I think the principles are great but incomplete. In order for the DAO to create value it needs to produce economic value on deployed capital. In other words the incremental cash flows from investments needs to generate a return above the cost of capital, any return below the cost of capital is value destroying, which creates a doom cycle of increasing the cost of capital for the DAO and therefore operating costs which ultimately puts sustainability of the DAO in question.
The below examples are illustrative.
Let’s say the cost of capital for Lido is 8%. The exact cost of capital can be solved for or polled from LDO holders but that’s beyond the purpose of this example.
Project A is requesting $1m. It estimates to generate an additional $100,000 per year in incremental fees to the DAO in perpetuity and has a 50% probability of success. The net present value of the project is $625,000 = ($100,000/0.08) X 0.50. The value added is -$1,000,000 + $625,000 = -$375,000. Since it’s negative value added this project should be rejected.
Project B is requesting $1m. It estimates to generate an additional $10,000,000 per year in incremental fees to the DAO in perpetuity and has a 10% probability of success. The net present value of the project is $1,250,000 = ($10,000,000/0.08) X 0.10. The value added is -$1,000,000 + 1,250,000 = $250,000. Since it’s positive value added it should be accepted.
One advantage is it gets teams and the DAO thinking about what the drivers of value are. It also will help create a framework for investing in projects VS returning capital to LDO holders.
An issue with buy and burn models (MakerDAO) is it doesn’t discriminate between value. If the DAO is buying and burning LDO above intrinsic value then value is being transferred from long term holders to sellers. However, if buying and burning below intrinsic value than value is transferred from sellers to long term holders of LDO.
A conservative approach to intrinsic value is to use residual value + current assets. Residual value is one year fees of the DAO in perpetuity (or perpetuity with growth if being more aggressive).
As an example: Let’s says fees accumulating to DAO are $100m/year. Residual value is $1.25B = $100m/0.08. Treasury assets are $70M, putting intrinsic value at $1.95B. If buying and burning the return to LDO holders would be (cost of capital)/(1-percentage undervalued). Using the current market cap of $1.6B that implies a 22% undervaluation so an expected return on buy and burn would be 10% = 0.08/(1-0.22). Therefore a buy and burn of $1m can be expected to return an incremental $100,000 to LDO holders. This can now be used to compare against proposed projects. Since project B contributes $250,000 it would be a better use of the $1M in capital, however buying and burning would be a better use than investing in project A.
Finally, once projects are funded the intrinsic value is updated to intrinsic value = funded projects + residual value + current assets. In our example above funding project B would contribute $250,000 to intrinsic value. When projects fail they should be removed from intrinsic value.
Adopting this framework for effective capital allocation would not only help drive economic value to the DAO, but would become a competitive advantage for Lido given that to my knowledge no DAO has implemented a proper capital allocation program.