What is a DAO investment?
A Distributed Independent Organization (DAO) that raises and invests assets in assets on behalf of its community is a DAO investment. DAO’s investments use the power of Web3 to democratize the investment process and make it more inclusive.
DAOs can have their units in tokens that are registered on a cryptocurrency exchange. The rules of society are adopted and governance is enforced through clever agreements. Government rights (voting) can be proportional to the holding in DAO.
Connected: Types of DAOs and how to create a distributed independent organization
A decentralized institution that invests in cryptocurrencies, real estate, fixed assets (NFTs) or other asset classes has some functional differences from traditional investment firms. This is especially true when the underlying investment opportunity is a cryptocurrency. DAOs that invest in start-ups are fundamentally different from traditional venture capital (VC).
Before we elaborate on the difference between traditional VC and DAO investments, let’s understand how traditional venture capital works.
What is a traditional VC?
The Enterprise Investment Fund is established and managed by non-profit partners (GPs). GPs are responsible for providing investment opportunities, conducting due diligence and closing investments in portfolio companies.
Venture capital is part of the capital pyramid and acts as a means of raising capital efficiently from large institutions such as pension funds and appropriations, thus distributing capital to portfolio companies. These large institutions, family offices and in some cases individuals who contribute capital to an investment fund are called public limited companies (LPs).
The role of GPs is to ensure that they raise funds from CDs, obtain high-quality start-ups, carry out a thorough due diligence, obtain the approval of the Investment Committee and apply capital successfully. As start-ups grow and deliver returns to VCs, VCs deliver the returns to LPs.
Traditional venture capital has been a successful model that has boosted the growth of the Internet, social media and many of the Web2 giants over the past three decades. However, it is not without friction and this is what the Web3 model promises to deal with.
Challenges of traditional VC
As effective as the VC model has been, it still has its problems. They are not very inclusive and decision-making is rather centralized. VC is also considered a highly illiquid asset class by institutional investors.
The VC model is not as inclusive as it could be. Due to the amount of capital involved and the risk profile of the asset class, it is often only economical for advanced investors.
It is important to ensure that investors assess the risk-return profile of their investments. Therefore, venture capital may not be suitable for all retail investors. However, there are subgroups of the small investor community that are advanced enough for this asset class. Yet it is often difficult for even sophisticated retail investors to be LP in venture capital funds.
This is either because it is often difficult to find proven GPs for retail investors or because the minimum investment in these funds is several million dollars.
If participation as an LP is exclusive, even investment decisions are usually made by a small group of people who sit on the investment committee of the VC fund. As a result, most investment decisions are highly centralized.
This can often be a limitation, not only in global investment but also in being able to identify supranational opportunities in the last mile of the world. A centralized team can only offer so much in terms of start-ups (investment contracts) and distribution capabilities around the world.
Another key point of a traditional VC is that it is an illiquid asset class. Funds invested in these funds are often locked up for many years. Only when the VC-fund has an exit, in the form of a portfolio company that is bought or marketed, the LPs are allowed to see part of the capital returned.
LP still invests in the venture capital category, where the return is generally better than more liquid assets such as bonds and listed equities.
Let’s now look at the Web3 option for venture capital – DAOs investments.
Advantages of DAO investments
DAOs combine the Web3 protocol and operational seamlessness of smart contracts. Investors who believe in a particular investment thesis can come together and raise capital to form a fund. Investors can contribute in different sizes to DAO according to their risk appetite and their governance (voting) rights are proportional to their contribution.
Connected: What are blockchain smart contracts and how do they work?
How does DAO invest in the shortcomings of traditional venture capital? Let us discuss the difference in activity.
DAO’s investments allow recognized investors to contribute in all sizes. By virtue of their contribution, these investors can vote on key investment decisions. Therefore, the processes of investing in DAO and the decision to invest in the portfolio are both more inclusive.
You can distribute a contract source, just like management. Imagine running a fund that focuses on technology for coffee farmers around the world. Having community members from Nicaragua to Indonesia certainly helps to get the best last-minute investment opportunities. This enables investment firms to be more specialized, international and yet highly local.
Because this DAO can be represented and investors can make smaller contributions. This allows them to choose from a basket of funds to which they can contribute and spread their risk. DAO is also more open to accepting investments from all over the world (with exceptions) than traditional venture capital.
Imagine a reputable retail investor with $ 100,000 who wants to be exposed to sub-clusters of Web3 and cryptographic startups. The investor can find DAO investments that focus on NFT, diversified financing, layer-1 cryptocurrencies and so on, to spread their investment across all these different DAOs.
In a traditional VC, LP companies cannot resolve their position in the fund before the fund offers exit. DAOs’ symbolic investment addresses this issue. DAOs’ investments can have tokens that derive their value from the underlying portfolio. At any time, investors who own these tokens can sell them in cryptocurrency.
By offering this functionality, DAO investments offer returns similar to traditional VCs, albeit with less liquidity risk. This makes them a better investment tool just compared to the risk-return format.
What is the treasure?
Each opportunity has its risks and vice versa; DAO investments are no exception. Despite their structural superiority but traditional VCs, there are still areas that are still unclear.
For example, due to the anonymous nature of cryptocurrency investments, it is often difficult to identify the sophistication of the investor. This means that it is more difficult to protect investors from taking high risks on volatile assets. This is a space that regulators seek to address by controlling the way DAO markets itself to bring investors on board.
There are also challenges in setting up DAO as the legal language is programmed to be put into smart contracts. In traditional markets, these investment tools are often handcrafted by large law firms. Relying on ingenious contracts to do so actually entails legal and technical risks.
However, there are companies like Doola that offer services to bridge the legal gap between Web3 and the real world. Here is a table showing the key differences between these two methods.
DAO investments are still being processed. Yet the model shows promise. When the legal and regulatory risk is eliminated, DAO investments could be the model that traditional securities companies adopt.
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