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.
Related: Types of DAOs and how to create a decentralized autonomous organization
A decentralized organization that invests in cryptocurrencies, real estate, nonfungible tokens (NFTs) or any other asset class has several functional differences from traditional investment vehicles. This is particularly true when the underlying investment opportunity is a crypto startup company. DAOs investing in startups differ fundamentally from traditional venture capital (VC).
Before elaborating on the differences between traditional VC and investment DAOs, let us understand how traditional venture capital works.
What is traditional VC?
A venture capital fund is founded and managed by general partners (GPs). GPs are responsible for sourcing investment opportunities, performing due diligence and closing investments in a portfolio company.
Venture capital is part of the capital pyramid and acts as a conduit that efficiently sources capital from large institutions like pension funds and endowments, and deploys that capital into portfolio firms. These large institutions, family offices and in some instances individuals who provide capital to a VC fund are called limited partners (LPs).
The role of the GPs is to ensure they raise funds from LPs, source high-quality startups, perform detailed due diligence, get investment committee approvals and deploy capital successfully. As startups grow and provide returns to VCs, the VCs pass on the returns to LPs.
Traditional venture capital has been a successful model that has catalyzed the growth of the internet, social media and many of the Web2 giants over the past three decades. Yet, it is not without its frictions and it is these that the Web3 model promises to address.
Challenges of traditional VC
As effective as the VC model has been, it still has its issues. They are not very inclusive and decision-making is quite centralized. VC is also considered a highly illiquid asset class by institutional investors.
Exclusive
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 viable for sophisticated investors.
It is critical to ensure that investors appreciate the risk-return profile of their investments. Therefore, venture capital may not be the right fit for all retail investors. Yet, there are subsets of the retail investor community who are sophisticated enough for this asset class. Yet, it is often difficult for even sophisticated retail investors to be LPs in VC funds.
This is either because proven GPs are often hard to reach for retail investors or because the minimum investment into these funds is several million dollars.
Centralized
If participation as an LP is exclusive, even investment decisions are generally made by a small group of people that sit on the investment committee of the VC fund. Therefore, most of the investment decisions are highly centralized.
This often can be a limitation not only to investing globally but also to being able to identify hyperlocal opportunities in the last mile of the world. A centralized team can only offer so much in terms of originations (of investment deals) and deployment capabilities across the world.
Illiquid
The other key issue with traditional VC is that it is an illiquid asset class. Capital deployed into these funds is often locked in for years. Only when the VC fund has an exit, in the form of a portfolio company being acquired or going public, do the LPs get to see…
Read More: cointelegraph.com