For most of 2023 Nouns DAO auctions have been won by ‘arbitrageurs’ whose primary goal is to extract profits from the DAO’s treasury by redeeming their Nouns to the DAO at a higher price than they paid at auction. This arbitrage is the result of the project’s history, having been launched in the previous bull cycle when treasury grew much faster than the DAO could spend it, followed by the bear market we’re in right now, with auctions settling at much lower prices.

This activity is problematic for Nouns because it blocks long-term-aligned participants from acquiring Nouns and contributing their energy, capital, and perspective to the project. Additionally, this process ‘leaks’ a portion of the DAO treasury to arbitrageurs at the expense of future proposers.

In this post we’d like to show how specific DAO parameter changes and activities can affect arbitrage in Nouns DAO auctions and help us get back to a place where we can attract one new long term member every day.

First, some quick definitions:

Fork Threshold

The % of the circulating (not including DAO-owned Nouns) Noun supply that’s required to exit to a new instance of Nouns DAO.

Book Value

The amount of ETH (and other assets) that a Noun NFT would bring with it upon forking to its own instance of Nouns DAO.

Arbitrageur (arber)

While not arbitrage in the purest sense of the word, Nouns DAO arbitrageurs are attempting to buy Noun NFTs in the daily auctions and exit them to their own instance of Nouns DAO with their pro-rata share of the treasury. Once in control of their own instance of Nouns DAO, they will withdraw the treasury ETH, hopefully earning more than they bid in the primary DAO auctions.

Natural Demand

The prices long-term Nouners are willing to bid to win Nouns auctions. At the time of this writing natural demand almost always loses auctions to arbers.

How an Arber Might Think

Arbers bid to make a profit. To do so, they attempt to predict the eBV (expected book value) at the time the next fork event will occur and win Nouns auctions below their eBV, leaving them with a profit margin.

To decide if and how much to bid, arbers ask themselves (1) when will the next fork happen, and (2) what will BV be at fork time (eBV).

When the next fork happens is affected by variables like: the fork threshold and adjusted total supply, which together tell us how many nouns must escrow to initiate a fork; and how many nouns are already held by arbers who intend to fork.

What will BV be at fork time is affected by variables like: auction revenues; predicted spend rate; and predicted DAO-owned nouns distribution.

We have a simplified spreadsheet model you can clone and play with, to better develop your arb intuitions.

With this understanding of how an arber might think, we can switch to the Nouner perspective, explore how Nouners can affect the arb game, and what Nouners might want to do to best serve the project.

How Nouners Can Change the Arb Game

The main problem we’re hoping to solve: not enough auctions are won by long-term players.

As long as eBV is greater than natural demand, arbers will continue to dominate auctions. We expect eBV to reach natural demand one way or another, and then we expect to see a growing portion of auctions won by long-termers.

Yes, eBV (and BV) is trending in the direction we think solves the problem. However, we think it’s too slow and too much value is leaking to arbers until we get there.

Nouners can change the arb game for the better. Let’s look at a few key variables and how they affect the arb. After that we discuss possible directions and their potential implications.

Spend the treasury

As long as Nouns DAO controls funds that sum up to BV being greater than natural demand, we expect arbers to continue their efforts to extract ETH from the treasury, either through forking or through malicious proposals.

Various poison pills like buying a Punk or sending funds to a timelock smart contract can certainly hurt the arb via forking; however we advise against such tactics as they grow the incentive to mount a majority attack.

The only way out is through. Spending on proposals is the safest most effective anti-arb strategy. Worth noting Nouners have been successful at decreasing BV through proposal spending ever since the last bull market ended.

Arbers are tracking the DAO’s spend rate. If they believe Nouners intend to accelerate spending, we expect lower auction bids due to a lower eBV.

Distribute Nouns

BV is the treasury value divided by the number of nouns in circulation, i.e. not owned by the DAO. Therefore distributing DAO-owned Nouns to any recipient other than the DAO dilutes BV. If arbers see more nouns distributed, they will predict a lower eBV and therefore bid lower.

At the time of this writing, adjusted (circulating) supply is 370, while the DAO owns 532 Nouns (303 treasury + 229 escrow). If the DAO were to distribute all its Nouns today, BV would immediately shrink by a factor of ~2.4x.

However, we don’t think this is a meaningful lever to impact the arb because realistic distribution rates seem to have a negligible effect. For reference, since fork 0 ended on September 15th, 12 nouns were distributed (including 3 to the PropHouse round) in 53 days, making the rate 0.226 nouns per day.

Change fork threshold

In the context of the arb game, it’s most useful to translate fork threshold into the number of auctions or days until the next fork becomes possible or likely.

We think this is the most interesting parameter to discuss, since it’s a simple configuration change that can have dramatic effects. To further develop intuitions on Fork Threshold, let’s discuss what might happen with a high vs zero threshold.

What might happen if Fork Threshold is much higher?

A longer time to fork makes eBV harder to predict, so arbers will bid lower to account for the added risk. Nouners can use higher threshold values to push arber bids down as a way of getting closer to natural demand.

A greater threshold leads to arbers holding a larger number of votes they will likely use to vote against most spending proposals, as we’ve seen before fork 0, in an attempt to preserve BV. It’s not all bad as it gives good reason for dormant voters to engage or delegate.

If Fork Threshold is raised and we continue to see arbers accumulating nouns, it might need to be raised again until we’re convinced eBV has met natural demand.

After a few months BV should catch up with eBV and natural demand, making it safe to lower Fork Threshold again to provide better minority protection.

And what if Fork Threshold is much lower?

A very low threshold provides arbers with high predictability and little time delay, making it rational for arbers to compete with each other up to a small profit margin. In other words, you should expect auctions to settle just short of BV at auction time.

A positive aspect is that per auction the treasury value leak becomes minimal, meaning Nouners can feel a lesser sense of urgency to spend BV down (some urgency should remain in order to meet natural demand).

The main downside is arbers are likely to continue dominating the auctions a while longer, until other factors like spending on proposals push BV down to where natural demand is able to compete with arbers.

Another concern is DAO potentially spending significant amounts of time in forking periods, unable to execute proposals. We may need to consider introducing a short cool down period between forks to ensure the DAO has time to execute proposals.

Example model tinkering

Let’s look at four configurations with different Fork Threshold and daily spending values.

Notice the big difference in time to fork between Fork Threshold at 10% vs 30%; this results in the big eBV difference we see between spending 30 ETH vs 90 ETH daily.

Let’s run a similar comparison, varying Fork Threshold and daily nouns distribution values.

Nouns distribution makes little difference to eBV at 10% Fork Threshold, while at 30% threshold it’s a bit more interesting. Still we maintain this lever isn’t cost-effective as a means of lowering eBV; it’s still an interesting activity for other reasons like growing Nouns’ network value.

A visual model

At some point we dreamed this post would be an exciting interactive page like the famous NYTimes infographic articles. Instead we have the simplified sheet above, as well as a more visual and interactive model below. We might post improved models if this version isn’t useful enough.

In this visual model we chose Fork Threshold for the X axis, as it seems like the most interesting parameter for Nouners. The Y axis is eBV, the variable Nouners probably want to push down to let natural demand win Nouns auctions.

The model lets you change the values of all other parameters and see their direct impact on the relationship between Fork Threshold and eBV. For example, try increasing spend rate and see how eBV declines much faster, or increase the number of Nouns already intending to fork, and see how eBV increases.

Conclusion

Right now 90%+ of auctions are won by arbitrageurs. As long as the ability to fork is a feature of the DAO, we would not expect arbitrage activity to ever reach zero.

So what can Nouners do?

• Iterate on high fork threshold values until eBV meets natural demand; run frequent reassessments until successful or a new approach is discovered.

• Lower fork threshold to zero (w/ upgrade) and let arbers compete on smaller margins, taking longer to spend BV down and accepting the reality of almost zero new long-term players joining via auctions.

• Change nothing. The current spend rate might be sufficient; a daily/monthly spending Dune dashboard is a critical missing tool to continue the conversation.

• Disable the fork, but we won’t elaborate on this option.

We believe that a good near-term milestone is seeing 50%+ of auctions won by long-term Nouners. The best way we have thought of so far is the high fork threshold coupled with fast-enough spending and ongoing analysis.

Please let us know if this breakdown was helpful, if any additional questions arise, and how might we make it better.

Thanks!
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