Aug 2, 2021
10 Benefits of Decentralized Venture Capital Nobody is Talking About
The official Oxford Language definition of ven·ture cap·i·tal (noun) is “capital invested in a project in which there is a substantial element of risk, typically a new or expanding business.”
What that definition leaves out, however, is the subversive truth that venture capital is a rich man’s game which only those with opportunity and access can (literally) afford to play.
But just like how reddit enabled a group of decentralized middle class traders to unify and nearly bankrupt a few very wealthy trading organizations over leveraged on Gamestop (GME) shorts, block chain technology (specifically, Ethereum) is enabling a new class of venture capital groups to challenge the current VC status quo.
Decentralized Venture Capital (DVC) organizations (such as Stacker.vc or AngelDAO) offer permissionless and transparent investing opportunities for the average person, which itself represents a fundamental narrative shift in fund raising opportunities for startups and investors alike.
Like many decentralized applications being built today, we’re too early to definitively say whether or not that narrative shift will disrupt traditional operators in the long run, but I wanted to flesh out 10 reasons why I think DVCs might do just that.
Smart Contract Trust
Traditional anything (i.e. traditional finance) not only requires building trust through developing interpersonal relationships over time (years), but relies on traditional financial tools (like banks and legal documents) to process the business itself.
And while this bureaucratic overhead is important to protect the investors and the projects being funded, it also so 2019.
What Ethereum does in providing programmable smart contracts is shift foundational trust from people and legacy systems that are slow and highly regulated to a flexible and globally accessible blockchain secured by math and cryptography that is fast and permission-less.
“Blockchain shifts trust in people and institutions to trust in technology.”
- Bruce Schneier, a fellow and lecturer at the Harvard Kennedy School from The Nature of Trust.
By offloading the trust requirement from people and overly bureaucratic legal processes onto the blockchain, you are able to (for the first time in history) open up the pool of investors to include anyone with any amount of cryptocurrency anywhere in the world.
Direct and permission-less investing is the kind of novel innovation that is game changing.
Onchain Transparency
One of the well-known concerns with traditional banking is transparency.
Not because they are inherently corrupt and intentionally obfuscate data, but more simply because they use closed-source platforms that depend on centralized services which makes them increasingly vulnerable to an attack.
And when your entire resiliency plan can be undone through a single file update, you build a fortress around it and protect it at all times, ensuring integrity by investing heavily in the surrounding walls. Naturally, then, this security-in-depth forces data access to be extremely limited in size, scope and time. You have no choice but to focus on controlling access at the gate.
Juxtapose this with public blockchains, however, which ensure integrity by investing in network validators working on large scale consensus, and you find the more public it is, the more secure it is, which by extension makes the data extremely accessible.
And that public accessibility fundamentally introduces something traditional investment vehicles lack — accountability.
One of the key benefits of blockchain’s transparency is that it allows consumers to hold the businesses they work with accountable for their spending.
This transparent feature is especially true for banks, credit unions, and other large financial institutions. Before blockchain, these finance powerhouses were able to anonymously do anything they wanted with the funds of their account holders.
— How Blockchain Can Make Transactions More Transparent and Safe, The Quantilus Podcast
Decentralized Venture Capitalist funds not only provide trust in technology by leveraging the security model of decentralized programmable smart contracts, but further extend that trust by processing all transactions on a public blockchain.
Crypto Project Demand Is Greater Than Available Capital
It’s no surprise that the most in demand software development jobs right now are in crypto.
And assuming no substantial change in supply, what follows demand? Price. Or in the context of software developers, salary.
And how do projects cash flow that price?
Fund raising (ehem, ehem, venture capital…).
The huge market demand for crypto developers spawning from the huge market of emerging crypto based products means there is a unprecedented demand for capital to fund those projects.
And there isn’t enough traditional VC money in the world to meet that demand.
This fundamental truth, then, means that only the projects who have the fortune of making it to the pitch room are the ones that have a shot at developing a product, while seemingly countless others are doomed from the start.
This upside down demand problem is, however, something that Decentralized Venture Capital funds help solve by tapping into the seemingly unending capital available in the strong hands of the cumulative wealthy middle class.
Deep Pockets of the Middle Class
With middle class spending expected to double by 2030 and crypto wallets (like Metamask) users continuously hitting new all time highs, the middle class is exactly the pool venture capital needs in order to keep up with project demand. However, because of dependence on traditional tools (noted above) which require deep layers of manual trust, they simply can’t.
Fortunately, emerging Decentralized Venture Capital projects can.
Consider the launch of Stacker Ventures Fund1 which closed in May of 2021, raising $7.3M from 292 investors over two months.
How’d they do this?
They set soft and hard cap goals on funds then opened the inaugural fund to anyone in the world with ETH, a crypto wallet, and, a web3 enabled browser.
Combine that equal access opportunity with some personal risk tolerance to trust a pseudo-anonymous Stacker Venture team and you could have participated in one of the first fully decentralized venture capital funds ever.
Tokenized Fund Allocation
It’s one thing to raise funds and then distribute fund allocation back to investors, but it’s an entirely different thing when the fund allocation is represented in a standard ERC20 token that can be traded natively on Ethereum.
Composability is perhaps the most fascinating advantage of tokenizing funds (or really anything), because just like Ethereum contracts allow for easy access to onboard investors, battle tested decentralized exchanges (like Sushi or Uniswap) allow for easy access for investors to exit their position, too.
This single benefit alone is slowly being discovered by every industry. From automobiles to home building we are starting to see the “tokenize everything” movement unfold before our eyes. Which is exactly what happens every time a new technology comes along that is markedly superior to the previous one.
Tokenized transactions are faster, cost less, immediate, verifiable, trusted and permissionless. Being able to tap into this superior onchain after market experience for your investment is a huge market differentiatior and is just another reason Decentralized Venture Capital projects are changing the industry for the better.
Rapid Fund Deployment and Fee Savings
Imagine you’re a project looking for funding. You put together your pitch deck, present and get a $1M deal.
How quickly do you expect to receive that money and how are you going to receive it? Check? Bank transfer? Depending on your legal jurisdiction that transfer could take days to weeks and cost 1–3% in bank fees (possibly enough to fund another full time position!).
If you’re willing to accept cryptocurrency, however, the project can get almost 100% of funding in minutes, paying only the Ethereum transaction fee to make the transfer.
Again, using Stacker Ventures Fund1 as our example, in the two months since closing funds in May 2021 the fund has announced investments in (9) projects (with a strong pipeline of projects being reviewed by their Due Diligence Committee) distributing 780 ETH (~ $1.5M USD at the time of this writing), spending literally low hundreds of dollars in Ethereum gas fees to make the transactions.
Deep Bench of Expertise
Of course, not everything is about cash flow.
Another major benefit to partnering with a well known venture capitalist group is access to the knowledge and technical support provided by the investor’s technical advisors.
But just how technical are they and can they really provide better support decisions than other investor groups?
And worse, if things aren’t going right, will they admit it or end up hurting the project in the long-run by propping the business up with cash (read the story about WeWork in this New Yorker article) until it fails anyway?
It’s almost impossible to say, of course, but I’d contend the more innovative the technology, the more technical depth is required from its technical advisors and is there a more technical space in the market right now than cryptocurrency?
As Lucas Campbell writes in Decentralized VC will eat venture investing about Metacartel Ventures (a Decentralized Venture Capitalist DAO):
“There is no need for technical advisors. MCV’s mages understand the viability of a potential investment, as many have been tackling the same challenges in their own projects. All members have hands-on experience in the space, which is key to the DAO’s ability to select the right projects to invest in and forms the basis for its ability to effectively support projects as they grow and mature into the household names of tomorrow.”
When it comes to crypto is there really a traditional venture capitalist firm out there whose in-house technical advisors are going to be technically better than the countless men and women who have actually been coding in the crypto community for years?
I don’t think so.
The only question then is how are Decentralized Venture Capital groups structured to provide technical support to start ups? The answer may vary, but in general, they do what crypto does best — leverage the power of the community.
In the case of Metacartel Ventures (noted above), they have DAO Members (called Mages) which provide this support, Stacker Ventures has a Due Diligence Committee and leverages snapshot governance for community votes, and AngelDAO has it’s Aragon powered DAO to make community driven decisions.
DAO Decisions
Speaking of Aragon and Snapshot, these are tools that fundamentally help organize another unique feature of Decentralized Venture Capital groups — Decentralized Autonomous Organizations (or DAOs).
If you’ve never heard of a DAO I suggest this Forbes primer, but the main point for this article is by structuring the DVC to be a DAO, the members of the DVC have the power to invest in projects (opposed to a small group of individuals), which is an important step in not only holding investment groups accountable for their decisions, but for developing trust and long-term believers from the investors themselves.
DAOs are an inclusive, transparent and global model for human coordination.
— AragonDAO
Now, of course, DVCs do not have to be run by DAO, but if you want to truly empower the community (typically token holders) and truly decentralize the organization, then there isn’t a better way than being able to physically empower the community with true onchain voting to change virtually anything about the project structure, especially with states like Wyoming in the United States of America legally recognizing them.
If you want to see an example of how the investment flow works and the power the DAO holds, you can view the exact Stacker Venture Fund1 investment process outlined here.
Product Diversification
In addition to traditional venture capital investment in start ups, crypto based venture capital projects have the ability to quickly develop new and innovative products to further attract capital and to reward current investors.
One real world example of this is Stacker Ventures Active Yield Fund, which:
…provides investors with a simple and transparent option to access the highest investment-grade yields in DeFi.
Active Yield Funds are managed, yield-seeking funds that retain decentralized control of capital while efficiently investing pooled funds in whitelisted strategies. These funds capitalize on the highest investment-grade yield, possibly even before the yield aggregators do.
- Copied from official Stacker Ventures documentation.
Decentralized Venture Capitalist projects are uniquely positioned to deploy and offer this type of product diversification because they are building tools and networking on the innovative rails of open source software and blockchain technlogy which enables rapid product development, but more importantly are already connected to existing and proven decentralized applications.
You can view current Stacker Venture’s whitelisted yield farm strategies here.
Maximum Capital Efficiency
While product diversification is great for crypto enthusiasts and project investors, another major advantage is the project fund itself can leverage their own tools to maximize capital efficiency and yield on the fund treasury.
That is, after the initial capital raise, the project can choose to invest the capital into safe and conservative money markets to gain interest and further grow the fund.
In the case of Stacker Ventures and ETH, they leverage Curve’s sETH + Yearn to maximize ETH yield while waiting on investments.
You can view all approved yield farming contracts in the official Stacker Ventures documentation here.
Closing Thoughts
Like many verticals leveraging the power and flexibility of blockchain development, Decentralized Venture Capital projects are changing the way project fund raising works by rapidly expanding the pool of investors to meet the increasing demand for project capital while simultaneously maximizing yield by offering innovative product diversification which leverages established and reputable money markets.
If that’s not game changing, I don’t know what is.
Disclaimer — I hold $STACK at the time of this writing.
