Crypto Market Commentary
4 August 2019
Doc's Daily Commentary
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Treasury Funding Debate
Recently there have been a number of discussions going on regarding the viability, ethics and function of a treasury of ‘dev fund’ as part of a blockchain block reward. There are three major events which are under discussion at the moment which really come at this problem from all angles.
ZCash has been in the spotlight for their proposal to extend their developer fund beyond the original four year period.
Ethereum proposal EIP-2025 was submit which proposes to introduce a block-reward portion over the next 18months to be skimmed off the top for developer funding of Ethereum 1.x initiatives (a total of 17,050ETH). This is amongst a number of issues with Ethereum funding, low transparency of the Ethereum foundation and new donation ventures like MolochDAO.
Decred has officially voted on-chain to transition the treasury to be an entirely on-chain entity effectively dissolving the LLC company which currently hosts the Multi-sig Treasury wallet. This product is now under active development. The timeline is around 5-8months from today for delivery which will be a game changing initiative and make Decred one of the biggest DAOs in the industry in terms of direct Assets under management.
Project Funding Mechaisms
Given that this industry is predominantly open source, there is a reliance on donations of time and effort to bootstrap these projects. As more projects come to market, there is a need for each project to seek funding to pay the bills and attract talent to build out these systems. There are a number of mechanisms which have been employed to achieve this goal:
Pure donation of time which we have seen for Bitcoin. Eventually companies like Blockstream, ChainCode Labs, Lightning Labs and even Microsoft fund and sponsor developers given the ability to monetize the protocol for other services. Arguably this is the most organic and ‘pure’ approach however does raise the conflict of interest as to whether the larger company can exert some force over the open source development (relatively low risk for Bitcoin at least in my opinion).
Fundraisers from Venture Capitalists or ICOs/STOs which is the mechanism started by Ethereum. This process in theory provides an initial warchest of funds. Once this warchest runs out, that is it, there is no more gravy for the table. The biggest risk here is misallocation / mismanagement of capital and/or burn rates which are unsustainable to deliver the final product. This differs greatly from traditional finance where startups have fundraising rounds after delivering stages of the product. Here, projects have an enormous pool of money and more often than not, spend it before delivering anything of value.
Treasury funds built into the protocol block reward as is employed by ZCash, Dash and Decred. In all instances of this to date, there is a centralization risk where a single legal company/entity is responsible for the management and allocation of these funds, at least in the early days. This system relies on appreciation in price of the underlying coin and thus there is incentive to deliver and deploy valuable technology. The centralization however is a risk and issues arise when non-transparent or sketchy application of the funds comes to light.
The real challenge is that these blockchain protocols are not companies. They do not produce income per say but instead rely on value accrual and appreciation of the underlying coin. This is a very new model to traditional finance and thus there are many moving parts at play, the most complex of which is the community support. Community support is essential for any project to survive and attract a bid in a sustainable way.
The ethics of a treasury fund
It is a very valid argument here that we are ‘printing money’ with these networks, especially those that do not deliver the promised product. In order to establish whether a particular funding model is legitimate, we need to assess the following:
Is the model purely rent-seeking and are the incentives aligned?
Is the governance of fund allocation and magnitude fair?
Is the product being funded realistic and achievable?
In the case of ZCash, the problem faced is that the original 4 year dev fund is soon to expire before the project is complete and it is now being proposed to extend it. This is an admission that the original product was not delivered on budget and since ZCash has centralised companies building it out, they own all the governance rights to execute such a change. They are effectively proposing to continue to tax ZEC holders as well as continue with diminished security on the network in return for continuing to pay the bills (90% to miners instead of transitioning to 100%).
This is a contentious issue and not a good look for the founding team. Some counter proposals are to proceed with the funding however allocate it to a different pool of developers and not to the founders. Since ZCash has no formal governance structure and is much like Bitcoin in that the nodes operating on the network will need to select the code version they wish to run. For a young project like ZCash, this process will be dominated by the miners and developers rather than the users and will not have the same user driven prevention capacity as the Bitcoin UASF.
EIP 2025 was met with strong opposition from the Ethereum community with only a small faction of developers in support of the proposal. It is unlikely this will get pushed through.
The challenge Ethereum is facing is a severe lack of funding as the pool of money raised in the ICO and held by the Ethereum foundation starts to dry up. Not only that but funds must now be allocated to developing two blockchains, Ethereum 2.0 as well as the current 1.x chain. Given that much relies on the delivery of Ethereum 2.0, yet this process is expected to complete in 3-5years, this is a long term problem to be solved.
The ethical issue with EIP 2025 is that if you open the door for one developer group to put their hand in the cookie jar, the can of worms has no limit. The general perspective is that since ETH is now being pitched as sound money, skimming off the top is exactly the same as central bankers printing money in their basement and would destroy the ETH value proposition.
That said, funding will be an ongoing issue for Ethereum especially as the 2.0 vs 1.x allocation and increasing pools of developers enter the mix.
note on ICO projects
We hear very little about ICO projects anymore. This is largely due to the majority of them running out of their warchest and effectively grinding to a halt. More and more valuable projects in Ethereum DeFi have no token and instead opt for startup VC funding behind the scenes. I expect this trend to continue and monetization (rent-seeking) such as profiting from DEX spreads and fees to become more common.
Giving an inexperienced team of people $50Million to deliver a project is almost guaranteed to get $0 in return. Even EOS which raised $4Billion is a blockchain that is littered with bugs, inefficiencies and broken promises. The original 1Million TPS claim has actually come in at around 1000 TPS under ideal laboratory conditions as well as numerous instances of instabilities and censorship by BP nodes. More money does not necessarily mean a better end product.
Decred vs Dash situation
Decred and Dash both have a 10% block reward that goes into a pool for funding development, marketing and any other value add proposals. Since they are both targeting a DAO structure with hybrid PoW and PoS, they make for a valid comparison.
For Dash, once a month, 10% of the block reward for that period is allocated in a ‘superblock’ which goes into a fund for distribution by Masternodes to Yes voted proposals. Any allocation that is not funded gets burned. A Masternode for Dash costs $100,000 at today’s prices.
For Decred, every block, 10% of the reward goes into a multi-sig wallet currently held by a company Decred Holdings LLC. These funds are allocated by PoS voting on-chain via the governance portal Politeia into a single hashed invoice for verification by stakeholders the funds are spent correctly. Only PoS holders with tickets have voting rights with a ticket being around $3500 at today’s prices (ticket splitting is available).
Where these projects differ on Treasury approach is in the cost of governance entry and the behavior of the DAO. With Decred’s recent vote, the developers are now building out a system to move the entire treasury fund on-chain which will be automated and owned entirely by PoS ticket holders. This dissolves the central company and removes this censorship risk. Considering ticket splitting and the lower cost to enter governance (and interactions on Politeia via soft signaling) there is significant community engagement.
The masternodes for Dash are largely unattainable by the majority of people and somewhat resembles an oligarchy. This can lead to conflicts of interest where masternodes may vote only for their own betterment not necessarily for the betterment of the community. In general, I’m not a huge advocate of masternode systems as they tend to provide incumbents with perpetual governance rights and no dilution to avoid infinite capture by the few. When the treasury is also controlled by the same people, it becomes unlikely that the status quo will be unseated in the long-run which actually negatively affects flexibility.
The ethics of a block-reward treasury are an interesting comparison to the other mechanisms. At the very least, these funds are owned and operated by people with a stake in the network. The lockup of DCR in tickets and the large capital outlay for a Dash masternode in theory aligns incentives with the good of the chain.
I do think this model is a healthier in the long term as it is owned by people who feel the risk of decisions and future income is reliant on good decisions today. It is likely a more sustainable model however MUST get the transparency and decentralisation right. Decred remains at risk of having a centralised company target until the DAO fund mechanism is fully built and delivered however is on the right track.
Closing perspective on treasurys
Different projects are experimenting with these funding models. In a sea of competition, funding becomes extremely competitive and sustainable funding even more so. Bitcoin has yet again broken free of this problem and now major companies are sponsoring developers to keep building as it benefits the larger ecosystem. All other projects, need to get creative whilst maintaining ethics and support of their communities.
Projects which have sustainable funding WILL attract the developer talent in the long run. Good governance of this funding will be essential and thus I see funding and governance mechanisms as key considerations for making good investment decisions.
Bitcoin maximalists like to use dev funds and treasuries as ammunition. They claim people should donate time for the betterment of humanity. It’s a cute argument, yet is completely detached from reality where people still need to get paid. Yes donations of time lead to better allocation of effort, however outside Bitcoin, this model doesn’t really work. Bitcoin is the yet again the exception not the rule here (that damn Satoshi got it so right…).
Ethereum is exploring interesting methods like MolochDAO and donations to build out Ethereum infrastructure. Increasingly, small teams are getting background VC funding and will eventually monetise their product by spreads, fees and effectively rent-seeking. This is not necessarily a bad thing but something to be conscious of. Ethereum is the only other chain which I see as having a valid non-structured off-chain governance model. It is similar to Bitcoin and this is important to compete at the top as an alternative design ethos to Bitcoin.
ZCash is soon likely to undergo a very contentious hard fork to get this issue sorted out. In my opinion, this is a very bad look for Zcash and the founding team have now proven that their planning was wrong, their execution was mismanaged or some combination of the two. ZCash made the mistake of assuming governance was not important to solve at the outset. This is an example outcome where governance was not built into the social contract from day one.
Dash and Decred are building/transitioning to fully on-chain block reward funding mechanisms. Their approach was transparent and visible from day one and they have formal governance mechanisms to support them. I believe this is the correct model for projects (except BTC and ETH) and is a distinguishing feature not a bug. Governance here and giving stakeholders and the community a voice is the key ingredient and this is where I see Decred leagues ahead of Dash.
ICO tokens will likely continue to bleed out what is left of their warchests and I don’t see many carrying on with much success. Even the IEO market has already cooled off and is fading away. This whole market will be overtaken by monetized systems without tokens (as in DeFi) and the STO industry which I consider to be a healthy transition.
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