Proposal
Authored by Milamber and Petr on 8 May-23 with review from the Treasury Council
Proposal: https://docs.google.com/document/d/1dIIxxK0xA8BRpuuLrx2qMn1LmcFwn_v9xMmtKtBF-6I
Workings: https://docs.google.com/spreadsheets/d/1fplDhB-DlgfoyFg1guUbQVTodm03-mTx30D6G0B5nwo
Summary
We propose to obtain yield on a portion of our current idle Ethereum holdings by deploying into liquid staking derivatives, and ignoring other riskier alternatives. We propose to deploy 1,000 (c.90%) of our current idle Ethereum holdings of c.1,100 $ETH, entirely to Lido to capture additional Ethereum yield on top of our LP positions in order to further offset the DAO’s monthly overheads.
In order to minimise any risk to our runway, we have decided against taking any risk on our stablecoin positions, therefore any potential future deployment of these does not factor into this proposal.
Motivation
The DAO’s Treasury multisig currently holds c.1,100 Ethereum (50 of which is currently held as $WETH), in addition to smaller amounts spread across operational wallets, which is significantly higher than at the same point last year. This is in part due to the recent reduction in LP sizing, as well as recent $ETH purchases and the claiming of fees from our LP which has benefitted from the $PRIME token launch.
This is a significant proportion of the treasury (c.$2m) which is currently idle and no longer earning fees through our LP, which could be put to use. With c.$2.8m of stablecoin and c.$1m of $PRIME in the treasury, we have sufficient funds to secure a runway for 30+ months excluding ETH, i.e. the treasury holds excess capital which can be put to use in order to earn additional yield and offset monthly costs.
As we wish to retain our $USD holdings to pay contributors and secure the project’s runway, and there are limited options with $PRIME as a new token, we propose that deploying a portion of our Ethereum holdings to earn yield would benefit ParagonsDAO by 1) increasing revenue and offsetting a reduction in fee revenue from reducing our LP size; 2) opening up potential additional yield options within DeFi; 3) reducing the amount of idle excess capital held over and above what is required to support runway; and 4) demonstrating to our community we are actively managing treasury without being overly conservative.
Specification
Agree mechanism(s) of Ethereum deployment
The full range of yield options was considered and discussed by the Treasury Council to determine risk appetite. Further LP use is not necessary at this time, and while higher yields are possible via riskier exotic options (yield farming, options), we propose a lower risk method, utilising a variant of staking.
Decide between CEX staking, staking pool (liquid/non-liquid), running a validator
Due to potential future regulatory issues and centralisation, staking on a CEX is not suitable for the DAO, and running a validator would be more challenging and costly than our appetite for similar return. We therefore propose deploying to a staking pool the best choice, with liquid pools being optimal due to the provision of a derivative token which can be traded and used (liquid staking derivative, “LSD”).
Select project(s) where Ethereum will be deployed
There are limited large-scale options for LSD deployment weighed against our risk tolerance, as well as overall similarity in rates on offer. While diversification of risk was considered and is a potential future consideration, we will deploy all of our allocated Ethereum to Lido, the largest project by market share.
Select amount of Ethereum to be deployed
Given the relatively low risk associated with LSDs/Lido, it has been deemed acceptable to stake a high proportion of our ETH holdings (i.e. 80%-90%). We propose to stake 90% of our ETH holdings, leaving 10% for operations and cognizant of the fact we plan to continue purchasing ETH at attractive prices. We have considered if the full amount should be deployed at once, or broken up into batches (from a risk/opportunity perspective e.g. depeg events), electing to deploy all allocated ETH in one tranche.
Execute transactions
Upon approval of this proposal, we will deploy 1,000 ETH to the Lido staking pool. All positions should be monitored on an ongoing basis and added to/removed in line with growth/scale and requirements.
Workings
Comparison of Ethereum liquid staking derivatives to direct staking
The workings below show the various available liquid staking derivative options available for Ethereum, relative to the base staking rate from running a validator node on the network, as well as their key KPIs. These also show the potential yield each month and year (in $ETH and $USD) if we were to deploy the maximum amount of idle $ETH in the treasury (1,100), at current rates and $ETH prices.
Projects selected reflect the largest projects by total value locked which are currently accepting deposits. While Lido is the largest project by total value locked, it doesn’t necessarily always have the best available rate (which changes daily for each project), which should be considered alongside risk.
While there are small differences in APR (%), deploying the maximum amount of idle ETH holdings would generate broadly 60-80 $ETH $115k-$135k per annum in yield at current rates and $ETH prices. Based on our peers, an LP of 10% FDV is prudent without drastically reducing liquidity.
Lido
The largest market share of liquid staking derivative projects by far and considered safest. There is some controversy due to market share and governance issues (largest validators control a reasonable overall share meaning reasonably centralised), however things are moving in the right direction. stETH is a rebasing token, meaning the amount of stETH is constantly increasing in addition to its value.
Coinbase
While this is the second-largest project by TVL and operated by a trusted business in the space, the token being issued by a centralised exchange is likely an immediate no-go for us due to the additional risks this presents, e.g. being looked at by the SEC. The potential yield is not worth the risk on its own, and it would not diversify away any of the general staking risk due to adding in new ones.
Rocket Pool
Allows you to run staking nodes without the need for 32 ETH, with the amount limited to a smaller value. Thus, unlike STETH, the value of RETH corresponds to the value of ETH + rewards, so the amount of RETH is constant. It is a possible consideration for diversification, however it currently has a low APR.
Frax
Slightly different approach to the others in that they have two different tokens (frxETH and sfrxETH). frxETH is like “classic” ETH, e.g. you provide liquidity with it and get yield from LPs. However, to get yield from staking you have to use frxETH, and lock it to get sfrxETH. Frax uses the coins from frxETH for validation. Yield looks reasonable, however the reward is in the form of CRV when we want ETH or USD.
Stakewise and Ankr
Rates are amongst the best on the list for both projects, however the size of their TVL represents too high of a risk of failure (compared to other projects), as well as their variance to the ETH peg being high.
Recommendation
We recommend the Treasury Council consider Lido for our initial ETH deployment, which provides attractive rates, is in line with our risk appetite and is sufficiently transparent. We may wish to consider future diversification of staking risk into other protocols such as Rocket Pool, but not at this stage.
Rationale
Our ETH holdings have significantly increased recently but fee earning has reduced
As noted above, the DAO’s treasury multisig currently holds c.1,100 Ethereum, which is primarily due to the recent reduction in LP sizing (c.400 ETH), in addition to newly earned/purchased ETH (c.150).
The ETH which was previously held in our LP position was earning yield from trading in and out of our LP on Uniswap. This represents a reasonable portion of the treasury and a reduction in fee revenues, which are important in a period where the project is pre-revenue and costs are ongoing.
By redeploying this ETH we stand to offset (and surpass) this fee revenue reduction with broadly the same risk to the treasury in respect of capital deployed.
We have an excess of capital above what is required to support the project’s runway
Excluding the ETH portion of our treasury, we hold c.$2.8m of stablecoin and c.$1m of $PRIME assets at today’s rates, the current value of which is sufficient to secure the project’s runway for 30+ months at the current monthly burn rate. Additional to this, we are earning $PRIME and $ETH totalling c.$120k from staking and our LP positions each month already offsetting overheads.
In the worst case, extremely unlikely scenario where the entirety of our ETH holdings were lost, the project has sufficient capital to continue for several years. We are therefore missing an opportunity to deploy this excess capital and some additional revenue to further support the project’s runway.
There are relatively low-risk ETH yield-earning options that satisfy our risk tolerance
There are a number of potential options for utilising Ethereum to consider, all of which carry their own risks in addition to the pervasive risk of deploying our Ethereum vs. holding. The least risky (staking and staking derivatives) are of an acceptable risk relative to the returns available regardless of the amount of capital in the treasury. We therefore believe a high portion of our idle ETH can be safely deployed.
Regarding general deployment risk, the treasury takes a low risk, conservative approach to treasury management in order to ensure there is next to zero risk to delivery of the project’s goals. Capital in excess of meeting that requirement (as is the case here) should be weighed against the risk of action, as ongoing capital generation is also important while the project is in pre-revenue build mode.
Timeline
Within one week of this proposal, subject to Treasury Council approval at its next meeting.
Costs
Minimal. Costs should relate to gas fees for deployment into the staking protocol and on withdrawal.