What is an investment DAO?
A decentralized autonomous organization (DAO) that raises and invests capital into assets on behalf of its community is an investment DAO. Investment DAOs tap into the power of Web3 to democratize the investment process and make it more inclusive.
DAOs can have their units in tokens that are listed on a crypto exchange. The community rules are agreed upon and governance is enforced through smart contracts. Governance rights (voting) can be prorated based on the holdings in the DAO.
How do investment DAOs address the shortcomings of traditional venture capital? Let us discuss the functional differences.
Investment DAOs allow accredited investors to contribute in all sizes. By virtue of their contributions, these investors are able to vote on key investment decisions. Therefore, the processes of investing in the DAO and deciding on investments in the portfolio are both more inclusive.
Deal sourcing can be decentralized, just like governance. Imagine running a fund focused on technology for coffee farmers across the world. Having community members from Nicaragua to Indonesia certainly helps in sourcing the best last-mile investment opportunities. This allows investment vehicles to be more specialized, more global and yet highly local.
As these DAOs can be tokenized and investors are able to make smaller contributions. This allows them to choose among a basket of funds to which they can contribute and diversify their risks. Also, DAOs are more open to receiving investments from across the globe (with exceptions) than traditional venture capital.
Imagine an accredited retail investor with $100,000 wanting exposure to subclusters of Web3 and crypto startups. The investor can find an investment DAO focused on NFTs, decentralized finance, layer-1 cryptocurrencies and so on, to spread their investment across all these different DAOs.
In traditional VC, LPs are not able to liquidate their positions in the fund before the fund offers an exit. Tokenized investment DAOs address that issue. Investment DAOs can have a token that derives its value from the underlying portfolio. At any point in time, investors that own these tokens can sell them on a crypto exchange.
In offering this functionality, investment DAOs offer returns similar to those of traditional VCs, albeit with a lesser liquidity risk. This makes them a better investment vehicle just based on the risk-return profile.
What’s the catch?
Every opportunity has its risks and vice versa; investment DAOs are no exceptions. Despite their structural superiority to traditional VCs, there are still areas that remain unclear.
For instance, due to the anonymous nature of crypto investments, it is often difficult to identify the sophistication of the investor. This means it is harder to protect investors from taking high risks on a volatile asset. This is a space that regulators are looking to address by governing how a DAO markets itself to bring investors onboard.
There are also challenges in setting up a DAO where the legal language is programmatically set into smart contracts. In traditional markets, these investment vehicles are often handcrafted by large legal teams. To rely on smart contracts to do that effectively poses a legal and a technological risk.
However, there are firms like Doola that offer services to bridge the legal gap between Web3 and the real world. Here is a table that illustrates key differences between the two approaches.
Investment DAOs are still works in progress. Yet, the model shows promise. Once the legal and regulatory risks are ironed out, investment DAOs could be the model that traditional VCs embrace.