The Bird in Hand Theory of Crypto

Note: I wrote this on my phone while watching a 1yo and 3yo, so it’s just brain vomiting on paper.

‘A bird in hand is worth two in the bush’. This saying has led to the “Bird in Hand" theory of equity investing that says dividends paid out to stock holders has more value than retained earnings. Regardless if this theory is correct in equity investing (one could argue depending on what you do with your dividends and that expected growth rate versus the return on equity a company can make retaining those earnings which is better), I argue here that under the current (lack of) legal regulations on protocols, DAOs, and crypto in general, a bird in hand is worth 10 in the bush.

I am going to make this argument with an example protocol ExWhyZee with a governance token XYZ. This toy example spans the current governance structure of many legitimate protocols. And everything I say here isn’t meant to be disparaging to protocols in general. It says more about the current tooling available, governance structuring, and overall legal framework we all live in.

Example Setup

ExWhyZee protocol (protocol) was started by a handful of devs that incorporated a company called ExWhyZee Labs (Labs). The protocol is live and generates legitimate revenue that is put into a wallet for the ExWhyZee DAO (DAO), controlled by a multisig of multiple Labs members and a couple community members/members of different protocols. XYZ token was launched as the governance token of ExWhyZee protocol, and the DAO treasury “belongs" to XYZ holders.

ExWhyZee has a process to put governance proposals on chain that will be implemented to upgrade the protocol, treasury, tokenomics, or other things that affect the protocol and/or DAO. The process includes a temp check, then on chain voting with a token voting model of 1 token = 1 vote. Once a proposal passes, it is up to the Labs team to actually implement the proposal.

In this common structure, governance is a meme. Usually only certain people can put a proposal on chain. Even if anyone can (usually with a minimum XYZ amount of tokens), only Labs can implement the changes. An even then, the DAO may or may not have any direct control of the treasury that is associated to it.

All that aside, the main question here is…. What should the DAO do with the revenue earned from the protocol? If this was a public or private equity investment, most would argue the company should retain all earnings and use those for growth initiatives, with the expectation that the return on equity the company can earn from retaining those earnings is sufficiently high enough to risk keeping all earnings in the company. It’s likely not profitable currently, but the path to profitability is a worthwhile one to risk keeping all earnings in the company. The “bird in the bush" is worth the risk here.

However, if things go wrong, management acts maliciously or is effectively incompetent, the board of directors can remove the management. And in extreme cases, equity holders have a legal right to dissolve the company and pay off all debts, then distribute excess assets above liabilities to themselves. The actual “equity” in the company (equity = assets — liabilities) is owned by the stock holders. There are legal frameworks in place to make this so.

Within the ExWhyZee DAO, the DAO has no legal claim on the assets in the multisig wallet/treasury. If the devs rug the protocol and take the assets, there is no legal framework in place saying these assets belong to tokenholders. Even if a proposal passes to dissolve the DAO and distribute all assets to XYZ tokenholders, it’s up to the Labs team to implement this proposal, not the courts. So is a “bird in the bush” really worth the risk here? Even if the expected return on equity is extremely high, it needs to be discounted (probability weighted) with the fact that there is no legal claim on assets retained by the protocol on behalf of the DAO.

Revenue Distribution

I argue that a distribution mechanism for assets in the treasury (think like a dividend) is actually much more valuable here than if ExWhyZee was structured like a public or private company and token holders were really equity shareholders.

So the simplest model to distribute some revenue is through a ‘liquid stake XYZ' and recieve revenue distributions. You could take this a step further and incentivize specific actions as well. If you want people to align on a longer term horizon with your protocol, maybe you do a “soft lock” model likd Minswap does. Users choose their soft lock period (1, 3, 6, 9 months) and get higher % of revenue for longer soft locks. Lock is soft because you can always unstake your MIN, but lose all the revenue earned, until your lock period is up. That penalized early unlock revenue could be redistributed to other soft lockers (gamified a bit) or go back to treasury. If you want hard locks, I like the Lifinity model, with a tokenized max lock feature for exits.

If you are a DEX, maybe you want to incentivize providing liquidity, so users must pair LP tokens with XYZ tokens to earn revenue. Or maybe you want more trading so you boost revenue to frequent traders (will get lots of wash trading here…). Or if you are a money market or borrow lend protocol maybe you only distribute revenue to lenders and borrowers, or CDP holders in addition to staking XYZ. The point here is, if you distribute revenue in a “dividend” like model, you can target, incentivize and reward specific behaviors.

Buyback and Burn

This is a common model and strong narrative right now. The model is, use some of the revenue to buyback XYZ token on the open market, then burn that XYZ token. This model ‘rewards' all XYZ holders through some price support/constant demand for the token. But this also rewards people who have a short term holding mindset and sell after the buyback. There is no way to incentivize specific holders and behaviors. It is similar to a company stock buyback, which is used (in my opinion) to immunize stock option grants and RSUs and inflate Price to Earnings (per share) metrics. Its possible one could argue something similar in crypto with vesting schedule dilution and inflating FDV (also a meme?). It is a valid method to distribute revenue, and is likely a better model in specific jurisdictions where dividend like models may force the token to be viewed as a Security by regulators. But in my opinion, a more discriminatory model to reward specific actions makes more sense.

If you are dead set with a buyback method, buyback and use (make) is much better than buyback and burn. Buyback the tokens and use then for working groups/sub DAOs, marketing campaigns, emissions/incentives, grants, or just sitting in the treasury (like stocks repurchased sit in a corporate treasury). And if for some reason your tokenomics are so out of wack that you have too much sitting in the treasury, then consider burning. Buying back tokens and burning them are two distinct decisions that should be made separately; they are not tied to the hip.

Conclusion

This article was written quickly just to get my thoughts down on paper, so I apologize for oversights in advance. Take it with a grain of salt as I do not work in crypto, just a curious outsider (help out with a couple DAOs). These topics require deep analysis and constant dialogue/discussion. Please reach out if you want to chat.

There is much more to think about here.

• DAO structure — crypto is great a speed running and DAO governance structure is speed running 1000s of years of corporate governance structure. My quick view is an advisory council doing capital allocation and spinning up sub DAOs and working groups (some permanent and others Agile like as needed) is a better model, with a delegation framework (representative democracy).
• Emissions — how to bootstrap liquidity through token emissions while aligning wanted behaviors and disincentivizing unwanted actions.
• DAO Capitalization — the capital stack shouldn’t be 100% ‘equity
• Treasury Management — don’t speculate with treasuries, diversify, run like an endowment thinking about liabilities/expenses and managing cash/investments appropriately
• Decentralization — eventually DAO runs protocol and hired dev teams (like Labs) to maintain and enhance the protocol

I am sure there is more. Thanks for reading and feel free to reach out, I love a good conversation.

References

https://www.investopedia.com/terms/b/bird-in-hand.asp

https://www.placeholder.vc/blog/2020/9/17/stop-burning-tokens-buyback-and-make-instead

About Marco

I am a DAO Working Group member and Iporian at IPOR. I am in the Kitty Farmer Committee and working group member for Minswap. I am also a member of Optim’s ODAO.

This is not financial advice!

I would love to hear your feedback/questions/comments. Reach out to me on Twitter… Marco_112358, or Discord… marco_112358