Gnosis and ENS to manage their treasuries was very useful (page 89-99). It provides good reference to the DAO on how we can potentially go about working with a treasury manager to better handle our assets.

I also appreciated the principles they lay down for working with a treasury manager

and investment philosophy Arbitrum should adopt for its treasury

@karpatkey

• According to the principles of a robust IPS and the strategic aims outlined in the DAO’s Amended Constitution, the primary goal of the Arbitrum DAO is to ensure the sustainability, viability, growth, and development of the Arbitrum ecosystem through responsible management and strategic resource allocation, guided by the established principles.
• This leads to several key guidelines for treasury management:

1. The treasury should support initiatives that drive growth and the long-term prosperity of Arbitrum products.
2. Capital preservation is paramount, with the goal of the returns at least covering a significant part of the grants and incentive programs, considering the treasury’s substantial size.
3. The long-term aim is to generate returns that can perpetually fund all necessary initiatives.
4. Capital preservation takes precedence over maximising returns.
5. The investment horizon is long-term, with a conservative approach to risk.
6. Preference should be given to proven investments and instruments with a solid track record.
7. Ethereum-aligned investments are favoured.
8. Investment opportunities on Arbitrum should be prioritised.

Aera’s exposition on the trilemma in DAO treasury management also gave good guidance on the trade-offs involved in diversification

@Aera

As the DAO treasury management landscape continues to evolve we have seen the solution space roughly fall into 3 buckets:

• One time treasury diversification - a static and point in time approach to treasury management that covers immediate needs of the DAO but doesn’t have a long term approach to treasury sustainability. This is a principled approach, but doesn’t evolve over time
• Centralized treasury management - where the DAO elects a treasury manager who has some restrictions on what they can do via smart contracts, but otherwise has broad remit on what asset class choices and investment strategies they can employ. This breaks a lot of the properties that DAOs seek to achieve like credible neutrality, limiting points of failure and others.
• Inaction by democracy - where the DAO makes large reallocation decisions based on voting. This is hindered by misaligned incentives from DAO members and apathetic/uninterested voters. In the worst case the DAO takes no action, and in the best case the DAO compromises to achieve consensus amongst voters.

From this we can see 3 pillars of a perceived treasury management trilemma: decentralization, principled allocation, and effective allocation.

Faced with three choices that are fundamentally unappealing, DAOs choose to keep their capital largely unallocated.

Their case study on Aera breaking this trilemma with Threshold was insightful

@Aera

The core strategy involved allocating $250K of T tokens to an Aera Vault, with a focus on volatility management. Threshold DAO chose a volatility-targeting strategy to mitigate risk and stabilize returns. This approach is helpful to control for risk, ensuring that while diversifying into assets like ETH and USDC, the portfolio’s volatility remained around 15%. This strategy helped Threshold maintain a steady growth trajectory without excessive risk exposure

@thedevanshmehta

Methods or case studies for increasing the amount of native token that is locked. Example: Golem Foundation creating Octant to lock up GLM supply

Karpatkey to the rescue again! Thankful for their case study on Octant and how we can stake sequencer revenue to fund our grant programs (page 81-83)

If we interpret the task more broadly as increasing ARB utility, we have the following suggestions

@elisafly

Currently an $ARB price feed is not supported by Chainlink on Ethereum. We think that having an $ARB price feed, together with some community coordination will increase the use-cases of $ARB token across DeFi. This could help counter some of the selling pressure that may come as a result of the recent distributions being made. For example, teams like Index Coop and Avantgarde Asset Management can add $ARB to indexes more easily. Another idea is that the community can work on getting $ARB added to Compound v3 so that long term holders can use it as collateral to borrow against. This increases the “buy” and “hold” appeal to $ARB. It can also increase the capital efficiency of long term $ARB holders.

And from Aera

@thedevanshmehta

• Generating yield on $ARB can make participants stake instead of immediately selling. The challenge is designing staking system that generates value for the ecosystem in excess of tokens spent
• Public leaderboards of $ARB hodlers and giving them recognition in some form
• Rewards such as greater voting rights for those users who have long held their tokens

Additional ARB utility such as collateral for shared sequencing like Metis, use in L3 payments, distribution of revenue to holders and more in page 41 - 47 of Karpatkey’s report

@thedevanshmehta

Any other valid research contribution

Thank you @sids2000 for your excellent analysis on an advised limit for ARB liquidations for diversification or grant programs.

@sids2000

Current bid levels suggest that selling $1.5-2 million worth of the ARB which accounts for 15-20% of cumulative open bids is likely to keep slippage within a limit of 2%.

Complemented by Karpatkeys more recent analysis

@karpatkey

The current market can absorb approximately $13.5 million in ARB sales daily with a 2% price impact, considering the combined liquidity from both on-chain and off-chain trusted sources.

Finally, let’s now look at our budget and try mapping cost incurred to outcome achieved

@thedevanshmehta

20 hours each per week from both liaisons, at 100 ARB a hour = 48,000 ARB

Help from community/service providers - 30,000 ARB

Total budget from September 2023 to Jan 2024: 78,000 ARB

If we had to give a break up on how we spent these hours , here’s some rough numbers

1. 30k ARB to each of the partners

2. 15k in time we spent onboarding partners, determining agenda, feedback before final release, summaries of report ( 1 2 ) and a tweet thread post release. This includes a recruiting trip I had to make to Berlin dappcon for recruiting Karpatkey and Avant Garde

3. 15k towards the STEP framework and the extensive time taken in recruiting the highly qualified committee members, speaking to RWA providers, drafting the framework, holding calls about it, incorporating feedback, etc

4. 10k towards @sids2000 analysis in price ceiling analysis and the CDP research report

5. 2k to Centrifuge for their report

6. 6k in miscellaneous (KYC/admin work, meetings with projects & people reaching out to us, reviews on other proposals etc)

As the PL grant has ended, our WG will be on hiatus until we figure out funding for season 2. However, we are happy to write up any additional details that might be left out in our self-evaluation for season 1!

We invite discussion on whether we have delivered value commensurate to cost incurred and how/whether we should secure funding for continuing the work we have begun.