Introduction

With recent failures in the crypto space (and in traditional finance banks), it is clear to organizations, delegates, and founders that having treasury assets on-chain is critical to their resilience and relevance. Having direct custody and accountability of one’s digital assets is, after all, the ethos of what crypto promises. Unfortunately, there is a shortage of effective treasury management solutions, and many projects have to patch together various dApps to meet their treasury needs, increasing their operating complexity and costs. Often, those handling the treasuries are under-resourced and under-qualified.

On-chain cryptocurrency treasuries refer to pools or reserves of cryptocurrencies that are managed and stored in a decentralized way, typically under the control of a Decentralized Autonomous Organization (DAO) or a cryptocurrency project team. These assets generally fall into two categories:

1. Native Token of the Project
2. Other Assets (gathered through partnerships, revenue, or fundraising)

These funds are held in public wallets, ensuring transparency and accountability. They support project development, reward community members, provide liquidity, or serve other project-specific purposes.

In this series on crypto treasury management, we will establish best practices for creating frameworks for policies every treasury needs well in advance of launching their organization. We will provide an overview of key topics in identifying risk and possible frameworks for mitigation.

Key Risk Drivers

Here are five key risk drivers affecting a cryptocurrency treasury:

1. Market Risk: Cryptocurrency markets are highly volatile, with price trends that can fluctuate widely. Identifying market risk involves understanding the factors influencing these trends and the amount of risk the organization can withstand based on its growth stage.

2. Liquidity Risk: The risk of being unable to buy or sell a significant amount of cryptocurrency without affecting the market price. It’s essential to understand liquidity conditions, especially when using native tokens as bounties or for ecosystem growth.

3. Operational Risk: Risks associated with transaction errors, technology failures, or process failures within the treasury.

4. Security Risk: Treasury assets face potential threats like hacks, exploits, scams, and loss of private keys.

5. Regulatory Risk: Regulatory changes can impact the value or operation of a treasury. This risk is particularly complex and project-specific, depending on the use case, publicity, and capabilities of the DAO’s chain.

Diversification / Correlation Risk

Diversification is critical in both traditional and crypto finance, especially due to the volatility of crypto assets. Diversification involves spreading investments across various assets, counterparties, and locations to mitigate individual investment or sector downturns.

• Market volatility is a key factor, and treasury managers must evaluate historical price movements, market trends, and potential factors like market sentiment or macroeconomic events.
• Optimal allocation: Generally, projects should aim for 12-18 months of operating expenses in highly liquid, low-volatility assets (e.g., fiat or stablecoins) and diversify custody across cold wallets, banks, and exchanges.

Liquidity Needs and Risk Tolerance

Liquidity needs vary with an organization’s growth stage, divided into three phases:

1. Early-Stage Companies: High liquidity needs due to limited funds. Such companies should focus on zero-volatility assets, aiming for 18-24 months of runway.
2. Growth Phase Companies: Requires more treasury usage to fuel growth, often balancing expenses and revenue projections.
3. Larger Treasuries: These should assess crypto liquidity, ensuring assets can be managed effectively without significant market impact.

Security Risk

Security for on-chain crypto treasuries demands rigorous protocols. Blockchain’s decentralized and immutable nature makes it a potential target for malicious actors. Key measures include:

• Choosing secure custody solutions
• Implementing multi-factor authentication
• Using cold storage for long-term assets

Regulatory Risk

Projects must assess regulatory environments carefully, considering jurisdictional compliance, licensing, AML/KYC requirements, consumer protection, taxation, and cross-border regulations.

Solutions to Mitigate Regulatory Risks:

• Develop compliance programs aligned with AML and KYC regulations
• Engage legal counsel specializing in crypto regulations
• Participate in industry self-regulation and engage with regulatory bodies
• Operate in friendly jurisdictions like Malta, Switzerland, Singapore, Estonia, and Gibraltar

Global Considerations: Regulatory landscapes in the US, UK, Europe, and UAE each present unique opportunities and challenges for crypto projects.

Conclusion

Regularly reviewing and adjusting crypto portfolios helps projects mitigate risks, adapt strategies, and ensure the optimal allocation of digital assets. As regulations and market conditions evolve, treasury managers must stay informed to protect assets and maintain organizational stability.

In short: Conducting comprehensive risk assessments, establishing contingency plans, and diversifying assets are crucial for effective treasury management in the crypto space.