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How the first investment DAOs challenged Venture Capital

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How the first investment DAOs challenged Venture Capital 

July 2022

Posted by

Jan Baeriswyl

Token design

In order to understand what the future of Web3 native instruments could hold, we need to consider investment DAOs’ landscape, along with who the most notable players are, what tools and frameworks they use. Further we must consider what some of the biggest challenges and trade-offs they face today.

The reasons why we’re particularly interested in investment DAOs are two-fold. Firstly, investment DAOs are not complicated from a technical perspective, instead difficulties tend to be of a legal nature. Secondly, the investment use case is already or will become relevant for a substantial proportion of all DAOs. For instance, many protocol DAOs with significant treasuries and other DAOs with significant liquid assets have already set up investment vehicles and/or grant programs.

Posted by Jan Baeriswyl - July 2022

July 2022

Posted by

Jan Baeriswyl

Token design

In a previous article, we outlined why DAOs could be a paradigm shift for the architecture of human organisation. We also gave an overview of the three types of DAOs most active today: protocol DAOs, investment DAOs, and worker/social DAOs. In this article, we will dive deeper into the investment DAO use case.

The state of investment DAOs

How the first investment DAOs challenged Venture Capital  Outlier Ventures

A key motivator for investment DAOs is the ability to make better investment decisions as a collective and/or gain access to more dealflow.  

In traditional finance, it is often difficult to syndicate investments across several countries due to many matters around: 

  • setting up complex legal structures, 
  • coordinating banks,
  • sending notarized papers around the world, and
  • complexities around unconventional target assets, e.g. blockchain-based tokens.

Arguably, the biggest advantage of investment DAOs is the removal of administrative friction in a global world. Participants can join and provide funding through a few clicks in a Web3 wallet. Collecting capital into a DAO is often much easier than figuring out what to do with the funds in question, evident through instances such as:

  • Original DAO, whose buggy code split the Ethereum community, to the more recent antics around, and 
  • Constitution DAO, which raised almost $50M in an attempt to buy an official copy of the US constitution.

Naturally, there has been an explosion of interest in DAO tooling and frameworks (more in our previous DAO article), with secure and off-the-shelf components increasing the trustworthiness of smart contracts holding pooled funds. The best tools should make the coordination of investment decisions and deployment comparatively simple and efficient.

In theory, a trusted smart contract like a Gnosis Safe multi-sig replaces the need for legal contracts and banks, amongst other red tape. However, investment DAOs are still subject to local laws and regulations despite not natively requiring legal structures. DAOs will often require a legal entity in order to comply with laws and regulations and  interact with the off-chain world to do things like hire employees and pay taxes. 

There are many risks DAOs without legal structures face:

  • If a DAO is profit focused, courts could consider it to be an “unincorporated general partnership”. As there is an implication is that two or more people appear to be engaged in a business relationship – even if those people have never met.
  • Potential liability for each member in an unwrapped DAO is unlimited. As such, investment DAOs are often launched as “wrapped DAOs”, i.e. launched under the umbrella of a legal entity.
  • Further implications of complying with existing legal frameworks include KYC/AML requirements, and that investment DAOs are often limited to a small number of accredited investors (e.g. up to 99 in the US). 

Investment DAO pioneers and their innovations

How the first investment DAOs challenged Venture Capital  Outlier Ventures

Let’s consider some of the most notable investment DAOs to date and some of the tools and mechanisms they are using.

MetaCartel Ventures

MetaCartel Ventures was the first venture/investment DAO founded in 2018. It now boasts an impressive array of Web3 pioneers, founders, and investors as its members. MetaCartel very carefully selects their members as they are very focused on generating value-add to their investments from their organisation’s base. MetaCartel has provided their set-up as open source tooling, which has enabled many others to follow suit. Notable investments include Zapper and Rarible. 

Moloch DAO

Moloch DAO focused initially on funding public goods (e.g. clients, wallets) on Ethereum. MolochDAO invented the “RageQuit” mechanism, which has subsequently been used by many other investment DAOs such as Flamingo DAO. The mechanism introduces a time-delay between investment decisions and deployment of funds, giving every member the option to exit with their proportional share of assets in the treasury before an investment is made. RageQuit provides a completely new assurance to members of an investment collective, previously not possible in traditional finance. The right to exit an investment, where a shared decision does not reflect the individual’s values or goals.   

LAO 

LAO is another notable entrant with the role it plays bridging between Web3 and the legal system of the US. Founded by OpenLaw, it was the first DAO to focus on complying with US law and was instrumental in passing the Wyoming DAO bill. Not only has the LAO been used as a framework for many subsequent DAOs, but Wyoming has become the first jurisdiction to legally recognise DAOs as entities. LAO shares give proportional voting rights and can be acquired by accredited investors within a cap per member of 7.2%, whereas the price per share increases with each investment made. Notable investments include Zerion, Reflexer Labs, and Async Art. 

Syndicate Protocol 

There have also been multiple attempts to productise these core mechanisms, and build infrastructure specifically for investment DAOs (“AngelList powered by DAOs”). Most notably, Syndicate Protocol is building a framework for DAO investment syndicates. The framework enables investment DAOs where investors collaborate on a deal-by-deal basis. 

The rise of NFT collector/investor DAOs 

How the first investment DAOs challenged Venture Capital  Outlier Ventures

The rising popularity of NFTs in 2021 gave way to a new kind of Investment DAO, one with a purpose of purchasing NFTs as a collective.

Some of the most notable successes in this domain include Flamingo DAO, an NFT-focused investment DAO spun out of the LAO. Flamingo DAO has an impressive track record including investments like OpenSea, Fractional, Upshot, YieldGuild, and many individual NFTs. The NFT fund, OneOf, is connecting the investment DAO tool kit with processes that allow the investor community to also share the utility of their NFTs. Mesha is betting on the investment DAO use case being more attractive for NFTs for those reasons. Their goal is to empower groups of friends to easily set up a DAO to collectively buy and manage NFTs.

There are a number of differences between investment DAOs focused on fungible tokens and DAOs investing in NFTs:

  • The motivation of reducing both risk and capital requirements that uniquely exist for (“blue-chip”) NFTs, which often come with price tags of tens or hundreds of thousands of dollars. 
  • By pooling funds together in a trusted group, the shared portfolio can hold a larger and more diversified number of expensive NFTs while each individual commitment is much smaller. 
  • There is also the dimension of NFT utility that is mostly absent from fungible tokens (except if we count the governance use case): they have an artistic or aesthetic value (as opposed to “only” financial value) and sometimes other utility attached to them (e.g. claimable physical versions, access to groups or events). 

The current investment DAO tool kit

The early pioneers of investment DAOs have validated foundational mechanisms that the next wave can leverage. Let’s now turn our attention to some of the crucial tools investment DAOs have come up with.   

Legal setup

A crucial set of tools are frameworks used to answer legal compliance issues and protect members from liability. Notably, the legal setup of MolochDAO and especially the LAO has been used as a framework for subsequent investment DAOs. The ZeroLaw framework (formalized by OpenLaw)  includes a “legal wrapper” in the form of a Delaware LLC (anchored legally in the US). This LLC is bound to the decisions of the DAO via the articles of incorporation, ensuring that decisions can be made on-chain but represented legally by the LLC. Within this framework, only a maximum of up to 99 accredited investors are allowed. In addition, there are more general legal wrappers available for DAOs, with Delaware and Wyoming LLCs being the most well-known. These entities provide for separate legal personhood, limited liability of members and a relatively flexible governance framework. 

Tools for pooling, deploying, and redeeming capital

Many investment DAOs aim for a simple but robust feature set, usually combining the tools described here. We can think of those tools being deployed along three processes of an investment DAO: the pooling, deployment, and redemption of capital. 

  1. The tool used for pooling capital together (generally Ether or a USD-backed stablecoin is at the core of any investment DAO. Usually, this is done through a multi-sig, often a Gnosis Safe, which is then connected to the governance of the DAO. If the legal framework described above is used, there would be a limitation of up to 99 addresses pooling funds (e.g. managed via a whitelist). 
  2. The second tool concerns the decisions on where to invest. Most often, this is done through governance tokens that are allotted proportional to the capital contribution of each member. From there, token holders can propose potential investments and vote on the outcome. Generally, voting power is proportional to the amount of tokens held (“Coinvoting”), and decisions are made based on a simple majority. 
  3. Finally, there is a need for a mechanism or tool for the redemption of capital. The simplest way is to allow token holders to redeem their proportional amount of assets from the treasury, at which point the governance tokens are burned. Practically, this is often only possible in a certain period, since there needs to be a clear Net Asset Value (NAV) on all assets in the treasury (which may be challenging with rare NFTs, for example). As previously discussed, some investment DAOs make use of the “RageQuit” functionality to allow investors to exit with a proportional share of the assets in the treasury before an investment decision they don’t agree with. 

When it comes to the allocation of capital in today’s investment DAOs, the tools currently in use still seem very coarse-grained and there is a lot of potential for innovators to improve the status quo. Likely because most investment DAOs are still limited to the manageable size of 99 members, there has not been a lot of pressure to innovate on these tools.

Outlook: In search of collective intelligence

Taking stock of the current state of things, we can conclude that the progress made by investment DAO pioneers is substantial. The foundational infrastructure for collecting and deploying capital in a Web3 native way has successfully deployed billions of dollars (e.g. BitDAO alone is reporting having deployed over $500 million). 

However, the road for investment DAOs to fulfil their full potential is long. First of all, many of the tools used (e.g. RageQuit) are not entirely compatible with existing legal frameworks. We will explore these legal challenges in a forthcoming post. Existing decision-making mechanisms do not seem suitable for investment purposes as they incentivize convergence on the common denominator (and miss asymmetric opportunities). Existing mechanisms in Web3 may provide important primitives for that –  for example, quadratic voting allows us to measure conviction and intensity, not just direction. We would also need mechanisms that can scale beyond 100 members without decreasing the quality of outcomes. 

In the long run, the innovation engine that is Web3 will undoubtedly produce relevant solutions to most of these roadblocks. Once the mechanism design challenges click into place, investment DAOs would be able to tap into collective intelligence at scale. Even if this potential of collective intelligence only partially materialises, the extent and speed of transformation to the venture capital industry would be surprising.