Introduction
One of the fields changed by the blockchain technology is investing. Decentralization disrupts the traditional model of fundraising in which startups depend on external capital, typically from venture capital or private equity firms.
An investment DAO is a (kind of) decentralized venture capital firm. It collects funds from DAO members and invests those funds. Like other DAOs, its members, those who hold governance tokens, decide where to invest those funds. It can be early-stage crypto projects or real estate, for example. Some DAOs are created with a single purpose. For example, Constitution DAO was formed in 2021 to purchase an original copy of the United States Constitution.
We can show three main advantages of investment DAOs over the traditional VC model:
- Members provide funds to DAOs in the form of governance tokens which are usually liquid investments. They can be traded on exchanges at any time. Conversely, legacy venture capital tends to be illiquid. When members invest in these firms, they typically lock their capital for years. That’s because for a company to go public or to be bought from another private firm tends to take several years.
- Decentralized decision-making. DAOs, by definition, are decentralized entities. They are governed by a bottom-up managerial approach. There is no single central body in a DAO which means that decisions are made by all voting holders of governance tokens. This is in stark contrast to the traditional venture capital model in which investment decisions are made by a few individuals.
- Inclusive access. Investment DAOs eliminate the elitism of hedge funds & VC firms. Anyone wishing to join a DAO can do so by purchasing the native token of the DAO. This not only gives users the right to be invested in the projects they are interested in but also allows them to have a say in the decisions made by the DAO. Furthermore, investment DAOs make diversification more affordable for retail investors. You can join any DAO you desire, such as one specialized in early stage DeFi protocols, or one funding decentralized science projects, or one whose mission is to purchase virtual land in Metaverse protocols.
How do they work?
Investment DAOs are usually created around a general goal, such as investing in a specific industry or sector. This could be either as broad as investing in DeFi protocols, or as narrow as early stage longevity research funding. Some DAOs were created with a single purpose. For example, BuyTheBroncos and DAO FC were set up with the mission of buying Denver Broncos, and an English football club respectively.
An investment proposal can be made by anyone holding a DAO’s governance token. However, some DAOs allow only several users who have the number of tokens above the specified threshold. This serves the purpose of preventing spam and encouraging “skin in the game” – only members with high enough stake have a say in the investment proposals.
Members stake their tokens to vote once a proposal has been made. The problem with staking is that on some blockchains (yes, Ethereum, I am talking about you) it can incur high on-chain fees. That’s why some DAOs apply the snapshot mechanism which allows the users to vote without paying gas fees. Snapshot fixes the number of governance tokens in a wallet at a specific time point, typically before voting. Another benefit of the snapshot mechanism is that it prevents the members from purchasing more governance tokens after they have seen the investment proposal.
Types of investment DAOs
Investment DAOs can be divided into three categories based on how they function: DAO + VC fund model, syndicate DAO model, and services DAO model.
is the combination of an investment DAO and a venture capital fund. In this model, the DAO creates an external sister VC fund to enhance its investment opportunities. By setting up a sister fund the DAO aims to reach more investors and raise additional capital. With the support of DAO members, the VC fund implements investment activities, and like a legacy VC fund charges a management fee while the DAO would get the lion share of profits. This model of DAOs accelerates the decision-making process since investing decisions are delegated to general partners who are capable to examine all proposals. That general partners are rewarded based on the VC fund performance means that incentives of the DAO and the fund are aligned.
The main drawback of DAO VC model is that it is capital-intensive to launch an external fund. Also, general partners can require more compensation than other DAO members because they are involved in the investment decisions. This would challenge the fair distribution of rewards which is the hallmark of decentralized autonomous organizations.
Orange Fund set up by the Orange DAO is an example of this business model.
The Syndicate DAO model is like the VC model in that the parent DAO sets up an external vehicle. But in this case the DAO creates not a VC fund but several sub-DAOs., typically a sub-DAO for every investment. The main DAO members can be a member of as many sub-DAOs as they wish; they can also invest their capital in whichever sub-DAO they select. It’s the parent DAO’s responsibility to prepare an investment memo on each potential investment opportunity. All profit is collected by sub-DAOs while the main DAO charges them a fee for doing due diligence for every investment.
Services DAO model, a DAO doesn’t itself invest in ventures but provides services or infrastructure to investors. DAO members with the technical skills or investment experience can offer their expertise to interested investors in return for equity or fixed fees. An example for this model might be New Order, a venture DAO which provides resources for DeFi builders.
Though investment DAOs will democratize investing process by allowing layman enjoy investment opportunities previously accessible only to wealthy individuals, there are still several risks one should consider. The first risk associated with them, like other investment entities, is poor performance risk. The fact that many investors holding governance tokens of the DAO participate in the investment process doesn’t guarantee that the DAO will perform well. Given the high-risk profile of most ventures, it is not unreasonable to expect some or maybe many DAOs will underperform from time to time. Note that when you invest in a DAO, you typically do it by purchasing its governance tokens whose price can fluctuate significantly.
As with everything associated with smart contracts, there’s a risk of smart contract failure. Malicious actors can steal the DAO funds. One of the most infamous hacks in the crypto industry happened in 2016, when The DAO, an investor-directed venture capital firm, lost $60 million of Ether due to a hack.
Then, there are a regulatory risk. Accepting funds from members who are not accredited investors can be a problem for DAOs. It is still unclear what SEC’s final verdict will be in relation to DAOs. As of time of writing, $LDO, the governance token of Lido DAO, fell roughly 20% after SEC issued a Wells notice to the provider of liquid staking solutions to Ethereum. A Wells notice is a letter sent to the target of SEC investigation – which can be people of firms – stating that a legal action is being planned against them.
How to find DAOs
If you want to join an investment DAO but don’t know where to start, you can go Messari a “Governor” a DAOs page. Here you can find a comprehensive if not the complete list of DAOs. By ticking a desired tag, you’ll get the list of DAOs around that topic. If you are interested in DAOs investing in NFTs, selecting NFTs tag will give you the list with more than twenty DAOs.
I believe that investment DAOs will disrupt the traditional VC business by democratizing the field of investing and giving power to small investors. It will benefit all participant of the DeFi ecosystem: protocols will be able to get funding they seek, and members will have a say in the DAOs they are invested in. Indeed, it is too early to claim that they will entirely the old investment setting. There are still risks and problems to be resolved.
