A Roadmap for YAM (Part 3 - Tokenomics)

This is the 3rd Part of my vision for YAM. Click to read Part 1 and Part 2

TL:DR - Allowing YAM governance participants to earn the yield that the treasury earns incentivizes them to steward and grow the treasury for their own self interest without directly rewarding those who choose not to participate in the DAO.

What is the role and value of the YAM token?

This is a question that has often been asked but rarely answered satisfactorily. The original answer for this was in the original blog post announcing YAM:

YAM holds zero inherent value; any value which might accrue would be an entirely emergent property of the community that takes control.

From: YAM: An Experiment in Fair Farming, Governance, and Elasticity | by Yam Finance | Yam Finance | Medium

This is a profoundly unsatisfying answer to many, and an equally silly answer for others who will look at the protocol and see actual value there. We can all agree that there is value to the YAM token, and that is borne out by a market for the token. The value is an emergent property of everyone buying and selling YAM.

What is clear is the primary utility for the YAM token: governance. The YAM token is the key to the DAO treasury and is the most basic way it is controlled and managed. A plurality of token holders (any collection of those holding 500k YAM tokens between them) are capable of unlocking the treasury. I find this to be the most accurate description of the utility of YAM as it stands today.

The obvious next question to ask is: “what is the value of a key to the YAM treasury?”

This is a difficult question to answer, and the beautiful thing about open markets is that they answer this question for us. The problem for us is that we may not like the answer1. So what can we do to make that answer into one that we want to hear? To an extent, nothing we can do will be certain to make a difference, but we have options!

The first attempt to create an “answer we liked” was the Great YAM Wall. This would hypothetically set a lower bound for the YAM market cap at the size of the treasury (Book Value). While an interesting idea, this mechanism is flawed because all it does is slow down the process to find the true market price of YAM, while simultaneously draining the treasury and giving it to those who are the least committed to the project. If you want to read more about why I oppose it and why it was removed, here you go.

Another proposal to get an “answer we liked” was that of buyback and build with profits, which I still think is a good first step and can be used in the short term. But the more that I have thought about it and the way that I framed it in the above post, the less incentive aligned it feels. The reason for this is that most token holders have minimal input on the DAO’s ability to earn a profit, even if they vote on every proposal2. If we go back to the original mandate of YAM, token holders hold the keys to the treasury and are therefore the stewards of the treasury. But the treasury in itself has limited ability to earn revenues.

Leveraged Yield Farming

The other dynamic to consider is that of book value (treasury size) to marketcap. When the book value is higher than the market cap, one could consider the project token undervalued because 1 YAM token controls more than 1 YAM token’s worth of treasury value. The key caveat here is the term “controls.” If the value of the treasury cannot be realized with that token, then this control doesn’t add additional value to the YAM token. This, as I argued to remove the Great YAM Wall, is a good thing for the long term health of YAM. But this only applies to the extraction of the principal and not to revenues earned by investing that principal.

If the book value is higher than the market cap then there is a way to realize value for token holders without naively giving them the ability to pillage the treasury. If the yields from investing the treasury go to token holders then the YAM token becomes a claim on leveraged yield farming up to the point at which the funds available to farm are less than the value of the tokens that are receiving these rewards.

If the token holders who are responsible for directing the funds to earn rewards are the ones earning the returns there is incentive alignment. If this revenue is only paid out to those who participate in governance (managing this fund) then this puts the risk and reward directly into their hands. YAM gains value when the market cap is low compared to the treasury size, but requires some work to realize that value (via governance).

Revenue earned by the DAO would not be claimable by token holders, but would add the treasury and available funds with which the DAO could invest. Building products that produce profits adds directly to the future extract-able value of the YAM token.

Combined with an improved governance model that also incentivized long term decision making and streamlines quorum and overhead requirements, this model could re-invigorate a userbase to care about the decisions being made around the protocol.

Possible Concerns:

  1. This model removes compound interest from accruing to the treasury and therefore limits treasury growth.

This is true. Treasury growth becomes limited to product revenues. This is a trade-off to be made.

  1. This model is less effective if the market cap increases above the treasury value.

There is a break even point at which the interest earned per YAM token is less than could have been earned making the same investment on one’s own. But this is not simply at the point that the marketcap and treasury size meet. It is also impacted by how many other people are participating in governance and what percentage of the treasury is farming/earning.

A few notes to consider:

  • Other projects that have similar models (PieDAO3 specifically) only have ~44% of their token supply participating. This means that those who do participate get an even larger cut of the farming yields.
  • If we assume a generous 50% of our tokens are staked ($2M worth), and $5M of our $7M treasury is used for farming, that a 2.5x rewards boost. Even at parity (3.5M staked), it is a 1.4x multiplier.
  • As an organization, the DAO may be able to participate in programs that the average farmer can’t. One example of this is earning rewards from YAM Synths without having to go through the process of deploying every month.
  1. Participating in yield farming and other good opportunities is difficult to do in a fully decentralized way

This is a real concern, but new tools are becoming available that may make this easier, including Gnosis Zodiac, which allows a multi-sig to be controlled by a full snapshot vote.

  1. This sound like a lot of work.

You’ve gotta spend money to make money, baby!

  1. Isn’t this risky?

No more risky than what we are currently doing. The DAO has been active in using its treasury to earn a return. This maintains the status quo, but distributes the risk and reward differently. If token holders mismanage the treasury then they are the first to suffer. If they manage it well, then they benefit.

Conclusion

Allowing YAM governance participants to earn the yield that the treasury earns incentivizes them to steward and grow the treasury for their own self interest without directly rewarding those who choose not to participate in the DAO. Good stewardship will entail a balance between treasury growth via investment in new revenue and profit sources, and the direct investment into yield bearing opportunities. Combined with an improved governance model, this can go a long way toward building an aligned community who share similar values and are interested in building a better YAM and web3/Ethereum ecosystem.

The next installment is Part 4 on Protocol Owned Liquidity. You can do it Anon!


Notes

1. This is also a security question. The value could be calculated at the cost to perform a governance attack and steal the funds in the treasury. This price increases significantly if there are deterrence measures like a guardian multi-sig and required locks for voting tokens.

2. This dynamic is mirrored by the contributors not being able to directly impact the token price, even if they do their job well.

3. Read about PieDAO’s implementation here: https://medium.com/piedao/announcing-dough-staking-6dab2561626a and a typical report from their treasury farming program: Treasury Farming Committee Recap / First 100 Days - Governance - PieDAO

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here are some really interesting and deep thoughts…but they may come too late, US Federal Reserve is reducing balance sheet and the increasing of interests rate may come. The market is turning bearish. the liquidity of the entire crypto market will shrink. I think make sure YAM can survive the incoming bearish market is important.

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Never too late to try to implement improvements and good ideas! Especially when there is clear value on the table.

The goal of my posts in this series are to work through what YAM needs to do so that we can survive a bear market and come out the other side stronger and thriving. I strongly believe that bear markets are where the real money is made, building a foundation that can then be used to reap the rewards of the bull markets. We have never really built that foundation, and so we aren’t reaping the full rewards of the current bull market.

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I have continued to think about the logistics of making this model work. The biggest hurdle that I see is the overhead needed to manage the investment side, and separate earnings from appreciation to then distribute is significant. This leads me to 2 options to move forward.

Option 1 is to develop a system where we determine baseline/benchmark return rates for our investments and pay out based on those rates. This is what PieDAO has done, and looking into it further it seems both complicated and somewhat arbitrary. It relies of accurate assessment of baseline rates as well as a lot of work to normalize and track investment returns. While this could be done, without someone stepping up to build and manage this endeavor, it isn’t going to happen.

Option 2 is to focus on investment opportunities that allow an easy split between funds invested (principal) and rewards earned (yield). This limits the number of locations that treasury funds can be invested, since many protocols compound rewards automatically (Yearn, for example does this).

One prominent example of a protocol that doesn’t auto-compound is Uniswap v3. I see this as a good option for the treasury for this reason, as well as some others: It is battle tested (safe) and the best returning pools are exactly what the treasury wants to invest (USDC and ETH). The ETH/USDC pool is consistently the highest volume pool on V3 and earns an average of 10-20% APR. Of course, impermanent loss is a risk, but over long periods this risk is limited by consistently high volume.

The DAO could enter the V3 pool over the whole range (or most of the range) similar to how a v2 pool works and earn steady rewards that can be harvested intermittently and distributed to voters. Yields could be paid directly in ETH and USDC, or a combination of YAM, USDC, and ETH.

This strategy could be improved by using other products that have recently come on the market that allow for concentrated liquidity to be provided and managed trustlessly. The most prominent of these is sorbet.finance, which is built on gelato.finance contracts and allows for concentrated liquidity in managed ranges that can be automatically rebalanced.

You can see and instance of one of these contracts for the USDC/ETH V3 pool here: Sorbet Finance - Automation for Uniswap, Quickswap and PancakeSwap.

Liquidity is deposited within a range (between 2000 and 4500 ETH/USD) to earn higher fees due to higher utilization. The rates shown for that pool may include compounding, but even without it this rate is well above market averages. If this is something that the community is interested in pursuing then I would be happy to reach out to the sorbet.finance team to figure out how we could create our own pool that is managed by DAO governance and returns the yield to the treasury (and then token holders) instead of reinvesting.

Depending on how much we wanted to apply to a strategy like this, the treasury may need to re-consider some of the other asset holdings to make sure that we have enough medium term runway for operational expenses. One option would be to reduce the amount of DPI, Index, and Sushi that we currently hold and convert it to USD and or ETH.

Curious to hear thoughts.

There are other options via pure yield farming like 88mph, which would allow us to deposit funds that are supplied to compound and then earns MPH rewards on top, which could be sold and given to voters, but these rewards are much more reliant on the farming token price and issuance rate.

There is another, easier option to make this work without changing how we invest the treasury.

Element.fi is a DeFi protocol that focuses on creating versions of current assets with fixed interest rates. Element incorporates Yearn Vaults and splits assets that are deposited into those vaults into principal and yield tokens. The fixed rates are created by users who split their assets and sell the principal at a discount.

For our purposes, we are not interested in the fixed rate, but instead the conveniently separated yield tokens. This provides a simple way for the DAO to split apart the principal invested from the yield generated and redirect it as needed. Both the yield tokens and principal have expiries at which point they can be redeemed for the underlying assets.

The DAO could continue to invest in Yearn Vaults as we currently do. We have USDC in the USDC vault, and soon will be depositing ETH in the stETH vault. Both of these products are available to be split into principal and yield tokens using Element. The DAO could do this every 6 months or so, where it mints assets, holds the principal tokens and distributes the yield tokens over the duration of the term to users who stake their YAM tokens and vote. At the end of the term, the yield tokens can be redeemed for the underlying assets.

The above is the easy part. We can simple allocated whatever portion of the treasury to yearn vaults and mint principal and yield tokens with those positions every few months. How to distribute the yield tokens is the tricky bit. However we do it, we would need to deploy the contracts to do so. A few options:

  • airdrops to snapshot voters similar to how Votium airdrops for CVX bribes. On L1, this may be expensive enough for small holders that it is not worth their while.
  • These rewards could be distributed to LPs in the YAM/ETH LP pool, which should boost liquidity. This would create yield for this pool that is denominated in ETH and USDC. At current liquidity levels ($1MM), and assuming $5MM in yearn @ ~3% APR, that yields ~15%.
  • Simple Staking.
  • Any other strategy the DAO wishes to incentivize.

This strategy is the easiest to achieve from an overhead standpoint, and should be, in my opinion, our first step in making yield distribution to token holders happen.