What Jack Doesn’t Know

Jack Dorsey, the former head of Twitter and current CEO of Block, caused an uproar in the Web3 community with two colorful tweets at the end of 2021:

And

There’s one particular reason, amongst others, that Jack’s prognostication of who owns Web3 may be wrong: Decentralized Autonomous Organizations (DAOs). The underlying premise on whether Jack is right or not has nothing to do with my opining on the VC model but the belief in how DAOs can emerge as a large player in the future of funding the Web3 ecosystem. They can help fund and build the Web3 ecosystem, and then distribute the benefits to the underlying community and participants.

What are DAOs

There are plenty of good primers out there on DAOs (here, here, here) so I won’t spend too much time on the basics here. The way in which I like to think about DAOs is that they are decentralized structures that enable bottom up economic organization; they are a mechanism to coordinate both financial resources and human capital towards a common goal in a decentralized (community owned) and autonomous (rules are encoded and automatically enforced on the ethereum blockchain) manner.

As i alluded to in my last piece, there are many different types of DAOs that we have seen thus far:

• Operating systems — DAOs that offer tools to help people to start DAOs (DAOstack)
• Grant DAO — take donated money and decide how money is allocated based on governance (e.g., Aave Grants)
• Protocol DAOs — sometimes synonymous with automated market makers, DAOs that give protocol users a collective say in future direction (e.g., which layer 2 networks the protocol should be displayed on, marketing initiatives, how treasury should be managed) (e.g., Uniswap, Lido)
• Investment DAOs — as name suggests, a DAO that raises money to invest (e.g., including a golf course or even a NBA team)
• Service DAOs — crypto-native talent agencies of sort
• Social DAOs — bring together people of similar interests
• Collector DAOs — focused on investing in collecting NFTs

DAOs have been growing quickly. DAO treasuries have now amassed a war chest of $10.7B in AUM with an increase in $1.2B alone in the last month. There are now 1.7M governance token holders and 590K active voters and proposal makers.

How they operate

- Ben Thompson

DAOs are taking the bundling and unbundling driven by the internet one step further, especially in the arena of work. Instead of a hierarchical top-down, small group of executives dictating organizational-level decisions, DAOs operate from the bottoms up. The individual members are able to influence what is focused on and how resources are applied to what is worked on through both soft consensus (influence through discussion) and hard consensus (ballot to vote). In this model, power moves to the person as opposed to the corporation because people have the freedom to choose how, and with whom, to work (evidence of this is that of those that are engaged in DAOs, DAO participants work with 1–2 DAOs, potentially in addition to full-time jobs). One interesting application of this new model of work is within Investment DAOs.

Investment DAO

Investment DAOs are internet communities with a shared bank account that aim to either generate financial return by investing in liquid tokens (i.e., on-chain tokens), start-up equity, or collectibles. Investment DAOs vary in their investment focuses — some are mission-driven (e.g., investing in minority or women led companies) while others are focused on specific types of investments (e.g., NFTs).

Historically, venture capital, with their deep pockets, have been the predominant financier for fast growing start ups aiming to raise capital. This is partially because of the structure and rules of the capital markets — e.g., usury laws limit the interest banks can charge on loans and the risks in start-ups usually justify a higher rate than allowed by law. Banks would finance new business to the extent that there are hard assets to protect the downside of a company going belly-up, but in today’s information-based economy, most startups have relatively few hard assets to use as collateral.

A simplified funnel for deal sourcing and funding in the VC model then looks like a bit like this:

Yet, there have been critiques around venture capital. Specifically that:

1. Venture capital is extremely selective, funding on average 3 or 4 companies for every 1,000 proposals they receive. VCs generally rely on their network of partners and projects they fund to secure deal flow. While these two statements in of itself are not problems, one result of the current model is that certain groups and minorities seem to receive a scant amount of that funding — 3% of venture funded companies are owned by African Americans and 2.3% of venture funding are owned by females
2. While the pandemic has certainly shifted the mindset that you needed to be in the Bay area, Silicon Valley, or Silicon Alley in order to get funded, the ten largest cities in the United States for venture capital investment account for ~80% of all US venture capital investments. And unless you are located in a “tech hub” internationally, it is even harder getting on a VC’s radar (and thereby funding) because VCs tend to invest disproportionately in regions where they have had success in the past. Therefore, if you happen to be born in an area outside of the U.S. that is not well known for venture capital investments, the cards are stacked against you

However, investment DAOs, or decentralized autonomous organizations comprised of crypto enthused investing their own capital into early stage startups, aim to broaden both the front end and the tail end of this model. What the new model could look like:

The front end velocity and number of opportunities seen is increased because on an absolute basis, networks of small groups of people (general partners in a venture capital firm) are limited. Especially in Web3 where changes are happening so quickly in various verticals within Web3, it is hard for a few general partners in a traditional VC, who meet on maybe on weekly basis, to keep tabs on everything that is going on. With a larger sourcing base in DAOs, more companies and opportunities will be evaluated including those started by individuals that have historically been underrepresented in the VC space.

On the tail end, DAOs broaden the participation of potential investors. Not anyone can become a venture capitalist (or it is at least difficult) but anyone can hypothetically buy a governance token in exchange for access to private spaces in an investment DAO where deals are sourced, discussed, and funded. Because of the expansion both on the front end and the back end, Investment DAOs could represent the democratization of investing in the future.

Investment DAOs vs. VCs

Besides for the two benefits mentioned above, there are also structural advantages of DAOs for investors:

• The traditional fee structure for a VC fund is 2/20 (2 percent fee of assets under management and 20% of profit above a certain predefined benchmark, usually original capital returned). In Investment DAOs, there is no carry fee to be paid by the DAO members given there is no general partner or managing members. As a reminder, Investment DAOs use code, instead of officers and employees, to manage shareholders’ investments and the other work like sourcing previously done by employees are now done by the DAO members.
• Corporations (and VCs) require articles of incorporation, legal expertise and approval whereas DAOs can be easily spun up (as easy as a few clicks for the cost of gas)
• In traditional VC, as an LP, your capital is locked up for the entire fund period (5–10 years). Investment DAOs usually give its members the ability to “rage quit” and immediately retrieve back their fair share of unallocated funds based on economic contribution. In short, Investment DAOs could provide liquidity that are not afforded to LPs in a venture capital fund.

For entrepreneurs, the members of the DAO are presumably a crypto-native community and can serve as real-time focus groups for product feedback and marketing machines for their product in the Web3 ecosystem. And because of the structure and speed in which Investment DAOs can be created and the velocity in which potential opportunities can be evaluated by the members, the amount of time an entrepreneur needs to spend fundraising (i.e., going on roadshow for investors) can be greatly decreased and he or she can be more focused on building rather than fundraising.

However, the venture capital model has its benefits as well.

• There is a certain level of rigor conducted in a traditional venture capital fundraise. Raising from a well known VC signals to the public (and other potential investors) that the company has met a certain high standard (e.g., strong unit economics, product market fit, etc.) — VCs have name brand recognition and rightfully so for their track record of successful investments in the past. Therefore, investors would naturally have less concern about getting “rugged” as an investor in a venture capital backed start up.
• Part of the venture capital investment process is diligencing the founders and team themselves. While Investment DAOs opens up the playing field to entrepreneurs who are seeking funding, Web3 community does not require founders to be doxxed as general practice (and the community can even get quite upset when founders get doxxed by media). Investing in start ups in of itself is already a high risk proposition. Putting money behind someone who’s “track record” is unknown? Even riskier.
• The traditional VC model for the most part does not leverage Discord as the main communication tool during an investment process. Discord can be an overwhelming and community management of the members in the investment DAO will be key. How will work / resourcing of the decentralized entity be determined?
• There is a defined legal structure for VC investments. There is the open question of whether the investments of Investment DAOs will be classified as securities given the fact the Investment DAOs are member managed. As of now, Investment DAOs have been able to avoid SEC rules by keeping membership to under 100 people and being classified as an investment club.

Investment DAOs to keep an eye on

See here for some Investment DAOs that are having success and / or doing interesting things:

• The LAO — aimed to be the follow up to the original The DAO investing in blockchain-based projects
• Flamingo DAO — took $10M and turned it into a $1B NFT portfolio
• Komerobi Collective — started by a partner at VC Firm Blockchain Capital; investing in crypto startups with female and non-binary founders
• Global Coin Research — tokenized community investing in pre-seed, seed fundraises, liquidity mining and growth equity
• Hollywood DAO — support movies that have budget of $2–5M that are abandoned by Hollywood studio system
• Noise DAO — investing in music and Web3 companies
• Neon DAO — investing in the metaverse
• Red DAO — investing in digital fashion
• Seedclub — Y combinator of DAOs

Powering The DAOs

• Tribute Labs — build and supporting DAOs including bridging real world contracting to onchain transactions (OpenLaw); DAOs powered by Tribute include The LAO, Flamingo, Red, Neon, Noise
• Syndicate — helps set up investment clubs at the cost of gas price including Komerobi
• SuperDAO — enables one-click DAO creation and management tool for DAOs (i.e., “shopify for DAOs”

VCs are aware of the power of DAOs and are looking to get involved, backing DAOs themselves (a16z led a round for $20M into Syndicate, Signalfire led a round for SuperDAO), raising a venture fund (dao5) with aims of eventually transitioning over to becoming a DAO, and launching a DAO (BessemerDAO) though it will be centralized to start. As Kinjal Shah, an investor at crypto VC firm Blockchain Capital and founder of Komerobi Collective, stated “DAOs level the hierarchy of a venture fund by ensuring everyone is going to have a seat at the table.”

What’s Next

Both DAOs and VCs have strengths in terms of what they bring to the table as sources of funding — DAOs for the strength of individual members and VCs for their operational expertise and deep pockets. Given the disruption we have already seen in Web3, I think no Web2 model is fully safe, funding of companies included. And the more involvement DAOs have in funding of companies, the more “ownership” goes back to the people in Web3. Can there be a world where both DAOs and VCs are both on the cap table? Yes, potentially so. The ecosystem of Web3 is not as black and white as Jack might have made it seem.

Much of the excitement around Web3 stems around how quickly things are being built and the experimentation. It only makes sense that the experimentation extends to the way in which these experiments are funded, with the potential of building a new internet native Silicon Valley.