Can we DAO it: How the trend of decentralized autonomous organizations is changing the venture capital landscape?

Written by: Adriana Hamacher, Translated by: DAOchurch

Summary

• Thanks to the booming development of NFTs and favorable new laws, DAOs are poised to become mainstream.
• There is great enthusiasm for the prospects, especially among venture capital DAOs.

Last month, a group of crypto art collectors made global headlines by bidding $525,000 for a promotional video about the crypto platform Uniswap created by the rapidly rising digital artist pplpleaser. This artwork is a combination of art and technology today, namely NFTs, and the funds from the sale were donated to charity.

However, despite the extensive publicity surrounding this acquisition, few media outlets mentioned the underlying infrastructure that made this purchase possible: decentralized autonomous organizations, or DAOs. Thanks to this revolutionary organizational structure, a completely different group of over 30 people, who previously intended to win the bid individually, were able to unite under the call of social media, organize funding, and win the bid in a very short time.

Essentially, a DAO is an organization on Ethereum governed by a set of rules executed by a group of smart contracts. Historically, they have been used by various groups in the crypto world to manage protocol development, raise funds, or accomplish various other tasks.

It turns out that the non-hierarchical structure of DAOs is particularly popular for collaborative asset management. And now, with the help of the NFT craze and new laws providing legitimacy, supporters of DAOs say they are about to become mainstream.

Just this week, 54 individuals met in a Discord room to establish a DAO ("BeetsDAO"), which raised 300 ETH (over $500,000) in an auction on OpenSea to purchase 4 EulerBeats NFTs.

José Nuno Sousa Pinto, Chief Legal Officer of one of the first DAO creation platforms, Aragon, told Decrypt: "DAOs are the perfect tool for managing these tokenized assets, like this new trend—NFTs."

Understanding DAOs

In an interview with Decrypt, Zheng and others stated that the rise of a distributed Web 3.0 (also known as the value internet) is nurturing a new type of organizational structure. This structure revolves around decentralized applications (dapps) and communities managed by their members, all of whom have decision-making power.

Chart / Data from DeepDAO, April 2

Generally, DAO members use tokens to vote on topics such as fund allocation. In many DAOs, the influence of a member's vote increases based on their contribution to the project, and the outcomes are determined by participation levels and the voting preferences of token holders.

As for the autonomous aspect, a DAO can be viewed as operating like a machine, determining the work to be executed through a series of pre-written smart contracts.

The concept has taken root in the rapidly evolving decentralized finance (DeFi) industry and has become one of the most popular building blocks in Ethereum's toolbox.

Aaron Wright, a professor at Cardozo Law School, told Decrypt: "Just like we see in DeFi, all these different systems are able to communicate with each other, and we believe the same thing will happen with organizations." Wright, co-founder of the digital contract platform OpenLaw, predicts that the independent functionalities people build for their personal DAO projects will one day be layered together to create larger organizations that could define Web 3.0.

"Once the Wyoming bill is enacted, it will allow a million or even a billion DAOs to thrive."

------Aaron Wright

But for critics, DAO-driven websites raise numerous legal and corporate governance issues and pose the potential for disaster—just as happened in 2016 when the first-ever DAO (The DAO) nearly led to the demise of the newly developed Ethereum network.

The project was ambitious, raising $150 million for a distributed venture fund, making it the most successful crowdfunding campaign at the time. However, an undiscovered flaw in the code caused The DAO to fail within weeks of its launch, with hackers stealing 55 million dollars from the collective fund.

Controversially, the Ethereum community voted to roll back the blockchain so that no one would lose any funds. This decision ensured the future of this fledgling platform, but the ongoing controversy set back the development of DAOs by several years.

"When the first DAO failed, because of the name 'The DAO,' people thought all DAOs were essentially bad. So it actually took years for people to change their minds," said Luis Cuende, co-founder of Aragon, in an interview with Decrypt last year.

Aragon and Radical Transparency in Governance

Despite being in the shadows after the collapse of DAOs in 2016, experiments around them have never truly stopped. Projects like Aragon, DAOstack, and Colony have drawn important lessons (and the importance of audits) from the original DAO. They continue to build and run DAOs for some of the largest DeFi protocols, including Synthetix, Aave, and Compound. After the value of these projects skyrocketed, all of them delegated more control to users in 2020.

José Nuno Sousa Pinto, CFO of Aragon. Image source: Aragon

Aragon now supports over 1,600 communities, including DeFi projects Aave and Curve. They use the platform and services to achieve financial transparency, asset management, and protocol governance.

Communities can adjust their DAOs and program them according to their goals. Sousa Pinto explains that the aim is to establish a new jurisdiction and "a set of technical contract rules that govern interactions between users," making "governance completely transparent, unlike traditional closed corporations." Aragon even provides a court for dispute resolution.

He claims that DAOs are the best way to attract communities with thousands of members and predicts that mainstream entities, such as corporations, charities, and community organizations, will soon adopt them as well. He stated: "It's a great technology; it's transparent, fair, honest, and it's open."

But not everyone believes that DAO-based governance will be revolutionary.

Dragonfly Capital, which has invested in many DeFi projects using DAOs, such as Compound, Maker, and Opyn, claimed in an August report that so far, DAO governance "looks almost identical to traditional corporate governance." They argue that those with the most tokens are often the ones calling the shots, dictating how their communities operate.

Meanwhile, the process of managing DAOs is also evolving with technological innovations. For example, the Vocdoni protocol, which Aragon acquired earlier this year, will soon release a digital voting solution that does not require participants to pay high fees to vote on-chain, encouraging more people to participate.

Moloch and the Second Wave of DAOs

Recently, a variety of radical ideas have emerged in the DAO space. Perhaps the most revolutionary is a new wave of venture capital-focused DAOs and hybrid financing concepts designed with regulators in mind—unlike the ICO cryptocurrency wave.

The purpose of creating MolochDAO was to manage grants for funding Ethereum 2.0 development, which is the network's ongoing scalability plan, playing a significant role in the new wave of venture DAOs. Its developers focused on simple smart contract solutions and explicitly designed the program to minimize the potential for attacks.

In 2019, developers in the Ethereum community forked its code. The fork was used to modify smart contracts to develop more complex DAOs, such as MetaCartel Ventures and Marketing DAO, which have the capability to distribute and transfer shares and other assets among members. Since then, MetaCartel Ventures, a profit-seeking DAO focused on early investments in Ethereum projects, has raised nearly $24 million from 64 members.

The spirit behind these initiatives is to foster a healthy venture capital ecosystem, providing easily accessible funding for DAO projects and helping technology flourish. It also offers experts using these cutting-edge technologies the opportunity for early investments.

Most importantly, MetaCartel and its peers provide a quick and efficient way to raise funds, unlike most ICOs from the 2017 era, which would conflict with U.S. securities laws. For example, MetaCartel Ventures has painstakingly registered as a limited liability company (LLC) in crypto-friendly Delaware.

Aaron Wright of OpenLaw states that in the U.S., even without managers, legal entities can enjoy limited liability and other benefits because "LLCs are creations of contracts," while DAOs primarily operate through smart contracts supported by software.

The LAO and Legal Considerations

Launched by OpenLaw in April 2020, The LAO (an acronym for Limited Liability Autonomous Organization) is another step toward reconciling radical crypto solutions with the traditional world. It is a venture capital DAO with added legal protections, aimed at investors who want to be compliant while reaping the next wave of returns from Ethereum projects.

Like MetaCartel DAO, LAO has adopted the Moloch framework, allowing the organization to accept capital rather than just pay it out. So far, the project has attracted $25 million in funding. To date, the company has invested about 30% of its funds in 40 projects, including the largest NFT marketplace, SuperRare. Another investment mentioned by Wright is aimed at improving privacy protections.

LAO even has the capability to incubate its own projects. In March of this year, it launched another DAO, this time targeting institutions. It will focus on providing much-needed liquidity for DeFi and blockchain projects.

Wright notes that many of those building DAOs have learned lessons regarding security and compliance. The 68 members of LAO (limited to 100) have undergone vetting to ensure they comply with relevant KYC and anti-money laundering laws. In the U.S., only accredited investors are eligible to join.

While LAO seeks to be a model of regulatory compliance, it is not always clear whether other DAOs are considering this as well. Wright states that this is especially true in the U.S., where legal minefields abound, particularly concerning token projects that may be viewed as securities.

However, he adds, "If you have a very flat, non-hierarchical organization where ownership and decision-making are very participatory, and all information related to the organization is accessible, I personally strongly argue that these interests should not be seen as secured."

Wright also helped draft landmark legislation in Wyoming to clarify the status of DAOs. The bill recently passed a key hurdle in the state Senate. Last year, Wyoming also became the first state in the U.S. to issue licenses for crypto banks, having already granted licenses to two banks, Kraken and Avanti.

If passed, the new law would grant DAOs the corporate personhood currently enjoyed by traditional companies. "It should allow a million—if not a billion—DAOs to thrive," Wright says. He explains: "To legally install such a device, a lot of work still needs to be done."

In fact, Wyoming is not the first place to consider granting legal personhood to DAOs. Malta initiated this process in 2019.

However, Malta's efforts have faced criticism from entrepreneurs. They argue that the legislation is overly complex and that managers bear too much responsibility, which contradicts the spirit of DAOs. But Malta is merely laying the groundwork, and further amendments could grant DAOs legal personhood while reducing managers' liabilities.

But not everyone supports this legislation. Preston Byrne, a partner at Anderson Kill Law, warns that it could be co-opted by "token-selling vendors" to justify the sale of "junk coins and immature code."

He calls for Wyoming to repeal the bill, claiming—something that has been attempted as far back as 2013—that the concept is unworkable and fraught with danger. In any case, the impact of Wyoming's plan may be limited, as the state has a small population, minimal ties to the financial industry, and federal securities laws are supreme in the U.S.

"Can We DAO It"

There are certain similarities between DAOs used for fundraising or venture capital and ICOs. Had it not been for the disaster that befell that early DAO, critics would have long established theories suggesting that the plans in Ethereum would have adopted DAOs as fundraising tools very early on. Unlike DAOs with restricted access like The LAO or MetaCartel Ventures, DuckDAO is a fundraising platform that allows anyone holding tokens to invest in early-stage startups while encouraging members to contribute to user acquisition, marketing for DAO-funded projects, and more, including NFT platforms like Bondly and crypto-asset-based protocols like Synthetic.

"Web 3.0 projects need long-term support."

------Toshi Kamei

DAOs like DuckDAO and DAO Maker are also operating public token sales. DAO Maker's initial fundraising, refundable Strong Holder Offering (rSHO), received approval from Maltese regulators in February. The project identifies which participants are more likely to become long-term token holders—valuable community members—through on-chain analysis and by checking participants' wallet addresses. VAIOT, a startup developing AI-powered services for businesses, chose rSHO as its fundraising method because it complies with Maltese law.

VAIOT's CEO Christoph Surgowt told Decrypt: "As we are the first regulated project in Malta, we have indeed paved the way for other projects and demonstrated that projects can benefit from a strict regulatory framework, innovation, and customer-centric sales processes."

In Asia, enthusiasm for DeFi and DAOs is also on the rise. Fracton Ventures is a Japanese startup that hopes to replicate the success of MetaCartel and The LAO. The project's founders, Toshi Kamei, Naoki Akazawa, and Yudai Suzuki, are committed to strengthening the DAO ecosystem by first establishing connections between Web 3.0 startups and Asian investment institutions, enabling them to enter the vibrant DeFi world. "Can We DAO It" is their slogan. A chart created by Fracton aptly describes the process of decentralized projects like this:

Fracton plans to involve institutional investors in venture capital DAOs. Image source: Fracton

Suzuki noted that currently, almost all investment DAOs are in North America. Many people in Asia are interested, but entering the networks formed in the U.S. is not so simple, with language barriers being one reason.

The three founders of Fracton have indeed recognized the long-term financing issues faced by early-stage startups. Kamei previously worked as a maker and investor at Mistletoe, a social impact fund led by Masayoshi Son's brother, the founder of SoftBank. He believes that the financing goals of venture capital often lack consistency. He stated: "Web 3.0 projects need long-term support. We believe that an investment model focused on Web 3.0 will be more suitable for this field."

One DAO, Multiple Scenarios

Today, DAOs are not exclusive to Ethereum. Dora Factory belongs to the Polkadot ecosystem and is building a public DAO infrastructure using Polkadot's own toolkit. In February, they completed their first round of funding.

But as the NFT craze (or bubble) reaches its peak, DAOs formed around NFTs are also attracting attention.

PleasrDAO was formed specifically to win the artwork of Pplpleasr, and they have since purchased three more pieces from the artist and plan to continue investing.

But this is not the first DAO focused on the NFT space. FlamingoDAO is a project established in October 2020 under The LAO. According to Wright, FlamingoDAO has a joint fund of $10 million, 40 members, and has acquired about 600-700 NFTs, including NBA Top Shot cards and a rare CryptoPunk.

For other types of organizations, we see no reason why they cannot be DAOs. There is now a writer DAO, mirror.xyz, which is gaining increasing attention (we've been following it for a while, friends). It holds a regular $WRITE competition, where writers wanting to join Mirror are voted on by the community.

Different types of projects will join LAOs and DAOs. Image source: OpenLaw

Meanwhile, Decrypt recently created its own NFTs and launched tokens to reward reader participation. According to Sousa Pinto, DAOs are an effective way to increase reader engagement while also deploying Decrypt's daily writing. He emphasized: "Voting will be the essence of participation; voting is a new form of 'liking.'"

Sousa Pinto believes that after asset tokenization, the next wave will be company tokenization. But it will not use ordinary stocks. Instead, tokens that can be traded across different markets will replace them, representing another form of participation or equity in the company. He stated: "This is very important because it incentivizes people to participate."

As interest reignites, developers are bringing tools focused on DAOs, such as decentralized automated payroll management systems, to act as human resources departments and ensure that every contributor is compensated for their efforts.

But not everyone is enthusiastic about this. MIT Technology Review argues that delegating important financial decisions to the crowd is a poor idea and is unlikely to yield returns. They believe that if DAO-related projects want to succeed on any scale, they need to make changes.

At the same time, scale is also an issue for Ethereum, including high gas fees, which severely hinder the development of DAOs. To offset this issue, projects like Metis are building what are called Layer 2 solutions, while others advocate that necessary transactions should remain on-chain, such as asset transfers and security-related decisions.

DAOs still manage a relatively small scale of assets. Image source: DeepDAO

From a broader perspective, DAOs can overcome many inherent shortcomings of traditional companies, such as governance issues. But DAOs still have many of their own problems to solve, such as simplifying voting processes and reducing the overall complexity of governance mechanisms.

Ultimately, DAOs are still just an emerging niche market in the vast crypto world, and certainly in the financial sector, as data from analysis tracking tool DeepDAO shows that the top DAOs manage only $931 million in assets. However, they have quickly attracted many new "converts," with over 65,000 PE members now identified as DAO members. Whether interested in owning a piece of a highly sought-after NFT, reading a Decrypt article, or having a seat in a massive virtual conference room, their ranks are expanding at a rate of 400 people per week.