How to Value a Community? A Brief Discussion on DAO Valuation Framework

Author: DAOrayaki

Original Title: 《 DAOrayaki ｜ A Brief Discussion on DAO Valuation Framework 》

Apple is the most valuable company in the world, currently valued at about $2.83 trillion. We all know why its valuation is so high—its substantial cash flow! All companies are motivated by profit/revenue at their core, and the entire valuation is calculated based on revenue potential. This is the mainstream valuation method, but how to value communities, especially DAOs today, remains a topic worth exploring. Therefore, DAOrayaki will discuss some possible valuation methods in this article.

First, let’s understand what community context is:

What Gives Communities Value?

Communities are inherently valuable. They bring together members' resources, skills, knowledge, and experiences to create value for members and other stakeholders interacting with them. From crowdsourced advice to supporting non-profit causes, and even raising funds and saving lives during the COVID wave, communities have historically been used to achieve and advance various goals. For example, in many rural societies in India, community-based initiatives (like cooperatives) have long been a tool that enables millions of unbanked individuals to access credit and other financial services.

As we have spent more time online in recent years, we have created and built more online communities. For instance, we are members of groups on WhatsApp, Facebook, Discord, Reddit, Quora, etc. These internet-based communities can leverage more resources and operate more efficiently because membership has no geographical boundaries. People from different backgrounds can bring diverse perspectives and skills, making their communities more valuable. The influence and value of these communities can also reach more people around the world. Communities no longer have to consist of people who look like us; they can form around more diverse factors such as ideologies, hobbies, or even arbitrary interests.

Depending on the community's goals, physical communities can often create and confer financial value to their members. For example, a local teachers' community can pool funds to start a business that allows members to share profits. They can do this because when community members are close to each other, it is easier to establish the trust and coordination levels needed to manage financial resources.

This is not the case for online communities, where members are often strangers spread across the globe. Establishing trust and coordinating decisions is nearly impossible. For instance, if you are part of an online digital art enthusiast group and your group decides to go beyond discussing art to maintain a collection, managing it becomes almost impossible. Therefore, the financial value created by today’s internet-based communities is ultimately captured by the community "leaders" or hosting platforms (like Reddit).

To coordinate financially, members need:

• Legal infrastructure
• Bank accounts for payments and receipts
• A scalable way to make decisions democratically and fairly

Traditional communities lack all of this, but Web3 solves the problem! How does it solve it?

Community—The Heart of Web3

In Web3, everything from DeFi to NFTs is community-centric. Communities become the first adopters of projects, incentivizing community members to contribute, drive distribution, and create immense value in exchange for rewards. In the Web2 world, communities function more as a participation feature, with different companies embedding communities to keep their users engaged on the platform and ultimately help the company profit from this stickiness. They have no intrinsic value on their own. The fuel for creating value in the Web3 internet is tokens.

Any Web3 project, after releasing its first version, will try to build a community around it—community members act as early users. This is similar to open-source development, where companies invite community participation, offering bounties, grants, and other incentives, developing in the open, building community, and introducing consensus in decision-making. Web3 projects follow a similar strategy. But here, they go a step further—besides fees/grants, they also offer tokens (equity), which changes the game!

To make things cooler, communities in Web3 also have their own name—DAO! Think of a DAO as "a group of people with a shared bank account." They are digitally native communities centered around a common mission.

DAOs represent a new way to fund projects, manage communities, and share value. If blockchain, NFTs, smart contracts, DeFi protocols, and DApps are tools, then DAOs are the groups using them to create new things. It is a common term for those who decide to pool resources into smart contracts and then use some form of decision-making mechanism (voting) to allocate those resources.

Now, having understood the basic aspects of communities and DAOs, let’s look at the core question—how do we value them?

Revenue and Cash Flow: The Driving Forces of DAO Valuation? (DAOs as Companies)

DAOs are often referred to as decentralized organizations or a new type of LLC (Limited Liability Company). They are also seen as a transition from corporate hierarchies to value creation networks. For traditional companies, the core is to generate cash or revenue now or in the near future, and valuations are based on this.

DCF Model:

Typical companies use the DCF (Discounted Cash Flow) valuation method to achieve widespread valuation— the intrinsic value of a company comes from its expected cash flows.

DCF is a complex valuation model! To simplify, let’s understand what drives traditional companies' value in the DCF model:

• What cash flows will be generated?
• What is the growth rate?
• How risky is the business?
• When will the company become a stable growth company—the ultimate valuation?

Types of DAOs

For example, Service DAOs generate cash through various types of projects they undertake, Social DAOs generate cash from their fans buying tokens or NFTs, and Protocol DAOs generate cash through lending.

For instance, Uniswap is a decentralized exchange (DEX) DAO that facilitates trading cryptocurrencies. It charges a fee of about 0.3% (ranging from 0.05% to 1%), distributed among liquidity providers and the treasury. In this case, cash flow comes from fees. Uniswap DAO generates about $1 billion in trading volume daily and approximately $3 million in daily trading fees, which can amount to up to $1 billion in annual cash flow! Therefore, we can calculate its value by discounting its estimated cash flows over the years using appropriate growth rates and risk factors.

Revenue Multiple:

Another typical method used by startups is the revenue multiple, which is simple: valuation/revenue.

It measures the value of a company's equity relative to the revenue it generates. A higher revenue multiple indicates significant growth potential, leading to substantial revenue, thus being overvalued in the short term.

For example, early revenue-generating startups have revenue multiples of 20-40 times, while companies like Uber have revenue multiples of 4-5 times. Now, let’s return to Uniswap:

Uniswap generates about $3 million in trading fees daily, distributed among liquidity providers (LPs). Therefore, let’s assume this is Uniswap’s daily revenue, giving the community or DAO about $1 billion in annual revenue. Based on its current market value, its valuation is about $10 billion, giving it a revenue multiple of 10 times! But why only 10 times? The reason for this could be that Uniswap, as a protocol, is relatively stable, with not much growth potential, and the risk of forks is ever-present.

GDP: The Magical Metric for DAOs? (DAOs as Nation-States)

What is a nation— a group of people with a constitution and economic system? DAOs or any Web3 community are similar! Let’s draw an analogy to make it more compelling:

• A nation relies on its people to create "value" or "GDP"—DAOs rely on their communities.
• Countries draft a constitution that establishes land laws. For DAOs, this constitution is written into the rules of smart contracts.
• Nations determine their political structure, governance, and power distribution, just as Web3 communities decide their governance and token distribution.
• They cultivate an emerging culture that stems from the community members themselves.
• They create boundaries through applications or tokens.
• They develop a vibrant economy, whether through tokens or other revenue-generating processes.
• They share a treasury—central reserves.

What is GDP?

It is the total monetary or market value of all finished goods and services produced within a country's borders over a specific period.

Now, let’s try to unveil all these components and draw some analogies:

C Consumer Spending: In a country, each citizen spends money to purchase their needs and luxuries. In Web3 communities, people often spend their fiat/tokens to buy NFTs, trade on DeFi protocols, which essentially form the consumption part.

I Investment: Just as individuals and companies invest in a country, community members also invest in community projects.

G Government Spending: Governments spend money for national welfare, just as DAOs can spend money to upgrade community features, execute airdrops, etc. The treasury balance of a DAO can serve as another metric.

X-M (Exports minus Imports): Just like a country's exports or imports, Service DAOs may export their services, Investment DAOs may import services, and so on. We can foresee many transactions occurring between DAOs in the near future.

Output as a Metric—Depends on the Type of DAO:

Another way to measure community GDP is to assess the "output" of the community:

• Distribution (How far-reaching is the impact of the DAO)
• Opportunities (How many opportunities do DAO members have access to)
• Capital (How much capital has been deployed)

Depending on the type of DAO, the value of output can vary significantly, for example:

1) Protocol DAOs: Metrics here will be specific to the protocol, such as:

• DeFi -> Total Value Locked
• L1/L2 Blockchains: Unique wallets, transaction volume
• Consumer Apps: Revenue generated

2) Service DAOs: Total revenue generated through services

3) Social DAOs: Treasury of collectibles, membership income

4) Investment DAOs: Return on Investment (ROI), Assets Under Management (AUM)

5) Media DAOs: Channels covering the DAO, such as Podcasts, Newsletters, etc.

Overall, the ratio between opportunities, distribution, and capital largely depends on the type of DAO. For Media DAOs, distribution (influence) is very high, while for Investment DAOs, the capital ratio is very high.

L1 Metrics: Metrics that Can Drive Community Valuation

In addition to GDP, various other metrics such as employment, foreign direct investment, and Gross National Income index also determine a country's health and wealth. Similarly, let’s look at some interesting community metrics to gauge the health of a community and its valuation:

1. Contributor Levels:

• Per Capita GDP (representing individual income) Average/Median community income
• Happiness Index (representing citizen happiness) NPS (Net Promoter Score), Community Utility Satisfaction (CSAT), Visual Perception and Consistency of the community
• Employment Level Percentage of active contributors, retention level

DAOrayaki Note: Here, the Retention Level refers to employee retention. Employee retention is a concept in economic development from the early to mid-20th century. Retention is defined as the process by which a company ensures its employees do not quit. Each company and industry has different retention rates, indicating the percentage of employees who remain in the organization over a fixed period.

2. Network Activity:

The activity of an economy is determined by metrics such as GDP, Manufacturing Index, etc. Similarly, we can measure metrics like interaction pairs, average response count, Turnaround Time (TAT) per conversation, topic initiators (daily, unique),

The Moat of DAOs: The Driving Force of Valuation

With so many DAOs launching in the market, maintaining a moat in the form of competitive advantage will become one of the biggest driving forces of valuation. The switching costs for communities or DAOs are very low. A particular individual can be part of many communities, which can certainly lead to digital flooding. Moreover, these individuals can easily switch between communities. While tokens do create some friction, there are also many DAOs and projects that airdrop, which can easily take away the user base of a community.

So, what could be the possible moats for communities? Let’s discuss:

Network Economy: As new users join the network, the service value of each user increases. The network economy is where DAOs have the potential to surpass traditional peers. This could be the strongest moat for successful DAOs. A great example of the network economy is Instagram; every time one of your friends joins, it becomes more valuable to you because you can talk to them and see what they are doing. DAOs are built on a crypto network that directly combines innovative protocols with currency (tokens), enhancing their network effects. For DAOs, users are owners, and theoretically, every time others join the DAO and/or use the protocol, the users' tokens become more valuable. Furthermore, as DAOs become stronger, more people build on top of them, making them even stronger, attracting more people, and so on. For example, the network effect of the Solana platform, akin to the financial effect of Windows. Once a DAO rises, it is hard to reverse.

Switching Costs: The expected value loss for customers arises from switching to alternative suppliers for additional purchases. This is a tricky issue. On one hand, DAO members incur switching costs because the tokens they own in one DAO may become less valuable if switched to a competing DAO, and the fear of forks is omnipresent. For example, SushiSwap forked from Uniswap because all the code is completely open to the world—this means DAOs can be easily replicated. While this scores low as a moat, low switching costs are part of DAOs: it creates an interesting dynamic where protocols continuously compete to keep their stakeholders happy and well-compensated. If a DAO does something that members disagree with, those members may quickly leave. Moloch DAO rewards grants to advance the Ethereum ecosystem and even has a built-in "angry exit" mechanism, allowing members to angrily exit and withdraw their tokens if they disagree with a specific community decision.

Brand: The higher value attributed to the same product derived from objective historical information about the seller. Part of the reason certain brands can charge higher prices for the same goods is that people associate their identity with those brands. Carrying a Louis Vuitton handbag is different from carrying an ordinary handbag. Similarly, people will associate their identity with the members they contribute to and the DAOs they own. If you consider Solana as a DAO, think about all the identities associated with those who own Solana. They are willing to promote Solana for free, buy in, and attack non-believers.

Monopolized Resources: The priority to obtain coveted assets that can independently enhance value under attractive conditions. The community of a DAO is its monopolized resource. While many DAOs employ or otherwise compensate people for their contributions, in many cases, people contribute to a DAO simply to make it or the blockchain it builds more valuable. Moloch DAO provides grants from ETH pooled from its members to make ETH more valuable and can submit proposals to do free work to improve Ethereum. The time of these engineers is independently valuable.

Communities as Products

Just as products have a range of metrics based on their user journey, we can observe a range of metrics based on contributors' journeys within the community:

In summary, by providing economic incentives to the users, contributors, and broader stakeholder ecosystem of a DAO, and allowing these stakeholders to have a voice in the governance of the DAO, DAOs have the opportunity to build very strong moats. The strongest is the network effect—once a DAO reaches a certain growth velocity, it becomes difficult to dismantle, especially considering that community governance means it should be able to adapt and evolve long-term value in ways that the community deems will create the most enduring value.

That said, DAOs should be wary of using these moats to become too comfortable. They should not extract too much value, grant too much power to too few stakeholders, act too slowly, or do anything else that might anger enough community members. If a DAO community does this, it will create opportunities for others. The threat of forks is always present. It is survival of the fittest.

Mergers and Acquisitions:

At the end of 2021, we saw one of the largest DAO mergers, where Rari Capital (a DeFi protocol) and Fei Protocol (an algorithmic stablecoin) merged to form a $2 billion liquidity participant, consolidating into a single governance token—TRIBE, which is Fei's governance token. As we move forward, we can expect to see more such mergers occur, making the valuation framework crucial for all stakeholders in DAOs to use for corresponding assessments and voting. Another factor of "synergy," i.e., how various communities/DAOs benefit from the merged entity, will be an interesting consideration.

Conclusion: Overvalued or Undervalued?

A good valuation always contains a story; it is the bridge between the story and the numbers. Behind every number in a valuation, there is a story, and every story about a company must be accompanied by a number. For example, Uber, as a city car service company, had an initial valuation of $6 billion. However, when positioned as a logistics company, the valuation rose to $53 billion. Similarly, the valuation of Web3 communities largely depends on the story and vision of the community.

"Valuation is not just a number; it is a story." — Ashwath Damodaran