[Temp Check] Proposal for introduction of ENS Investment Policy Statement

DAO-Wide
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Abstract

Introduction of Investment Policy Statement for the ENS Endowment.

Introduction

ENS Endowment was established via EP 2.2.4 with the goal of ensuring the long-term viability of ENS. The RFP for the Endowment was crafted based on the initial requirements and priorities of ENS. However, internal (ENS-specific) and external (market-) conditions are constantly evolving. As such, we propose the creation of an Investment Policy Statement (IPS), which will serve the following purposes:

  1. Define and assign the responsibilities of all involved parties.
  2. Establish clear investment goals and objectives of Endowment assets.
  3. Offer guidance and limitations to the Endowment Manager regarding the investment of Endowment assets.
  4. Establish a basis for evaluating performance of the Endowment Manager.
  5. Manage Endowment assets according to prudent standards.

In general, the purpose of the IPS is to outline a philosophy and framework to guide the management of the Endowment toward the desired results. It is intended to be sufficiently specific to be meaningful, yet flexible enough to be practical.

You can read karpatkey’s proposed ENS Investment Policy Statement here.

Next Steps

  1. Feedback period (Sep 10 - Oct 1): we will gather feedback of the IPS via ENS Forum discussions, and during Metagov Working Group weekly meetings
  2. Snapshot vote: to formalise the IPS
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Thanks for putting this together KPK!

In the IPS, you mention the following

In the long run, the aim is for ENS to be self-sustaining, and for the DAO to work within
constraints of the Endowment returns.

In your vision of the long run, what happens with the registration, renewal, and premium income for .eth names?

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Really exited to see the outcome of this discussion.

  1. Could you help us understand the rationale behind the
  • 80/20 strategy as opposed to any other ratio
  • Biweekly rebalance trigger as opposed to any other schedule

  1. The guidelines and constrains are highly quantifiable and clearly defined. What is the scope of complete automation of the strategy given these parameters?

  2. Are the values under return objectives calculated as an average of yield across chains or what is the methodology employed?

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Thanks for the question Limes!

To achieve the end goal of ENS of self-sustainability, the Endowment needs to be able to fully fund ENS’ expenses. Minimally it should be able to fund 1. ENS Labs, and 2. DAO Working Groups. Ideally, it should also be able to fund Service Providers, which helps improve the ENS system. This means being able to fund $8.5M - $12.1M per year to perpetuity.

The current Endowment size is insufficient for funding the above numbers; larger Endowment size can be achieved passively (being overweight on ETH, and waiting for ETH appreciation) and/or actively (increasing Endowment size via incorporating income to Endowment). However, ETH appreciation involves considerable uncertainty, and taking an active approach provides greater control over the Endowment’s goals. Incorporating income to the Endowment has previously been discussed, and we are looking to further the discussion and eventually take a vote on incorporating a portion of income (e.g. 50%) on a regular cadence to increase the Endowment size. This will also help the Endowment towards its goal of self-sufficiency, and also increase capital efficiency of DAO-held assets.

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Thanks for the question jengajojo!

Regarding ratio: The 80/20 suggested ratio is the ‘upper threshold’, i.e. ETH shall not exceed 80% of the Endowment. We will rephrase this in the IPS document to make that clear. One of the most important constraints here is the years of runway in stablecoin, and once that condition is satisfied, the rest should ideally be exposed to ETH upside. Such allocation will help achieve the eventual goal of self-sustainability. If the runway requirements change significantly in the future, we will reassess this part of the IPS.

Regarding biweekly rebalance trigger: to clarify, this refers to rebalancing of strategic asset allocation (80/20 ratio). The frequency of rebalancing trigger was set frequent enough for it to be responsive, yet infrequent enough to not be swayed by market volatility. Given ETH’s implied volatility (~60% annualised, ~12% 2wks) it was deemed a reasonable cadence of rebalancing.

Regarding automation: In terms of complete automation of the strategy, we see the ‘strategic allocation’ to be very formulaic with clear sets of constraints. However, the ‘tactical allocation’, i.e. the DeFi activities, requires a more nuanced understanding of various types of risks, not all of which can be reduced to a formula, and be automated.

Return objectives calculation: the inputs are only mainnet yields

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Thank you for putting this together.

I think this needs rethinking a bit. The goal of the endowment is indeed to ensure ENS’s long term survivability, but that does not necessarily equate to funding everything at the current levels of expenditure.

More broadly, perhaps we should be thinking in terms of a DAO budget; this would consist of the endowment’s investment returns plus some percentage of income, with the remaining income adding to the capital of the endowment. With this percentage set at 0, the endowment stays constant in size and the DAO spends 100% of its income plus investment gains. With the percentage set at 100%, the DAO is funded entirely from investment returns, and all income funds the growth of the endowment (and hence the eventual increase in investment returns).

Currently this percentage is de-facto set at 0%. The stated goal would have it set - eventually - to 100%. Probably, we should settle on a percentage and do two things:

  • Specify that percentage in the IPS.
  • Adjust our own budget to meet the resultant income level.

In July and August, revenue was approximately $1M, and income was approximately $2M (reflecting a higher past revenue, and the earning-out of registration fees over time). If we use $1M/mo - $12M/y - as a conservative figure reflecting sustainable long-term income for now. With the endowment earning circa $250k/mo - $3M/y - that gives us an annual income of $15M.

The IPS lists the DAO’s total outgoings as $12.1M/year. Thus, at present an income split of 75% to operations and 25% to increasing the endowment would balance the budget.

If we use the current income figure of $2M/mo as a baseline, 66% of income could be contributed to the endowment while balancing the budget.

Outgoings are likely to change - Labs has proposed a budget increase to allow for the extra work involved in building an operating V2 of ENS and an ENS L2. Changes in registration and renewal rates will also have large impacts on results here, of course.

This definitely needs rephrasing, as the current document also calls for rebalancing both on an ongoing basis and as soon as the IPS becomes effective, to maintain that ratio. Such a high proportion of exposure to ETH also seems incompatible with the endowment’s goal of long-term sustainability.

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Thank you @karpatkey team for putting this together for review! Few thoughts here on my side:

  • I agree with @nick.eth 's point above re: the assumption of fixed funding levels across Labs + DAO-- instead of backing into the math based on a fixed past spending # , it would be more realistic to set funding budget goals the other way around.
  • While I agree that the ISPs should be aligned with broader ENS Ecosystem values (“Ecosystem objectives”), I would be hesitate about wording that limits or equates investment strategies to Ethereum-only yields or result in an excessively high ETH exposure strategy only. For example, I know that in the past there have been discussions around RWA opportunities-- which can certainly still be considered “low-risk” assets and not compromise the objective of Capital Preservation. In other words, I certainly don’t think Ecosystem and Return Objectives are mutually exclusive, and would like to preserve optionality for investment strategies in the long run.
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Thank you @nick.eth and @katherine.eth for the feedback.

Our initial approach was working back the required endowment size based on required spending - this was due to uncertain future revenues and expenses. However, we agree that the DAO Budget approach could be a better one, given it allows the DAO to think about Budgets and Endowment in a more holistic manner. The IPS would also be regularly updated (annually, at least), and the revisions could take into account the changing revenues and expenses.

We will revert with revised IPS based on your comments.

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Thanks for the proposal, @karpatkey team!

We agree with the comments by both @nick.eth and @katherine.eth.
For the objective of the investment policy, it is unnecessary to make large gain with this endowment because ENS DAO has income accrued continuously that has been covering expenses. That being said, we support the idea of investment as having larger treasury should help DAO or even Ethereum ecosystem. We should find the right objective to keep conservative fund management.

For ETH exposure, we agree to lower the share of ETH exposure to mitigate the risk that comes from ETH price volatility. RWA can be a good option as long as the endowment can create diversified portfolio of RWAs to avoid overexposure to any single asset class or currency. One point of consideration is the potential overreliance on USD-denominated assets, such as T-bills. T-bills have been popular tokenized RWAs and are traditionally seen as low-risk investments, but excessive allocation to such assets might create an outsized USD exposure, especially when combined with the stable exposure.
Therefore, we should be discussing RWA portfolio based on sub category of RWAs such as T-bills, private credits, real estate, etc. Maker DAO’s RWA dashboard can be a good example, though this is a custodian-based view.

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Based on the feedbacks, 2 major changes to the IPS have been introduced to the IPS.

1. Increased % of stables in the Endowment allocation:

  • Original: target asset allocation of 80% ETH / 20% stablecoins; constraint of at least 2 years of runway in stablecoin ($17.8M)
  • Change: target asset allocation of 60% ETH / 40% stablecoins; constraint of at least 3 years of runway in stablecoin ($26.7M)
  • Purpose: decrease overall endowment volatility

2. Introduction of regular (monthly) transfer of Income from Controller to Endowment

  • Original: none
  • Change: 33% of Income to be transferred from Controller to Endowment, based on net cash flow margin (Income - Expenses)
  • Purpose: to continuously fund the growth of the Endowment. Regular transfers will also minimise the need for Endowment funding tranche requests in the future.

The above suggested changes have been made in the Investment Policy Statement - v2 of the Draft can be found here. We would like to gather further community feedback on the changes, and will move this proposal to Snapshot once sufficient feedback has been gathered.

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Thanks for the update. If we’re now fixing the percentage of stables, how will gains or losses on unearned income be accounted for and presented?

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For further clarity, are you asking how we plan to track the Endowment’s results for unearned income versus earned income?

From accounting perspective, there is no difference between results from unearned income and earned income. Under the proposed model, returns on overall portfolio, as well as individual underlying assets (i.e. ETH, stablecoins) are tracked. Additionally, unearned income would be tracked to ensure there’s always sufficient ETH to match it, as per IPS constraint.

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No; what I mean is that right now, we always hold enough ETH in reserve to cover the unearned income, meaning we’re not exposed to exchange rate risk, where our theoretical liabilities for unearned income could exceed our assets. If we cease holding that reserve as a policy, we can end up with a situation where we’re notionally in the red (though fine in reality, since there’s no way to cancel a registration and claim back the unused fees).

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Thanks for the clarification Nick. The IPS continues to have the clause regarding unearned revenue (“unearned revenue may be incorporated into the fund, but must be risk-neutral with regards to ETH”), but you are right in pointing out that there could be circumstances in which the guidelines for asset allocation conflict with each other.

In the IPS, there are 3 restrictions for asset allocation (between ETH and stablecoins).

  1. Minimum ETH allocation: unearned revenue must be risk-neutral with regards to ETH, implying unearned revenue as minimum ETH allocation
  2. Minimum stablecoin allocation: “at least 3 years of DAO’s operating expenses runway should be held in stablecoins and stablecoin-neutral positions, based on last calendar year’s expenses”
  3. Target allocation of 60% ETH and 40% stablecoins

In case of conflict, we would suggest for the following priority: 1-> 2-> 3

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Is unearned income calculated in real time? Such that rebalancing bi-weekly as outlined is actually feasible noting this constraint. If so, where? It would be cool to see these numbers…

With the constraint that “unearned revenue may be incorporated into the fund, but must be risk-neutral with regards to ETH”, is the solution not to simply keep the maximum of those three constraints in stablecoins? I.E:

max(unearned revenue, 3 years DAO operating expenses, 40% of the fund)

As discussed in the Metagov calls,

Strictly speaking this isn’t Investment Policy, but I appreciate that for bureaucratic simplicity there is value in housing this all in one document.

This makes sense. It just so happens that this means with current numbers (as outlined) that registration/renewal income funds the DAO and investment returns can be reinvested.

Noting the proposed DAO budget approach, were 100% of income to end up in the endowment what would the process be for funding the DAO operations with those returns? It looks to be the case that this will need to be followed up with proposals for the technical implementations of these processes…?

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Thanks for the questions and feedback @clowes.eth, hope the points below answer the questions!

  • Real-time unearned income: this data can be seen via Steakhouse’s Dune accounting dashboard and queries

  • Asset allocation formula: the unearned revenue is to be kept in ETH and ETH-neutral positions, so the formula would need to be adjusted accordingly

  • (Hypothetical Scenario) Impact to funding operations should all income end up in the Endowment: the funding operations for the DAO will continue to be governed by standard ENS governance process. However, the difference would be that the funds would be withdrawn from the Endowment vs. DAO wallet currently.

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Thanks for the extensive proposal and discussion. I don’t have anything more to add here, except that as Katherine said we should be careful to not phrase things in a way that would limit the investment strategy to something that is underperforming just because of ecosystem values.

The goal should be clear and to preserve capital.

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The results are in for the [EP5.20][Social] ENS Endowment Investment Policy Statement off-chain proposal.

See how the community voted and more ENS stats:

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