With this post I would like to kickoff discussion around robust financial planning for ENS DAO to effectively fulfil its intended role.
I don’t see it as formal document, but rather as initial framework to start thinking about financial planning
Key considerations determining approach towards financial planning:
- Non-profit nature of enterprise
- Ability to consistently deliver and maintain decentralised domains based on ethereum
- Be financially stable for at least for the period of 2022-2032
- Provide service in the format of “public good” to the extent it is seen by traditional economics and Web3 community
- Channel excess liquidity into development of Web3 ecosystem
Overview of approach
The starting point for formulating financial strategy, should be development of something called “financial model”. This would’ve been the core document, from which the rest of decisions are flowing, however there is not enough publicly available data to build such document right now. Therefore I’m going to outline here approach, which can then be molded into fully functioning model and strategy, by anyone within community.
ENS Financial model:
- Part 1 - Core operations - True Names Limited - Singaporean entity. Financial statements are not publicly available and I don’t know if its prudent to make them publicly available. However in the absence of historical financials I don’t have a starting point. Here and after when I’m referring to financial model, what I’m referring to is this classic valuation model built by investment bankers and consultants, except for “valuation” part which we don’t need in this case. I’m not going to go into too much details how it works, but those familiar with basics of financial analysis would know how to build these kind of documents. Important point to highlight here is that it allows to build more or less robust forecasts.
I’m going to assume that financials for TNL are available and we can indeed build this part of model. In the resulting documents its possible to model forecasted balance sheet, income statements and cashflow statement, as well as supplementary schedules as necessary such as financing.
Key take aways from this document is that it allows to model required forecasted cashflows
cash inflows-1 (+)
cash outflows-1 (-)
All information is derived based on forecasted operational activity of TNL such as number of employees, respective roles and other expenses.
It is vital to understand how Part 1 will function in the years to come in order to plan accordingly.
- Second large part of financial model is cashflows arising from DAO activity. At the moment this part contains the only item which can be forecasted with some reasonable assumptions, that is revenue from .eth name registrations. We can interpolate historical numbers into the future and see what cash inflows-2 (+) will be.
Cash outflows-2 (-) for DAO are comprised of [cash outflows-1] and [cash outflows-2-operational], where CO2op are various activities where DAO is sponsoring own ENS growth and stimulating ecosystem development.
Putting 1 and 2 together
Traditionally all financial models are built with 5 year forecast period, after 5 years it is assumed that enterprise is still functioning, but enters so-called “steady” state, where detailed forecasting is not necessary and due to long time horizon no longer possible.
Realistically even 5 years detailed forecast is a bit too long, so 1-3 years is more of a realistic forecast, then 4-5 years is the transitionary period between realistic part and “steady state”.
What I propose is that we build traditional 5 year model, ignore the “steady state” calculation because we don’t need to factor it into stability planning, then take 3 years forecast as indication of what is required in terms of cashflows, multiply it by 5 and arrive at more or less robust figure of how much cash is required to be financially stable.
5 times multiplier is due to volatility within blockchain based assets markets. In some extreme cases price of Ethereum can fall 3-5-7 times and more and bear markets can last for several years, hence we should account for that to have bullet proof budget.
So cashflow summary looks something like this:
cash inflows-2 (+) → revenue from .eth registrations
cash outflows-1 (-) → TNL expenses, in terms of budgeting this item comes first
[cash buffer = cash outflows-1 * 5] (-) → To cover for TNL operations even in some extreme volatility scenario and bear market
cash outflows-2-operational (-) → own ENS growth initiatives, ecosystem and public goods, this item is discretionary and can be completely scaled down during potential crypto winter
net extra liquidity available (+/-) - in case of insufficient cash flow even after cash buffer, this item will be negative and TNL would be required to seek external funding, certainly we would like to avoid this scenario
From here arrive to various cash thresholds
cash outflows-1 + cash buffer = minimum required cash threshold 1
[cash outflows-1 + cash buffer] + cash outflows-2-operational = required cash threshold 2
Then you revise your forecasts as applicable, every 6 months, or every year and adjust everything accordingly.
Liquidity management [net extra liquidity]
Treasury of ENS DAO is not an investment fund, as such it should not be engaging in any kind of risky investments, all instruments utilised are used solely for the purpose of financial stability.
ENS DAO would require use of stable coins to stick to forecasted model. I’m yet to see decentralised SC, possibly sUSD. But holding SC in tethered coins is a risk which is best mitigated by holding a combination of DAI and sUSD.
I suppose it is possible to generate extra yield on this part of liquidity as was discussed in another thread, however in my opinion rewards are not worth the risk. Smart contracts are broken constantly all over the place even with the most advanced protocols.
Diversification
Those who observed markets long enough can see that all assets are very tightly correlated, everything effectively follows index made of BTC or BTC/ETH. This is a very well known investor behaviour in traditional finance measured by stock BETA. Pretty much all tokens within blockchain universe of assets have BETA of 1 to BTC. In practice what that means is that any percentage movement of BTC induces same percentage movement in other assets. Its been theorised that sooner or later “decoupling” should happen, disconnecting some major assets from BTC but in practice this is happening very slowly.
Additionally its been shown that on average any token other than Ethereum long term underperformed Ethereum - very few protocols actually grew in terms of Eth. I’m not going to build full scale analysis here to illustrate this to keep this document brief, but can be done as side exercise.
On top of that in order to diversity into token of protocols outside of Ethereum ecosystem ENS DAO would need to go through CEX, which present additional risk.
In my mind the only reason to diversify into other tokens is if ENS DAO makes decision to support that particular protocol, give it additional PR spin, in other words some non-financial reason. I don’t know right now why can this be the case, but its possible.
To sum it up diversification within universe of blockchain assets given conservative nature of DAO liquidity management doesn’t make too much sense, holding Eth seems to be the most sensible strategy.
If diversification really required, instead what I propose in order to achieve it is to allocate part of capital to fiat instruments. In theory there is nothing stopping ENS DAO from holding various conservative blue chips both debt and equity from non-tech and non-financial sectors. For example mix of Renewable energy / Pharma / FMCG stocks and bonds. We could channel capital via ENS foundation into reliable broker and achieve true diversification into assets which are not correlated with BTC and overall blockchain market.
SUMMARY:
Step by step approach
- Build model forecasting cashflows for TNL and ENS DAO for next 5 years
- Calculate required cash thresholds to comfortably stay operational for at least 3 years, the remaining part is liquidity available for other manipulations
- Given constraints of ENS as protocol there are not that many liquidity management options available, consider holding everything in ETH and diversity into fiat instruments
CONCLUSIONS:
So if I was to build financial plan for ENS as protocol, aiming for stability I would instrumentally approach it like I described it above. There are many moving parts involved and it always helps to have them all quantified and available at fingertips to make informed rational decisions. Plus once everything is quantified you can incorporate switches for various scenarios to see how sensitive model is to rapid changes in EHT/USD for example. I would suggest that this model is built on monthly basis with annual numbers calculated as totals.
This is just a rough sketch of ideas which appeared in my mind while I was exploring ENS.
Fork it, discuss, challenge, expand, add thoughts, criticise, dislike, like, share!