How to value a community? — DAO Valuation Frameworks
Apple is the world’s most valued with ~$2.83 Trillion as its current valuation and we all know why it’s valued so much. Insane Revenue! All companies have profits/revenue as their core motive and the entire valuation is accrued based on the revenue potential. That’s mainstream, but have you ever thought, if we were to put a valuation number for a community. How would we do that? Yes, we are talking about “Valuation of a Community!” and in this piece, we will discuss some possible approaches to do that🤯. First, let’s understand what’s a community👇
What gives the community value?
Communities are inherently valuable. They bring together members’ resources, skills, knowledge, and experiences to create value for members and other stakeholders who engage with them. From crowd-sourcing advice to supporting non-profit causes and even raising funds & saving lives during COVID waves, communities have historically been used to accomplish and advance all kinds of goals. For instance, in many rural Indian societies, community-based initiatives like co-operative societies are an age-long vehicle for enabling millions of unbanked people to access credit and other financial services.
As we have spent more of our time on the internet over the last few years, we’ve created and established more of these communities online. We’re part of groups on WhatsApp, Facebook, Discord, Reddit, Quora, and so on. These internet-based communities are able to leverage even more resources and run more efficiently because there are no geographical boundaries to membership. People from different backgrounds can bring diverse perspectives and skills to make their communities more valuable. The influence and value of these communities are also able to reach more people worldwide. Communities no longer have to be made up of just people who look like us; they can be formed around more diverse factors like ideologies, hobbies, and even arbitrary interests.
Depending on the community goals, physical communities can often create and give financial value to their members. For instance, a local community of teachers could pool money together to start a business that allows the members to split profits. They can do this because it’s easier to develop the level of trust and coordination required to manage financial resources when community members are in close proximity to one another.
This isn’t the case for online communities where members tend to be strangers spread out across the globe. It’s near impossible to build trust and coordinate decisions. For instance, if you’re part of an online group of digital art enthusiasts and your group decides to go beyond discussing art to maintaining a collection, it could be almost impossible to manage. As such, the financial value created by internet-based communities today ends up being captured by the community “leader” or the host platform (e.g. Reddit).
To financially co-ordinate, members would need:
- A Legal Infrastructure
- A bank account to make and receive payments.
- A scalable way to make decisions in a manner that is democratic and fair.
The Traditional community lacks all this👆
Not Kidding Web3 solves for this! How?🤔
Community — The Heart of Web3
In Web3, everything from DeFi to NFTs is all centered around community. Communities become the first adopters of a project, are incentivized via tokens to contribute, drive distribution and create massive value in exchange for a stake in the upside. In the Web2 world, communities are more of an engagement feature, where different companies embed communities so that their users stick to the platform and ultimately help companies monetize that stickiness. They don’t have an intrinsic value as such. The fuel that generates value to the web3 internet is tokens.
Any Web3 project, after releasing its first version, tries to build a community around it — who are like their early adopters. Just like in Open Source development, companies try to invite participation from the community, give bounties, grants, and other incentives, develop in the open, build community, and introduce rough consensus on decision-making. Web3 projects follow a similar strategy. But here, they go one step further — and also offer Tokens (Equity) apart from Fees/grants and that’s a game-changer!
To make things cooler, the communities in Web3 also got their own name — DAOs! Think of DAOs as a “Group of people with shared Bank accounts”. They are digitally native communities that are centered around a shared mission.
DAOs are a new way to finance projects, govern communities, and share value. If blockchains, NFTs, smart contracts, DeFi protocols, and DApps are tools, DAOs are the groups that use them to create new things. It’s a vanilla term for a collective of people deciding to pool resources into a smart contract and then use some form of decision-making mechanism (voting) for allocating those resources.
Now, after understanding a basic aspect of community and DAOs, let’s come to the core question — How do we value them?
Revenue and Cashflows: Driver for DAO’s Valuation? (DAOs as Companies)
DAO’s are often referred to as Decentralised Companies or a new type of LLC (Limited Liability Corporation). They are also said to be a much-needed transition from corporate hierarchy to value-creating networks. For traditional companies, the core is to generate cash or revenue at present or in the near future and they are valued based on that.
Typical Companies are widely valued using the legendary DCF (Discounted Cash Flow) Valuation methodology — where the intrinsic value of the company is derived from its expected cash flow.
Let’s not get overwhelmed by the DCF calculation. It’s fairly complex! To make things simple, let’s understand what drives the value of a traditional company for DCF Model:
- What are the cash flows that will be generated?
- What’s the growth rate?
- How risky is the business?
- When will the firm become a stable growth firm — to estimate a terminal value?
However, Do any of these apply to Web3 communities? Yes and No. While the last three are fairly inconclusive for a community, the first and most impactful factor — cash flow can be factored in. These Cash Flows will obviously different for different types of DAOs:
For instance, Service DAOs will be generating cash from taking various types of projects they undertake, Social DAOs would be generating cash from their fans buying tokens or NFTs, Protocol DAOs would be generating cash from Lending.
For instance, Uniswap is a Decentralised Exchange (DEX) DAO that facilities people to trade cryptos. It charges a fee is of ~ 0.3**%** (range from 0.05% to 1%) which is distributed between the Liquidity providers and treasury. Cash flow in this case is generated from Fees. The Uniswap DAO generates $1 billion in daily volume and ~$3 million in daily transaction fees, or a whopping $1 Billion in Annual Cash flow by this calculation! So, we can calculate its value by discounting its estimated cash flow over the years and using a suitable growth rate and a risk factor for discounting.
Another typical methodology used by startups are Revenue Multiple which is simply: Valuation/Revenue
It measures the value of the equity of a business relative to the revenues that it generates. Higher Revenue Multiple shows it has very growth potential and will eventually generate huge revenue and hence be overvalued in the short-term.
For instance, early-stage revenue-generating startups have a revenue multiple of 20–40X, while companies like Uber have a Revenue multiple of 4–5X. Now, Let’s come back to Uniswap:
Uniswap generates ~$3 Million in daily transaction fees, which is distributed among Liquidity providers (LPs). So, let’s assume this as the daily revenue for Uniswap as the community and we get ~$1 Billion as Annual revenues for the community or DAO. As per its current market cap, its valuation is ~$10 Billion, which gives it a Revenue Multiple of 10X! But why just 10X? The Reason for this might be that Uniswap as a protocol is fairly stable, with not very high growth prospects with risk of forking being omnipresent.
GDP: The Magic Metrics for DAOs? (DAOs as Countries)
What’s a country — a group of people having a constitution and economy? Same are the DAOs or any Web3 community! Let’s draw some analogy to sound it more convincing:
- A Country relies on its people to generate “Value” or “GDP” — DAO relies on its community.
- Countries draft a constitution that creates the laws of the land. For DAOs, this constitution is written into the rules of the Smart Contract.
- Countries determine their political structure, with associated governance and power distribution, just like a Web3 community determines its governance and token distribution.
- Foster an emergent culture, which springs from the community members themselves.
- Create borders, either through an application process or token-gating.
- Develop a vibrant economy, whether through a token or other revenue-generating processes.
- Shared treasury — Central Reserves
All these give a perspective that DAOs are more of a ‘country’ than a ‘company’. So, doesn’t it actually make sense to measure their value, just like countries do? Now, How do countries measure their value — GDP (Gross Domestic Product)! Yes, there may be other L1 metrics like FDI (Foreign Direct Investment), Unemployment, Imports & Exports, etc but GDPs remain the North-star metrics here.
It’s the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.
Now, Let’s try to demystify all these components, and draw some analogies:
C → Consumer Spending: In a country, each citizen spends the currency to buy their needs and luxury. In the Web3 community, people usually spend their fiat/token money to buy NFTs, trade on DeFi protocols, which can essentially form the consumption part.
I → Investment: Just like private individuals and companies make investments in a country, Community members do make investments in community projects.
G → Government Spending: Governments spend money for the welfare of the country, just like DAOs can spend money to upgrade the community features, perform Airdrops, etc. The Treasury balance of DAO can be another metric to look at.
X-M → (Exports — Imports): Just like a country exports or imports, Service DAOs may export their services, Investment DAOs may import services, and so on. We can see a lot of trades happening between DAOs in the near future.
Outputs as a Measure — Depending on the type of DAOs:
Another way to measure Community GDP can be to measure the “Output” of a community:
- Distribution (How much is the DAO’s reach)
- Opportunities (How much are DAO’s members exposed to opportunities)
- Capital (How much Capital deployed)
The Value of Output varies a lot depending on the types of DAO, For instance:
1) Protocol DAOs: The Metrics here would be very protocol-specific like:
- DeFi -> Total Value Locked
- L1/L2 Blockchains: Unique Wallets, Volume of Transactions
- Consumer Apps: Revenue generated
2) Service DAOs: Total revenue generated through services
3) Social DAOs: Collectible Treasury, Membership Revenue
4) Investments DAOs: Return on Investment (ROI), AUM (Assets Under Management)
5) Media DAOs: Reach of DAO’s channels like Podcast, Newsletter, etc
Overall, the proportion between Opportunities, Distribution, and Capital would very much depend on the type of DAOs. For a Media DAO, the distribution would have a very high percentage while for Investment DAOs, Capital would have a very high percentage.
L1 Metrics: Metrics that can drive Community’s Valuation
Apart from GDP, various other metrics like Employment, FDI, GNI Index also determine a Nation’s health and wealth. Similarly, let’s look at some interesting community metrics to measure a community’s health and its valuation:
- Contributor Level:
- GDP per Capita (represents how individuals are earning) → Mean/Median Community Earnings
- Happiness Index (represents how citizens are happy) → NPS (Net Promoter Score), Community Utility Satisfaction (CSAT), Community’s Vision Perception & Alignment
- Employment Level → % of Active Contributors, Retention Level
2. Network Activity: The Activity of an economy is determined by indicators like GDP, Manufacturing Index. Similarly, we can measure indicators like Interaction Pairs, Average number of responses, TAT (Turn-around time) to each conversation, Conversation Starters (Daily, Unique),
Moats of DAO: The drivers of Valuation
With so many DAOs getting launched in the market, maintaining moats in the form of the competitive edge will be one of the biggest drivers of Valuations. The switching Costs in Communities or DAOs are very less. A particular individual can be a part of many communities which certainly can inflate the numbers. Moreover, these individuals can easily switch between communities. While Tokens can do create a bit of friction, but again with many DAOs & projects airdropping, they can take away a community’s userbase very easily.
So, What can be some of the possible moats for a Community? Let’s discuss some:
- Network Economies: The value of service to each user increases as new users join the network. Network economies are where DAOs have the potential to grow over their traditional counterparts. This can be the strongest moat for successful DAOs. A good example of network economies is Instagram, which gets more valuable to you each time one of your friends joins because you can talk to them and see what they’re up to. DAOs, built on crypto networks that combine innovative protocols directly with money (tokens), provide network effects on steroids. With DAOs, users are owners, and every time someone else joins the DAO and/or uses the protocol, the user’s tokens theoretically get more valuable. Additionally, as the DAO gets stronger, more people build on top of it, which makes it stronger, attracts more people, and so on. For instance, Solana has platform network effects, like Windows, but with financial steroids. Once a DAO picks up steam, it’s going to be very hard to reverse it.
- Switching Costs: The value loss expected by a customer would be incurred from switching to an alternative supplier for additional purchases. This is a tricky one. On the one hand, DAO members would incur switching costs because the tokens they own in one DAO may become less valuable if they switch to a competing DAO, but the fear of forking is omnipresent. For instance, SushiSwap was forked from UniSwap as all the codes are completely open to the world — so this means DAOs can easily be copied exactly. While this scores low as a moat, the low switching costs are part of the beauty of DAOs: it creates an interesting dynamic in which protocols are constantly competing to keep their stakeholders happy and well-compensated. If the DAO does something members don’t agree with, they might run away quickly. The Moloch DAO, which awards grants to advance the Ethereum ecosystem, even has a “rage quit” mechanism built-in, through which a member can rage quit and withdraw their tokens if they don’t agree with a particular community decision.
- Brand: The durable attribution of higher value to an objectively identical offering that arises from historic info about the seller. Part of the reason that certain brands are able to charge higher prices for the same item is that people tie their identity to those brands. Carrying a Louis Vuitton HandBags says something different than a regular handbag. Similarly, people will tie their identity to the DAOs in which they’re contributing members and of which they’re an owner. If you consider Solana a DAO, think about all of the people whose identities are tied up in owning Solana. They’re willing to market Solana, buy dips, and bash non-believers for free.
- Cornered Resource: Preferential access at attractive terms to a coveted asset that can independently enhance value. A DAO’s community is its cornered resource. While many DAOs employ or otherwise compensate people for their contributions, there are many instances in which people contribute to the DAO just to make it, or the blockchain on which it’s built, more valuable. The Moloch DAO gives grants from its members’ own pooled ETH in order to make ETH more valuable and can submit proposals to do free work to make Ethereum better. Those engineers’ time is independently valuable.
Community as a Product:
Just like a product has a range of metrics as per its user journey, we can observe a range of metrics based on a contributor’s journey in a community:
Taken together, by granting economic incentives to a DAO’s users, contributors, and the broader ecosystem of stakeholders, and giving those stakeholders a say in the DAO’s governance, DAOs have the opportunity to build incredibly powerful moats. The strongest is network effects — once a DAO hits escape velocity, it will be hard to take it down, particularly given the fact that community governance means it should be able to adapt and evolve in a way that the community believes will create the most long-term value.
That said, DAOs should be wary of using those moats to get too comfortable. They shouldn’t extract too much value, grant too much power to too few stakeholders, move too slowly, or do anything else that might piss off a sufficiently large piece of the community. If they do, they give others an opening. The threat of forking is ever-present. It’s survival of the fittest.
Mergers and Acquisition:
At the end of 2021, we saw one of the largest DAO mergers, where Rari Capital (a DeFi protocol) and Fei Protocol (Algorithmic Stablecoin) merged to form a $2 Billion Liquidity player and integrated into a single governance token — TRIBE which is Fei’s Governance Token. We can see more such mergers & acquisitions happening as we move forward and a valuation framework becomes of utmost importance, which all stakeholders of DAO can use to evaluate and vote accordingly. An additional factor of “Synergy” i.e how various communities/DAOs can benefit from the combined entity will be an interesting thing to consider.
Overvalued or Undervalued?: Conclusion
A good valuation always has a story embedded in it and is a bridge between stories and numbers. Every number in a valuation has a story behind it and every story about a company has to have a number attached to it. For example, Uber was initially valued at $6 billion as an urban car services firm. However, when positioned as a logistics company, the valuation rose to $53 billion. Similarly, the Web3 community’s valuation will depend much on a community’s story and its vision.
Valuation is not just a number, there’s a story to it ~ Ashwath Damodaran (Dean of Valuation)
That’s all folks! — Hit me up at @yashhsm on Twitter for anything around Web3.