May 5, 2022
Unbundling venture capital via DAOs
Service DAOs, Incubation DAOs, Investment DAOs
In the past, there have been many attempts at disrupting venture capital:
- The proliferation of angel investors (AngelList, 2010)
- Enactment and regulation of equity crowdfunding (Jobs Act, 2012)
- Cryptonative crowdfunding via token sales (2013)
While many of these efforts were successful at generating a greater supply of passive capital for founders, they have largely under-addressed the founders’ operational needs that enable projects to go to market faster and succeed throughout their entire lifecycle: talent, design, product, marketing, research, economics, engineering, community building, business development, regulatory guidance, and domain expertise.
Capital itself is abundant, valuable services are not.
Despite the abundance of capital flowing into the tech and crypto ecosystem, high-value services have remained scarce.
We believe this due to the following factors:
- Founders have no publicly verifiable data on the quality of services investors can provide, nor do many founders conduct due diligence on their investors. As a result, many founders are unable to optimize their investors based on the services they offer.
- The lack of quality data on investors has led to a sales-first-oriented venture environment where investors are overpromising and under-delivering. Unlike service providers that are held to contractual obligations or even founders who are held to vesting schedules, investors are not held to the same standard despite only getting access to highly competitive funding rounds with their proposed value proposition.
As a result, the funding landscape in both crypto and the broader venture capital landscape is composed of predominantly passive capital.
While 1kx and a small number of other funds are working every day to be an exception to the norm, we have been unable to push for a fundamental change in the broader investor landscape. Fortunately, we believe a shift is on the horizon — and we believe they start with Service DAOs.
But before we speak on Service DAOs, let’s first take a look at the lineage of the DAOs that have participated in the venture funding landscape.
The rise of investment DAOs (1st Generation)
The original hypothesis of the first investment DAOs (MetaCartel Ventures and the LAO) was that the aggregate network and expertise of 60–100 DAO members (builders & investors) was able to better assess and provide value add to projects than the typical venture fund that is run by 2–3 partners.
Despite this initial thesis, many of the first-generation investment DAOs have mostly been unable to add value past providing access to the personal network of the DAO members themselves and/or the personal access to the internal investment DAO deal lead. This has been the result of many DAOs being overly focused on making investment decisions as opposed to other more helpful value add efforts. We expect investment DAOs to expand their operational focuses over time as they face increased competition as more investment DAOs enter the market.
But even so, investment DAOs today have been able to consistently secure funding round allocations purely based on their breadth of network and the reputational signal they provide to other investors.
The rise of incubation DAOs (2nd Generation)
Incubation DAOs are communities that collectively help launch and spin out new products and projects — while taking a small cut of project ownership in exchange for the initial incubation provided.
While these incubation DAOs often provide ideation programs or design sprints in which pre-launch projects are able to plan out their product strategy going forward — behind the scenes, many of the incubatees often apply to get involved for the community signal these DAOs provide as opposed to the actual operational value add.
With communities often preceding social and technological revolutions, incubation DAOs play a key role in exploring the idea maze of nascent markets becoming the ‘homebrew computer clubs’ of various ecosystems.
Next: Rise of Service DAOs — disrupting the unit economics of venture capital
While the DAOs mentioned so far have mostly only tangentially addressed the ecosystem need for high-value services, we believe that in order to evolve the venture landscape for founders, we need to assess venture capital from a services point of view as opposed to a purely financial function:
- Projects receive funding and value-added services from investors
- Projects pay in project ownership dilution
(selling % of either their token supply or equity)
Rather than starting with a focus on investing, we foresee more DAOs starting first as ‘service DAOs’ — organizations that aggregate high-quality practitioners under one community to provide services to third parties (engineering, audit, design, legal, research, treasury management, etc.) in exchange for project ownership. As these service DAOs build up demand for their services, they will be able to accumulate ownership in the protocols they work with, further aligning incentives between them.
While some funds have traditionally offered a variety of services under the same umbrella, we will likely see much more granular pricing of services being offered via service DAOs, and likely at far better unit economics than funds that offer a bundled set of services under their ‘platform’.
Case 1: Let’s say there was a team that most needed help with regulatory guidance, which of the following options would they potentially go with?
- A platform that offers capital, brand awareness, talent sourcing, and regulatory guidance that looked to acquire 10% of the project’s token supply;
- A regulatory guidance service DAO that provided an equally as high quality of service in exchange for 1% of the token network
If a team needed the other available services offered by the fund alongside regulatory guidance, then it could make sense for the team to work with the fund. But otherwise, a service DAO model enables projects to directly address their needs without taking on the significant dilution that would typically come with traditional funds.
From our perspective, we see this increased bottom-up competition for the services radically improving the unit economics of venture capital in favor of founders and communities.
Why DAOs?
35% of US employment is to establish trust (legal contracts, law enforcement, auditors), this is reflected in the administrative processes needed to set up and operate an equity company — it takes weeks as opposed to potentially minutes via a smart contract enabled organizational stack.
This is a fundamental advantage cryptonative organizations have over legacy equity organizations today. However, despite this unique advantage, there are major blockers for DAOs to succeed as a model at scale.
These include:
- Being able to retain the best contributors
(The best contributors of DAOs will likely face significant economic incentives to level and join individual projects in a greater capacity.
How can DAOs offer equal financial upside for participation?) - Solving the free-rider problem
(DAOs need to figure out how to balance community ownership with individual participants to ensure that the most active contributors are rewarded for their work and have a long-term stake in the DAO while minimizing the effect of passive members) - Difficulty activating latent community talent
(Even for DAOs with access to talent, getting the talent within the network to contribute is difficult. How can we create scalable coordination processes to produce high-quality output efficiently?)
While DAOs today still haven’t yet nailed 100% long-term operational excellence, we believe the lowered cost of cryptonative entity formation and coordination will enable a far greater proliferation of not only DAOs but experimentation around new novel incentives and ownership structures. Through permissionless innovation and access to an open-source pool of contributor talent, we believe DAOs will eventually surface far more flexible, programmatic and expressive organizational structures that are able to better aggregate, retain and attribute value to the best contributors. In turn, we believe these internet-native organizations will establish far higher quality output at greater efficiency.
A vision of a DAO native venture landscape
We are standing on the brink of a revolution in venture capital and want to accelerate the vision of a DAO native venture landscape.
Over the next 18–24 months we continue to:
- Invest in service DAOs, incubation DAOs, and investment DAOs
- Help various DAOs partner with one another to form joint ventures
- Create a network of service DAOs to cross-pollinate operational insights
- Help identify how service DAOs can work with projects of varying maturity from early-stage teams to large scale token managed treasuries
So far we’ve already seeded a vibrant ecosystem of DAOs under our portfolio:
to directly address their needs without taking on the significant dilution that would typically come with traditional funds.
‘Helping early stage teams bootstrap token networks’
- Designing token models (distribution strategies, incentive programs, governance structures, value accrual loops)
- Ecosystem building (launching or guiding go-to-market supply and demand DAOs, community coordination, contributor coordination, governance participation)
- Bootstrapping infrastructure ecosystems (running validators, building open source infrastructure for portfolio projects, running liquidity provisioning and arbitrage bots)
The future is bright and we are ever more excited about it. If you are building a service, investment, or incubation DAO, please reach out to us!
Thank you to Jason Choi, Linda Xie, Victor Rortvedt, Danny C, Jake Brukhman for all the feedback on this thesis + Nadja for editing.
Closing caveat:
The above-outlined commoditization of capital resulted from an unprecedented bull market of historic proportions. We remember times when crypto capital was scarce and investors only had to provide money.
We hope that enough availability of capital persists so that the hard job of being a founder keeps becoming easier by forcing that abundance of competitive capital to differentiate itself through real value-added services.
There is a risk that a radical reduction in liquidity in the future could once again make capital the primary driver of a decision in working with funds. While we don’t hope for this future, we have to acknowledge that it’s a risk.
