CIP-Draft: Should CowDAO consider revenue-share tokens to reduce COW sell pressure?

The purpose of this CIP is to gather feedback and support within the community to consider a modified version of the “ve” token structure that will protect the COW token.

Simple Summary

  • Sell pressure on the COW token destroys treasury and project value
  • Forced selling at all-time lows is a sure fire way of destroying value
  • Similar to the “ve” token model, CowDAO can implement revenue-share tokens
  • Revenue-share tokens can be expressed as transferable ERC-20 tokens
  • ERC-20 revenue-share tokens give CowDAO a way to reward contributors, customers, and liquidity providers without putting sell pressure on the native token during a bear market

CowDAO has 1 tool (the COW token) but 2 types of holders: short-term (looking for immediate yield (namely liquidity providers and some customers)) and long-term (core team and core community). By using the COW token to incentivize long-term and short-term stakeholders, the COW token is exposed to unwanted sell pressure by the short-term holders, especially in a bear market. Using revenue-share tokens gives CowDAO a tool to reward short-term stakeholders that are in search of yield while protecting long-term holders from value destruction as a result of COW token sell pressure.

Motivation

The CowDAO treasury is made up primarily of the COW token. The value of CowDAO as a project, and the project’s runway, depends on the value of the COW token. Unfortunately, this is what has happened to the token since inception:

The COW token is currently the only tool CowDAO has to manage the project. This applies, among other things, to customer incentives and liquidity provider incentives. Unfortunately, not all stakeholders who receive COW tokens are long-term believers in the project. For example, it is well documented that liquidity providers sell their native token rewards back into the pool they provide liquidity for (Pool 2 rewards). While having COW listed on DEXs is useful for price discovery, rewarding liquidity providers in COW can be overly costly in dilution and sell pressure.

A proxy for expected price reduction is slippage, which as we know is the “loss” incurred by liquidity providers as a result of the price of the assets moving relative to one another in liquidity pools.

1inch is a DEX aggregator that can be used to estimate the slippage from native token emissions. In his post (link) on Affiliate Program Incentives, @middleway.eth suggested 600k COW retroactive rewards to customers that participated in the referral program. Based on the illustrative transaction in 1inch below, these rewards could push the price of COW down another 30% if they are all sold (note that I strongly support @middleway.eth and his proposed incentive program, I am just using this as a current example to illustrate my point):

When stakeholders that do not believe in the long-term potential of CowDAO receive COW tokens, excessive sell pressure becomes costly for the project in terms of value destroyed and lost runway.

Specification

This problem has become so acute that we’ve seen DAOs across DeFi experiment with various strategies to mitigate token selling. The “ve” model popularized by Curve incentivizes native token holders to lock their token for a portion of protocol revenue (and locking means they cannot sell) [link]. “POL” or protocol owned liquidity, a model popularized by OlympusDAO, was designed in response to mercenary liquidity providers in Pool 2 liquidity pools with the goal of reducing the sell pressure on native tokens [link]. DAOs recognize they need to diversify their treasury but they cannot afford the market slippage, so they are opting for asset swaps instead [link]. Finally, DAOs are experimenting with vesting schedules for customer rewards [link].

All of these potential solutions are designed to improve the long-term outlook of the treasury by diversifying assets or by redirecting native token towards long-term holders. However, these solutions remain anchored in the idea that the native token is the only tool DAOs and protocols have at their disposal.

It seems to me like there is an alternative solution that would be easy to implement.

Taking example from Curve’s “ve” token revenue-share model, CowDAO could implement a revenue-forwarding mechanism to holders of a specific revenue-share token (this could take the form of a transferable ERC-20 token).

For example, 600k COW is currently worth $81,600 ($0.136/COW). Rather than issuing 600k COW tokens to customers that will likely sell them into the market (again, just an example for now), CowDAO could mint revenue-share tokens. The revenue-share tokens could have the following structure:

  • 10,000 ERC-20 tokens (1 basis point per token)
  • CowDAO forwards 20% of revenue to wallet addresses that hold revenue-share tokens
  • Revenue-share tokens are distributed the same way the 600k COW would have been distributed
  • Tokens are burned and revenue-forwarding ends after ~$85,000 is received

Rationale

Structuring a temporary revenue-share agreement this way allows CowDAO to pay for things without exposing the COW token to unwanted sell pressure.

By using the ERC-20 standard, revenue-share tokens would be easy to understand, easy to transfer across all existing infrastructure, and easy to manage across all existing tools. CowDAO could reward customers and incentivize liquidity providers with non-dilutive revenue-share tokens instead of continuously issuing COW tokens.

As mentioned in the Summary, the crux of the issue is that CowDAO has 1 tool (the COW token) but 2 types of holders: short-term (looking for immediate yield, namely liquidity providers and some customers) and long-term (core team and core community). By using the COW token to incentivize long-term and short-term stakeholders, the COW token is exposed to unwanted sell pressure by the short-term holders. Using revenue-share tokens gives CowDAO a tool to reward stakeholders in search of yield. The COW token can be used to incentivize believers in the long-term potential of the project.

Further, being a forced seller of any asset in any market represents a sure way of destroying value and leaving money on the table. Using the native token to pay for things in a bear market is extremely damaging to the runway and value of the project. CowDAO would benefit greatly from having another tokenized asset at its disposal.

Finally, with something like revenue-share tokens, CowDAO could develop more sophisticated treasury management solutions. It is easy to imagine a scenario where CowDAO purchases or sells revenue streams for other project assets with the dual purpose of (i) generating attractive returns and (ii) adding a diversified currency to the treasury.

I look forward to discussing this proposal with everyone.

Cheers,
Habs4Lyfe

4 Likes

Thank you for the well written proposal! You are specifically talking about revenue sharing (not profit sharing), right? It’s true that the protocol is generating between $50k-$100k in revenue at the moment which could potentially be passed on to token holders.

At the same time the protocol has significant operating cost (beyond paying for its development) which mainly stem from solver rewards and are in itself still slightly exceeding the current revenue.

Without any change in the fee structure, a revenue sharing model would therefore accelerate the rate at which the DAO’s treasury would be used. This would likely eventually also lead to sell pressure (as you are correct COW is the largest asset in that treasury).

Therefore I have two clarifying question:

  1. Does this proposal assume the DAO will actually have excess cash flow from operations (ie. by increasing the trading fee) as in would it be fair to change it to be a “profit-sharing” proposal?
  2. How would this proposal fundamentally differ from a buy-back program where the DAO agrees to purchase a fixed $ amount of COW per week?

An interesting opinion was shared by @Hasu on bankless recently where he argues protocols should not jeopardise their treasury to pay premature dividends.

One side note:

I disagree with this statement, as this assumes the entire buy demand for CoW is currently expressed by LP providers.
I think what your screenshot (I personally prefer to use CowSwap over 1Inch for these type of queries :wink: ) shows instead is that the market is very illiquid - you cannot buy/sell larger amounts of tokens in one trade without incurring price impact - and therefore the current price discovery of CoW is innefficient/incomplete. By no means would I equate price impact with “loss” for liquidity providers as some parties which aren’t actively providing liquidity would likely step in correct a price drop that steep.

3 Likes

@fleupold

Thanks for reading the whole proposal and providing a clear reply! Your feedback is much appreciated.

My suggestion is not to pay dividends prematurely. On the contrary, I am suggesting raising non-dilutive capital using future revenue instead of using COW tokens, thus protecting the COW token from further selling and increasing the treasury value as a result.

Revenue-share tokens are just a way of accessing non-dilutive capital based on future revenue, without collateral.

Revenue-share tokens would never lead to any treasury depletion because the payment amount is variable; it is calculated as a proportion of incoming revenue, not as fixed obligation. For example, payment to revenue-share tokens would always be 50%*[revenue]. The lower bound of the payment is $0 if the DAO generates $0 of revenue.

In certain instances this does accomplish the same goal. However, constantly issuing COW tokens and constantly buying back COW tokens isn’t a cohesive capital allocation strategy. Revenue-share tokens provide an alternative reward mechanism (or fundraising mechanism) for periods when minimizing COW token issuance is a priority (I would argue that this is the case in the current environment).

You’re right that slippage on 1inch is a far from perfect proxy for sell pressure, and you could be right that there will demand at lower COW prices. However, given the recent performance of the COW token (and the market broadly), it is far from certain that demand would step in at any level.

I completely agree with you and @Hasu’s Bankless post that DAOs should be run more like businesses. If we believe the “equity” in the DAO (in the form of COW tokens) is valuable, it’s not clear to me why we would choose to use it as a currency (i.e., to to pay for things) if there is a viable alternative (future revenue). Conversely, if the DAO constantly uses the token as a currency, it’s not clear to me why we should expect anyone to hold it like equity.

The goal is to treat the COW token more like equity: minimize COW issuance to short-term holders, minimize dilution, and minimize unnecessary sell pressure so as to maximize treasury value. Using revenue-share tokens can help us do that.

1 Like

Interesting, I indeed understood your initial proposal differently. My understanding now is that you are suggesting to introduce a new type of equity (a claim on future excess cash flows) - veCoW - which is more senior to CoW (assuming [v]CoW holders voted to share future profits amongst governance token holders).

That is, as soon as the protocol makes a profit veCoW holders would get a fixed share of that cash flow before the rest gets redistributed to the treasury or any other token holder.

This new token would then be used for rewards instead of the more junior claim.

I deliberately replaced “revenue”-sharing with “profit”-sharing because of your statement:

Clearly this is only true for profit sharing tokens. If a company has $100 in revenue and $100 in cost, assuming it gives away 50% of revenue, it would start making a loss and deplete its treasury.

Please let me know if I’m still mis-understanding this proposal.

1 Like

You are right, @fleupold, that the revenue-share token, taken together with other expenses and capital outlays, would not absolve the DAO from requiring treasury funds if revenues were insufficient to meet the sum of its obligations. My statement pertained to the revenue-share instrument by itself: because revenue-share payments are calculated as a % of revenue, they can never be greater than revenue. My apologies for this not being more clear.

Like any form of financing that is not equity, the revenue-share tokens protect equity from being diluted (or treasury from being depleted) because they bring revenue from future years to the present, which is critically important considering this price environment and considering the potential sell pressure on the token and the impact on the DAO’s runway from excessive issuance.

See below for an illustrative example of how moving money through time via revenue-share can reduce dilution or treasury depletion.

Revenue growth via partnerships

The key in the illustration above is the revenue growth, and I think we are all in agreement that volume is the critical requirement towards driving revenue increases the DAO.

In this discussion thread from the spring, @fleupold and @defiparasite you guys talked about veTokens and increasing fee revenue. Another thing that came up was network effects. While I don’t have an opinion on the fee increase, I tend to agree with what @0xSami_ posted over the weekend that distributing revenue in the form of dividends and share buy-backs should be reserved as later stage capital allocation decisions.

That being said, issuing short duration revenue-share tokens to some of the institutional DeFi funds that seek sustainable yields could be an interesting way to increase the notoriety for CowDAO and kick-start network effects. Thinking about it further, there are 3 ways finding an institutional DeFi investor for short duration revenue-share tokens could help CowDAO drive trading volume (and therefore revenue growth):

  1. CowDAO can promote the new partnership (earned media)

  2. Institutional investor meets the team, tries using the product, and (hopefully :crossed_fingers:) becomes a long-term repeat customer for CowDAO

  3. Institutional investor becomes a brand ambassador, incentivized to promote CowDAO among other institutional players because they benefit from revenue increase via faster repayment

Ultimately, revenue-share tokens can be used to bring on partners the same way native tokens are used. Issuing native tokens to partners is a well-trodden go-to-market path in DeFi and I think CowDAO could benefit from the same kind of publicity. As a shorter duration, less volatile, revenue-generating asset, revenue-share tokens would attract a different kind of investor than the COW token, thus broadening CowDAO’s partner base.

What do you think?

2 Likes

Thanks for clarifying and thanks for the added calculations to help understand the idea behind the revenue token better.

My personal impression is that the reason COW is trading at some positive value today mainly comes from the fact that people expect to vote on sharing part of protocol’s future profits with token holders. Creating a revenue token should reduce those future profits and consequently lower the value of COW by roughly the same amount the token is valued at.

However, I must admit that this kind of financial engineering is beyond my expertise, so I will defer to more financially literate people to comment on the effects and drive the discussion forward.

@fleupold appreciate your continued feedback! :grinning: It’s a very valid consideration though this kind of structure would not affect the long-term profit potential of the project:

1 Like

From my (naieve) perspective, paying COW to solvers is an expensive endeavor over the long term that contributes to excess COW to be sold when solvers cash out.

Is it possible to switch the solver reward from COW to a non-COW token?