Financial aspects of DAOs
Token Economics
The study of economic systems and incentives surrounding tokens, otherwise known as “tokenomics”. Token economics involves understanding the process in which tokens are minted (created), distributed, utilized, and sometimes burned (destroyed) to drive certain behaviors within a network. In the realm of governance, tokenomics is important to ensure representativeness of a community’s will by reducing inequality among token holders, to drive voting participation in the organization and in general to balance the incentives of all stakeholders through financial means.
Total Token Supply
The maximum quantity of a particular cryptocurrency that can ever exist. This supply is often pre-determined at the time of a project's launch and can be found in the project's white paper or on blockchain explorers. The total supply of a cryptocurrency is a fundamental aspect of its token economics, as it influences the token's value, especially when combined with demand from users.
There is an important distinction to be made between the total supply and the circulating or floating supply of a token. The latter is the one that determines the clearing price of a token, while the former represents the supply that will eventually become available in the market.
It is also worth noting that the supply of a token can be set as either finite or infinite when programming the token’s smart contract.
Circulating or Floating Supply
The number of tokens that are currently available and circulating in the market. It excludes tokens that are locked, reserved, or not yet released. The circulating supply impacts the token's market price, as it's the supply that is readily available for trading in the market.
The transition of tokens from the total supply to the circulating supply is usually governed by a vesting schedule.
Vesting Schedule
A predetermined token release schedule set out by a project, which dictates when and how tokens within the total supply become part of the circulating supply. For example, tokens allocated to the project's team or early investors may be subject to a vesting schedule where a certain amount of tokens are released periodically (monthly, quarterly, annually, etc.) over a set number of years. This mechanism is designed to prevent market flooding and maintain a stable token price. It also aligns the incentives of token holders with the long-term success of the project, as they can't sell all their tokens immediately.
Vesting schedules vary widely but commonly include a "cliff" (a set period of time before any tokens are released or vested), followed by a gradual release of tokens over time. The release schedule of tokens is usually linear.
Market Cap
Short for Market Capitalization, it is the total value of a token or cryptocurrency in the market. It is calculated by multiplying the current price of a single token by the total circulating supply of that token. The market cap provides an estimate of the overall size and value of a token or cryptocurrency in the market.
Token Price
The value of an individual token or cryptocurrency. It represents the cost at which a single unit of the token can be bought or sold in the market, usually denominated in dollar terms. The price of a token can be influenced by various factors, including supply and demand dynamics, market sentiment, project developments, and overall market conditions.
Token Burn
The intentional destruction of tokens to reduce the overall supply, often resulting in an increase in the remaining tokens' value. Token burning can be used to control inflation, reward holders, or rebalance the token economics of a project. Burned tokens are usually sent to a public and unspendable address known as the "burn address", effectively removing them from circulation.
Token Bonding Curve
A mathematical curve that defines the relationship between the price and supply of a token. The curve is designed so that as more tokens are issued, the price to purchase further tokens increases, and vice versa. This model is used as one way of dispersing tokens and placing them in the hands of the community and relevant stakeholders.
Halabi, K. (2023). How can bonding curves help align DAO stakeholders? [online] Outlier Ventures. Available at: https://outlierventures.io/bonding-curves-and-a-prelude-to-sptokens/ [Accessed 9 Jul. 2023].
Staking
The process where users participate in network activities by locking up a certain amount of digital assets, such as NFTs or fungible tokens.
When fungible tokens are staked, they serve a dual purpose. Firstly, they act as a guarantee of the user's commitment to the network or protocol. Secondly, they often serve as the basis for reward mechanisms that incentivize the user's effort towards a common goal.
In the setting of on-chain governance a fitting example can be found with veTokens (voting escrow tokens). In this case, users stake or 'lock up' their tokens for a fixed period of time, receiving veTokens in return. During the lock up period, users are not able to withdraw their tokens as they are made illiquid by a smart contract. The obtained veTokens represent a user's long-term commitment and are used to increase their voting power in DAO governance decisions. The longer the lock-up period, the more veTokens a user receives, providing them with a greater say in the DAO's decision-making process. Hence, staking serves to incentivize and reward long-term participation and commitment.
veToken
Short for "voting escrow token," it is a term used in various systems where users can obtain these tokens by locking up their existing tokens for a specific duration of their choice. In the Curve protocol, for instance, users can lock their CRV (Curve DAO Token) to acquire veCRV (vote-escrowed CRV) tokens. veCRV serves as an asset for voting power within the Curve DAO governance system.
The duration for which users lock their tokens determines the voting power associated with their veCRV tokens. Specifically, the longer the remaining lock time, the higher the voting power attributed to the veCRV tokens. Conversely, as the lock time decreases, the voting power of the veCRV tokens diminishes accordingly.
Overall, the veToken mechanism allows users to trade the potential financial gains deriving from holding a liquid token for the voting power necessary to shape the governance and direction of the organization.
Curve DAO: Vote-Escrowed CRV — Curve 1.0.0 documentation. [online] Available at: https://curve.readthedocs.io/dao-vecrv.html.
Treasury
Refers to the pool of funds or assets owned and managed by a DAO and serves as a financial resource that the organization can utilize for various purposes, such as acquiring assets, funding projects, or rewarding contributors.
It consists of cryptocurrencies or other digital asstes. These funds can be acquired through various means, such as token sales, contributions from members, or revenue generated from the organization's activities. The treasury is collectively owned and controlled by the DAO's members, who can influence its management and allocation of resources through voting mechanisms defined in the organization's smart contracts.
Quadratic Funding
A funding mechanism based on the concept of Quadratic Voting to allocate funds in a democratic and fair manner. It aims to aggregate funding preferences of members by the principle that smaller contributors' voices should be amplified and valued in a disproportionate manner with respect to larger shareholders.
Imagine that we have $10,000 in a matching pool that was provided by our matching partners and we have 3 projects participating in a funding round.
- Project A got $1,000 in funding from 5 contributors ($200 each).
- Project B also received $1,000 but from 2 contributors ($500 each).
- Project C received the same amount – $1,000 – from 20 contributors ($50 each).
Let’s have a look at the matched amounts (the amounts eventually received by each project) to see the power of quadratic funding. Matched amounts are calculated by using a mathematic formula where the amount received by the project is proportional to the square of the sum of the square roots of contributions received.
- The first project got an additional $1851.85 which is an extra ~185% on top of the contributed amount. Project B received only a match of $740.74 which is around 74% of the total contributions. Now here comes the magic, Project C received a whopping $7407.41 of matched funding, which is 740% of the initial amount contributed.
Of course, in the real world scenario, a project would most likely receive multiple different contributions with different amounts, for example, $1, $5, $20 etc, but the principle stays the same – more contributions converts into higher matched amounts.
Quadratic Funding is particularly effective in supporting public goods or projects that benefit the broader community rather than individual stakeholders. By distributing funds based on a quadratic formula, it encourages widespread participation and incentivizes collaboration among community members.
However, it's important to note that Quadratic Funding is just one approach to resource allocation within DAOs. Other funding mechanisms may also be employed depending on the specific needs and goals of the organization. Nonetheless, Quadratic Funding has gained attention and popularity within DAOs because it aligns with the principles of decentralization, transparency, and community-driven decision-making. It promotes a more democratic and inclusive approach to resource distribution, empowering individuals and fostering collective decision-making.
Jakub (n.d.). How Can $1 Turn Into $27? Quadratic Funding Explained – Finematics. [online] Available at: https://finematics.com/quadratic-funding-explained/.
Matching Pool
A matching pool is a pool of money that is provided by the matching partners. Matching partners are companies, individuals or even protocols supporting public goods projects. The funds collected in a matching pool are used to magnify the individual contributions to different projects.
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In this section we cover all financial aspects related to the life cycle of a DAO, spanning from its origination to its operations. It is worth stressing how the degree of financial aspects involved in a DAO varies widely and as such the topics discussed in this section are more applicable to some DAOs with respect to others.
It is possible to divide the key financial aspects of DAOs into:
