Is the Future of VC Decentralised?

Imagine decentralising the current VC model.

This would mean creating transparent governance systems to make decisions which automatically get executed on smart contracts. Designing incentive structures that attract an expert investment community to contribute value, opening up the power of network effects and wisdom of the crowd (proven to often be correct). Allowing contributors to be rewarded for successful work through reputation tokens, assigning them clear ownership.

This is the promise venture decentralised-autonomous-organisations (DAOs) bring.

But, this shift didn't happen overnight. The core innovation enabling this development is blockchain technology, which allows for the creation of organisations with transparent rules that are enforced via code. DAOs use incentive structures coded into smart contracts on blockchains to align members behind a shared mission.

Venture capitalism itself has steadily innovated over the past decade, with the rise of micro-VC, syndicates, equity crowdfunding, rolling funds, and novel structures like venture studios. Venture DAOs represent the decentralisation of these models, relying more heavily on community intelligence while reducing centralised control.

In this article, we will explore the evolution of DAOs, changes in the broader venture capital landscape, the current state of venture DAOs, and finally where the model may head next. 

The Current State of VC

Venture capital has endured growing pains in 2023 after the "FOMO" dealmaking of 2021. As the market cools, the Q3 global VC deal value declined 15% quarter-over-quarter to $73 billion in Q3 2023 (Crunchbase). Several high-profile startups that went public last year, like Instacart, have seen their valuations slashed by over 75% post-IPO.

Later stage rounds still made up nearly 60% of total VC funding at $43 billion last quarter, increasing 30% quarter-over-quarter. However, this meant that early stage deals took a hit, declining 16% quarter-over-quarter to $23.4 billion in Q3.

The bursting bubble has further rippled through the ecosystem. Both startups and VC funds shut down at record rates in 2023 as markets turned. With alternative investments like public stocks, bonds, and crypto recovering, VCs are finding it harder to raise new funds from limited partners (LPs). More startups now opt to bootstrap rather than pursue VC backing.

In 2021, poor capital management from some funds overinflated startup valuations. Capital was too loosely available, directing it to unsound companies and ideas. The current market consolidation brings back principles of investing in quality teams and ideas at reasonable valuations.

Within this chaos lies the opportunity to improve the VC model for both LPs and founders. Restoring diligent analysis and a long-term focus, investors can spot resilient startups poised to drive the next wave of innovation.

Introducing Venture DAOs

A venture DAO is a community that makes startup investments using self-executing smart contracts, functioning as a digital venture capital fund. DAOs source capital from investors and coordinate funding, governance, and profit-sharing across globally distributed members.

In a traditional VC fund, the general partners (GPs) actively manage operations and investments while serving the limited partners (LPs) who provide investment capital. GPs tend to be experienced investors or startup operators, while LPs are often high net worth individuals or funds looking to diversify assets. Given high fundraising competition, GPs are challenged to demonstrate differentiated value.

While venture DAOs decentralise governance and operations across members, they vary in structure. Some like MetaCartel Ventures and Global Coin Research (GCR) closely mirror angel syndicates with members serving as investors. Others like Orange DAO and VC3 raise LP funding more akin to traditional VCs, yet with the DAO controlling decisions. Additionally, venture DAOs typically have an application process for entry, evaluating skills that can contribute capital and knowledge - for example, Orange DAO exclusively accepts Y-Combinator-backed founders. 

Venture DAO governance relies on transparent proposal processes, incentive structures, and reputation systems encoded into smart contracts on the blockchain. Unlike opaque governance in traditional partnerships, this transparency better aligns incentives across members. Members who actively contribute value by sourcing deals, offering expertise, or making other contributions earn higher voting shares and token allocation sizes. Automated distribution of profits/losses directly to members' crypto wallets also incentivises participation.

Venture DAOs have also become early adopters of tokenised assets. Tokenised assets improve real-time investment data, secondary markets, compliance processes, access to further defi products, and more.

To learn more about tokenised assets impacting funds, read my article here.

The success of venture capital depends on which deals you can access, but the best deals are hard to get into. This is where venture DAOs thrive. By aggregating more participants, DAOs can source more venture deals and specialise evaluation in niches. As you bring together a community of successful investors, you create a powerful network effect that benefits the DAO. These network effects then attract founders as they look for value-add investors who can make valuable introductions.

DAOs also promise lower barriers to entry for at least some forms of startup investing. While there is often still a competitive application process, DAOs are designed to decentralise decision-making power. Additionally, venture DAOs can be created with niches bespoke to an investor's tastes, therefore allowing you to access communities where you can add the most value.

But before we claim that venture DAOs are the next iteration of venture, we need to take a look at the traction of existing venture DAOs. 

The Current state of Venture DAOs

While there isn’t a lot of financial performance data on venture DAOs, due to them being so new, understanding each DAO's approach can give us an insight into the industry.

VC3

Launched in 2022, VC3 is a venture fund DAO focused on raising capital from LPs. It was created by the VC firm Mindset Ventures for over 150 investor alumni of the Kauffman Fellowship programme.

The VC3 Fund I has a $25 million fund that makes pre-seed, seed, and Series A startup investments. Mindset Ventures manages the fund for compliance, but VC3 members vote on what deals to back. There is a 6-person committee with fiduciary authority to make final investment decisions.

VC3 has already co-invested in 18 deals, including a $25 million seed round for Co:Create. This demonstrates early success in leveraging the DAO's network for deal flow and investments. They are also looking to expand beyond the crypto sector, with venture capital funds, accelerators, and hedge funds.

The experienced network VC3 has brought together means the DAO has access to a vast network of investors, deal flow, and a wide range of expertise. These components highly increase its chances of success.

Meta Cartel Ventures

MetaCartel Ventures (MCV) is a for-profit DAO created by the MetaCartel community to invest in early-stage decentralised applications (DApps). MCV consists of a code and law pairing - a Moloch v2 smart contract on Ethereum tightly integrated with a Delaware LLC legal entity. Members source deals, conduct diligence, and vote on investments.

While there aren't exact data points on MCV's progress, they were one of the first venture DAOs to exist. This combined with their unique network of early Ethereum adopters means they have likely had access to some competitive web3 startup deals.

The community has recently launched Hydra Ventures, a $10M fund that invests in other venture DAOs. Think of it like a fund of funds, but for DAOs.

Orange DAO

Orange DAO is a DAO of over 1,300 Y Combinator alumni that backs web3 startups through an accelerator and an associated $80 million venture fund.

The DAO itself is structured as a Cayman Islands foundation company. Similarly to VC3, the associated venture fund is a separate legal entity run by general partners who leverage the DAO's members to source deals and conduct diligence.

Since launching in January 2022, Orange DAO has grown to 1,300 members and backed 90 startups with an average check size of $100,000. They also run a fellowship program to attract founders to web3 and provide services through their portfolio company Origami.

The Future of Venture DAOs

Like many other applications, fully decentralising the venture ecosystem seems a bit far fetched, which is why I’m a fan of the hybrid approach. The hybrid approach takes aspects from decentralised and current centralised venture structures. This could include governance and incentive systems.

For instance, a fund could use on-chain voting to make final investment decisions, while using governance systems to skew voting power based on experience and contributions. This then creates a transparent voting system recorded on a digital ledger and provides the opportunity to incentivise valuable contributions from team members.

Venture DAOs still face their challenges. Setting up a leaderless decentralised entity has proven to be a challenge with restricted solutions on the market. While setting up a compliant venture DAO is possible, it’s not the easiest process.

Additionally, DAOs can be very difficult to organise. I can’t help but think that humans gravitate towards having a leader, especially when working in a for-profit organisation. I once contributed to a DAO building decentralised tooling with misaligned incentives which led to slow progress, a confused vision, and centralised decision making from the founders. With non-profits it seems to be easier to organise in a decentralised manner.

These challenges among the fact that venture DAOs are largely unknown in the larger world limit their adoption. Even current venture DAOs are largely focused on the Web3 sector investments. But, we’re seeing a shift in applying venture DAOs to further sectors, such as VC3 who is launching an AI-focused fund.

As DAOs become more well known in the larger investment landscape, I hope to see an emergence of hybrid venture organisations allocating capital to the next generation of unicorns.

Conclusion

Venture DAOs represent an evolution in startup investing by leveraging decentralised networks and blockchain-based incentives. As opposed to closed-door VC funds, DAOs coordinate transparent, member-driven diligence, governance, and profit sharing across potentially thousands of investors around the world. Automated operations via smart contracts reduce costs while engaging a wider range of perspectives.

Despite challenges in organising decentralised entities, pioneering Venture DAOs show promising traction. By aggregating expert investor talent, they drive strong deal flow and diligence. Hybrid structures balancing traditional VC with decentralised wisdom-of-the-crowds intelligence provide a path to democratised, efficient access. 

As blockchain adoption advances, DAOs may grow into the next paradigm for allocating capital - one that is transparent, networked, and token-incentivised in unprecedented ways. The model's disruptive potential remains in its early days, but the initial displays of collective intelligence coordinating investments at global scale provide reasons for optimism.

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