Thoughts on Investment DAOs
DAOs, or Decentralized Autonomous Organizations, can be thought of organizations that are managed by a community (“decentralized”). This could be a protocol DAO managed by its token holders (see DeFi protocol governance), or a venture DAO where community members collaborate to manage a fund. In its purest form, DAOs are on-chain organizations with decision making dictated by votes from token holders (“autonomous”) without any central management. An Internet native organization managed by whoever might hold its tokens around the globe. In practice, most DAOs are not autonomous in this manner and have some sort of centralized management function whether officially or unofficially, and a legal wrapper.
On-chain DAOs command $9 billion of capital, according to data from DeepDAO. If we include off-chain DAOs this figure would be a bit higher. Based on this data, 129 on-chain DAOs individually hold at least $1 million of assets.
The DAO space represents several different categories, such as protocol DAOs, investment DAOs, service DAOs, social DAOs, and others serving a broad range of communities. Hutt Capital funds have exposure to a number of individual DAOs, as well as DAO tools and infrastructure startups. We are particularly interested in investment and venture DAOs as new sources of capital for startups. Below you can see an example of some investment DAOs, courtesy of crypto fund 1kx from a piece we enjoyed reading back in May.
Historical funding for pre-seed and seed stage startups has come primarily from angel investors and venture capital firms. These venture firms are small partnerships with small teams, at least for those focused at the earliest stages. Traditional funds continue to provide the vast majority of funding to startups, but there is an emerging world of investment DAOs that have captured a small market share for pre-seed and seed stage venture funding, specifically in the blockchain/crypto space.
As a fund of funds, our job is to identify and access the “best” blockchain VC funds, with the idea that these funds will provide our Limited Partners with exposure to the most promising startups. In that sense, individual funds are just an avenue to consistently and sustainably access the top startups at the earliest stages. Accordingly, if venture DAOs are funding some of the top startups and take even a very small market share from traditional funds, this is something that we need to track closely. The venture capital market may move slowly but does change over time, and investment DAOs are part of this evolution similar to past trends with micro funds, more specialized funds, rolling funds, and so on.
To date, Hutt Capital has made one venture DAO investment, Seed Club Ventures, and we are in process of closing another. We are also an investor in Seed Club DAO, which has elements of an investment DAO.
Investment DAOs can be thought of as communities of individuals members who pool capital in order to make investments. DAO members are collectively responsible for setting strategy, sourcing deals, collaborating on diligence, voting on investment and exit decisions, and portfolio support.
DAOs can offer a compelling source of capital if they bring together a diversified group of members who have unique expertise, relationships, and hands-on operational experience in the DAO’s focus area(s), and who startups may otherwise not have access to. The idea of bringing on not just one fund but an entire community onto the cap table at the earliest stages is an attractive option for many founders. We have seen this firsthand with Seed Club Ventures, which is a highly sought-after partner for startups in and around the DAO ecosystem, at times receiving special access and terms.
But not all investments DAOs are the same. Key variables include:
· How centralized is the DAO’s management
· How are members incentivized to participate
· How do members join the DAO
Centralized vs. Decentralized Management: Investment DAOs may be “decentralized” in terms of their decision making and other aspects of their operations, but this looks very different across investment DAOs. Some have full-time team members who are responsible for managing the DAO’s operations and processes, preparing documents for members to utilize in making decisions, and so on, effectively “running” the fund. Others do not have full-time team members, and may have an initial core team to manage things at the earliest stages, but will be far more dependent on members to ensure smooth operations and processes.
Hutt Capital’s Opinion: As a fund of funds, we are today more comfortable with DAOs that have centralized management, though it is crucial to couple that with a strong and active community. Some of the more decentrally managed DAOs have generated very strong returns to members but hold a higher level of operational and execution risk. On the other hand, centrally managed DAOs have more traditional risk around dependence on key team members.
Member Incentivization: One ongoing learning for investment DAOs in their early days is how to incentivize members to participate, thus avoiding the free rider problem. Some of the early DAOs ran into this issue, where all members of a DAO earn the same return so there was not sufficient incentive and motivation for many DAO members to participate, at least not in a material way. They could rely on others to do all the work for the DAO instead.
Many DAOs do not have financial incentives for members to participate outside of generally wanting to make the DAO successful and thus earning a higher return on capital. Some have built incentives where members earn carried interest on deals that they source and lead for the group. Others are experimenting with new ideas, for example setting member ownership of a DAO to a combination of financial participation (i.e. capital investment) and labor/time contribution to the success of the DAO. How to best measure and reward participation remains in experimentation, though some use tools such as Coordinape can help manage this process.
DAOs will also use social pressure and reputation as a motivator. In a simple case, this could be rewarding with public attention those who are providing value to the DAO. Others take this further and use in-house analytics to track member participation/contribution and will display leaderboards or scores for each member in hopes that members will want to increase their score or position within the group.
Hutt Capital’s Opinion: The free rider problem is real, and is best solved by either a highly curated membership process, or a combination of social and financial incentives to participate. However, the financial side of this is still in the experimental phase and it will take time to test ideas and see what works.
Membership Process: The spectrum of DAO membership is from a) highly curated with some sort of membership review process that prospective members need to pass, to keep membership more close-nit, selective and strategic, to b) anyone can join (or often anyone who buys a small amount of the DAO’s tokens can join). Examples of the former include Seed Club Ventures and Flamingo DAO, which have strict membership processes. DAOs with more open membership include Global Coin Research (GCR), where anyone who holds 100 tokens can participate, and Seed Club DAO (not an investment DAO but anyone who holds 10 CLUB tokens can participate in the community, including elements of the accelerator application screening process).
Hutt Capital’s Opinion: We are big fans of DAOs that allow broad membership through purchase of a nominal value of tokens. However, Hutt Capital has a preference to evaluate DAOs with highly curated membership processes to ensure members are well-aligned and be valuable to the DAO’s strategy and mission. It is also helpful for the group to be small enough that members can get to know each other as they collaborate over time.
As a final thought regarding investment DAOs, being a member of a DAO is different than being a Limited Partner in a traditional fund. Structure aside, you are expected to participate, review and vote on deals, and be active in the community in a way that is not expected of LPs in traditional funds (even if managers seek out and welcome help in various ways from their LPs). It would be difficult for a fund of funds to be a member in several venture capital DAOs while giving each the time attention that we would believe appropriate (unless you want a reputation as an absent member which we do not). As Hutt Capital evaluates opportunities to invest in venture DAOs, we must consider both the usual investment and operational evaluation processes, but also the incremental time and effort that would be required from the Hutt Capital team post-investment.
About Hutt Capital: Hutt Capital is a blockchain venture capital fund of funds platform. We partner with leading blockchain VC firms to provide diversified exposure to the most promising blockchain & crypto startups globally through fund, secondary, and direct investment strategies. You can find more at www.huttcapital.com
