Recently, Aera was engaged to produce a research report for Arbitrum's Treasury and Sustainability Working Group, with the goal of better understanding the price impact and efficiency of grant distributions. This blog post reviews some of the insights from the report related to grant funding efficiency.

The Status Quo

The current approach taken by most DAOs when financing grant programs is to directly use their native token (for example, ARB) as a form of payment. Since many DAOs hold a large share of their treasury in native tokens, this is usually the simplest and most convenient option for the DAO. However, grant recipients typically have costs that are not denominated or paid in tokens, such as payrolls, infrastructure, and software costs. This means that recipients eventually need to swap their tokens for a more widely accepted form of payment, and are incentivized to do so quickly due to the risk of unfavorable price movements that could jeopardize their operations. This status quo can lead to a significant price impact on the native token as recipients are unlikely to achieve optimal execution in their token sales. As shown by the chart below, execution quality varies greatly in observed trades, and grant recipients are rarely specialists in trading (they are not expected to be).

Poor execution reduces the overall efficiency of the grants program by requiring larger distributions to make the grants viable at a less favorable price. This means that the DAO will end up spending tokens at an inherently lower ROI than if the execution were ideal. While DAOs can try to provide guidance on how to reduce price impact, it is important to acknowledge that recipients have their own constraints and objectives and are under no obligation to follow such advice. We propose a different approach to grant funding that could help address some of these inefficiencies.

Protocol-Owned Execution

A more favorable scenario might be if the DAO could finance its grants with other tokens, such as stablecoins, that are less volatile and more widely accepted as a means of payment. To obtain the tokens for grant funding, the DAO can swap its native token using a more optimized execution strategy, a concept we call Protocol-Owned Execution (POE). This approach does not materially change the final token ownership structure, as the DAO is still distributing the native token to the community. However, by doing this through optimized execution, the DAO is able to better manage the price impact and realize more value from its treasury. In other words, by distributing the native token to users who are buying voluntarily in the open market, the DAO can secure a more efficient price than by distributing it via recipients who are often forced sellers due to their operational needs.

To highlight the impact of POE, we can consider some illustrative edge cases. For example, the DAO could theoretically swap the entire native token budget to stablecoins immediately, mimicking the action of forced selling by grant recipients. This would be the least useful type of POE, as it does nothing to improve execution. On the other hand, if the DAO strategically limited its sales to times when liquidity and volume conditions were favorable, it could markedly enhance the quality of execution. The assets obtained from these sales could then be allocated to generate yield, or otherwise optimized to the DAOs risk tolerance and payment needs. This strategic approach could lead to more stable market conditions and potentially better financial outcomes for all parties involved.

Aera for Protocol-Owned Execution

Strategies like POE are a perfect use case for Aera’s onchain treasury management vaults. To fund a grants program, DAOs could simply deposit their planned budget in an Aera vault that has been set up to swap the native token into a specified mix of assets. Once the execution is complete, the DAO could then distribute grants directly to recipients from the self-custodial vault. Recently, Aera demonstrated this capability through a pilot vault with Threshold, which successfully swapped $270K of Threshold’s native token into a yield-generating mix of ETH and stablecoin assets. Though the vault was fairly large relative to the typical onchain liquidity available in the native token, the execution was completed over roughly 6 weeks with minimal price impact. For grant programs, this type of Aera vault could enable significant improvements in efficiency and help mitigate excess price impact during grant distributions.