We can DAO it: How the trend of decentralized autonomous organizations is changing the venture capital world

Written by Adriana Hamacher Translated by Turboggs, Jane, and Salmon from DAOchurch

summary

• Thanks to the NFT boom and favorable new laws, DAOs are ready to go mainstream.

• There is enthusiasm for the prospects, especially for venture capital DAOs.

Last month, a group of crypto art collectors made global headlines when they bid $525,000 for a promotional video about crypto platform Uniswap created by the fast-rising digital artist pplpleaser. The artwork was a combination of today’s art and technology mediums, or NFTs, with the winning funds going to charity.

But despite the massive amount of publicity the acquisition received, little media coverage has been given to the underlying infrastructure that made the acquisition possible: the decentralized autonomous organization, or DAO. Thanks to this revolutionary organizational structure, a disparate group of more than 30 people, all of whom had previously been interested in winning the bid, were able to unite behind a call on social media, organize funds, and win the bid in record time.

Essentially, a DAO is an organization on Ethereum with rules enforced by a set of smart contracts. Historically, they have been used in the crypto world by groups large and small to manage protocol development, raise funds, or accomplish a variety of other tasks.

The DAO’s nonhierarchical structure has proven particularly popular for collaborative asset management, and now, with the help of the NFT craze and new laws lending it legitimacy, DAO backers say they’re about to go mainstream.

Just this week, 54 people met in a Discord room and built a DAO (“BeetsDAO”) to raise 300 ETH (over $500,000) to purchase four EulerBeats NFTs in an auction on OpenSea.

“DAOs are the perfect tool to manage these tokenized assets, like this new trend, NFTs,” José Nuno Sousa Pinto, chief legal officer at Aragon, one of the first DAO creation platforms, told Decrypt.

Parsing DAO

In an interview with Decrypt, Zheng and others said the rise of the distributed Web 3.0, also known as the Internet of Value, is giving rise to a new type of organizational structure centered around decentralized applications (dapps) and communities governed by their members, who have decision-making power.

Chart/data from DeepDAO, April 2

Typically, DAO members use tokens to vote on topics such as fund allocation. In many DAOs, the influence of members' votes increases based on their contribution to the project, and the results are determined by the level of participation and the voting preferences of token holders.

As for the autonomy part, think of a DAO as operating like a machine, with a series of pre-written smart contracts determining the work to be performed.

The concept has taken root in the rapidly growing decentralized finance (DeFi) industry and has become the most popular Lego block in the Ethereum toolbox.

“Just like we’ve seen with DeFi, where all these different systems are able to talk to each other, we think the same thing will happen with organizations,” Cardozo Law School professor Aaron Wright told Decrypt. Wright, co-founder of digital contract platform OpenLaw, predicts that the independent functions that people build for their personal DAO projects will one day be stacked together to build larger organizations that may define Web 3.0.

“If the Wyoming bill is enacted, it will enable a million or even a billion DAOs to flourish.”

—Aaron Wright

But for critics, DAO-powered sites raise numerous legal and corporate governance issues, as well as the potential for disaster — which is what happened in 2016, when the first-ever DAO nearly led to the demise of the newly minted ethereum network.

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

Controversially, the Ethereum community voted to roll back the blockchain so that no one lost any funds. The decision secured the future of the fledgling platform, but the ongoing controversy set back the DAO’s development by several years.

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

Aragon and Radically Transparent Governance

While DAOs remain in the shadows following the 2016 debacle, experimentation around them never really stopped. Projects like Aragon, DAOstack, and Colony have learned important lessons from the original DAO (and the importance of audits). They’ve gone on to build and run DAOs for some of the largest DeFi protocols, including Synthetix, Aave, and Compound. All of these projects are set to delegate more control to users in 2020, following a surge in project value.

Aragon CFO JoséNuno Sousa Pinto. Source: Aragon

Aragon now supports more than 1,600 communities, including DeFi projects Aave and Curve, who use the platform and services for financial transparency, asset management, and protocol governance.

The community can tweak the DAO and program it to suit its own goals. Sousa Pinto explained that the aim is to make “governance completely transparent, unlike traditional closed companies” by establishing a new jurisdiction, as well as “a set of technical contractual rules that regulate the interactions between users.” Aragon even provides a court to resolve disputes.

He claims that DAOs are the best way to engage communities with thousands of members, and predicts that mainstream entities such as businesses, charities, and community organizations will soon adopt them. “It’s a great technology, it’s transparent, it’s fair, it’s honest, and it’s public,” he said.

But not everyone thinks DAO-based governance will be revolutionary.

Dragonfly Capital, which has invested in many DeFi projects that use DAOs, such as Compound, Maker, and Opyn, declared in an August report that DAO governance so far "looks almost identical to traditional corporate governance." They believe that those who own the most tokens are usually the ones who call the shots and can dictate how their communities operate.

Meanwhile, the process of managing DAOs is also evolving with technological innovation. For example, the Vocdoni protocol, which Aragon acquired earlier this year, will soon release a digital voting solution that will not require participants to pay expensive fees in order to vote on-chain, thus encouraging more participation.

Moloch and the Second Adventure of DAOs

There have been all sorts of radical ideas emerging in the DAO space lately. But perhaps the most revolutionary is a new wave of DAOs focused on venture capital, and the concept of hybrid financing designed with regulators in mind — not unlike the ICO cryptocurrency wave.

MolochDAO was created to manage grants used to fund the development of Ethereum 2.0, the network’s ongoing scaling initiative that has played a major role in a 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 the smart contracts to develop more complex DAOs, such as MetaCartel Ventures and Marketing DAO, which have the ability to distribute and transfer shares and other assets between members. Since then, MetaCartel Ventures, a for-profit DAO focused on early-stage 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, provide easy access to funding for DAO projects, and help the technology flourish. It also provides early investment opportunities for experts using these cutting-edge technologies.

Most importantly, MetaCartel and its ilk offer a way to raise money quickly and efficiently, and unlike most ICOs of the 2017 era, one that doesn’t run afoul of U.S. security laws. MetaCartel Ventures, for example, has taken pains to register as a limited liability company (LLC) in the crypto-friendly state of Delaware.

Aaron Wright of OpenLaw said that in the United States, legal entities can enjoy limited liability and some other benefits even without managers because "LLCs are contractual creations" and DAOs operate primarily through smart contracts, the software that powers them.

The LAO and the Law

The LAO (acronym for Limited Liability Autonomous Organization), launched by OpenLaw in April 2020, is another step towards reconciling radical crypto solutions with the traditional world. It is a venture capital DAO with additional legal protections, targeting investors who want to be compliant while getting the next wave of returns from the Ethereum project.

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

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

Wright noted that many of those building DAOs have learned lessons about security and compliance. The LAO’s 68 members (out of a limit of 100) have been vetted to ensure they comply with relevant KYC and anti-money laundering laws. In the U.S., only accredited investors are eligible to join.

While The LAO seeks to be a model for regulatory compliance, it’s not always clear whether other DAOs are also considering it. Wright said this is especially true in the United States, where legal minefields abound, especially related to projects with tokens that could be considered securities.

However, he added, “If you have a very flat, non-hierarchical organization where ownership and decision-making are very participatory and all information relevant to the organization is available, I personally would strongly advocate that those benefits should not be seen as guaranteed.

Wright also helped Wyoming, a crypto-friendly state, draft landmark legislation 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 issued licenses to two banks, Kraken and Avanti.

If passed, the new bill would give DAOs the legal personality that traditional corporations currently enjoy. “It should allow a million — if not a billion — DAOs to flourish,” Wright said. “It would still take a lot of work to legally install one of these,” he explained.

Wyoming isn’t the first state to consider granting Dawes legal personhood. Malta started the process in 2019.

However, Malta’s efforts have been criticized by entrepreneurs. They say the legislation is too complex and puts too much responsibility on managers, which goes against the spirit of the DAO. But Malta is only laying the groundwork, and further amendments could give DAOs legal personality and reduce managers’ responsibilities.

But not everyone supports the legislation. Preston Byrne, a partner at Anderson Kill Law, warned it could be usurped by “token peddlers to justify selling” shitcoins and half-baked code.

He called on Wyoming to repeal the law, claiming — having already tried it in 2013 — that the concept is unworkable and fraught with danger. In any case, the impact of Wyoming’s plan is likely to be limited because the state has a small population, minimal ties to the financial industry, and federal securities laws are supreme in the United States.

“We can DAO it.”

There are similarities between DAOs and ICOs, which are used for fundraising or venture capital. Without the disaster that befell that early DAO, critics would have theorized that plans in Ethereum would use DAOs as a fundraising tool very early on. Unlike restricted-entry DAOs like the LAO or MetaCartel Ventures, the DuckDAO fundraising platform allows anyone with a token to invest in early-stage startups while encouraging members to contribute to user acquisition and marketing for DAO-funded projects, including NFT platform Bondly and crypto-based protocol Synthetic.

“Web3.0 projects require long-term support.”

——Toshi Kamei

DAOs such as DuckDAO and DAO Maker are also running public token sales. DAO Maker’s initial fundraising, the Refundable Strong Holder Offering (rSHO), was approved by Maltese regulators in February. The project uses on-chain analysis and checks the wallet addresses of participants to identify which participants are more likely to become long-term token holders, that is, valuable community members. VAIOT, a startup developing AI-enabled services for enterprises, chose rSHO as its fundraising method because it complies with Maltese law.

“As we are the first project to be regulated in Malta, we are paving the way for other projects and proving that projects can benefit from a strict regulatory regime, innovation and a customer-centric sales process at the same time,” VAIOT CEO Christoph Surgowt told Decrypt.

In Asia, enthusiasm for DeFi and DAOs is also growing. 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 working to consolidate the DAO ecosystem by first establishing connections between Web3.0 startups and Asian investment institutions so that they can enter the vibrant world of DeFi. "We can DAO it" is their slogan. A chart made by Fracton describes the progress of decentralized projects like this well:

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

Suzuki said that currently almost all investment DAOs are in North America. There are many people in Asia who are interested in this, but it is not so easy for people to enter the network formed in the United States. One of the reasons is the language barrier.

Fracton's three founders are actually aware of the long-term financing problems faced by early-stage startups. Kamei worked as a producer and investor at Mistletoe, a social impact fund led by the brother of Masayoshi Son, the founder of Japan's SoftBank. He believes that venture capital's financing goals are often inconsistent. He said: "Web3.0 projects need long-term support. We think an investment model focused on Web3.0 will be more suitable for this field."

One DAO, multiple scenarios

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

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

PleasrDAO, a DAO formed specifically to win artworks by Pplpleasr, has purchased three more works by the artist and plans to continue investing.

But this is not the first DAO focused on the NFTs space. FlamingoDAO is a LAO project established in October 2020. According to Wright, FlamingoDAO has a $10 million joint fund, 40 members, and has acquired approximately 6-700 NFTs, including NBA Top Shot cards, and a rare CryptoPunk.

As for other types of organizations, we can’t think of any reason why they couldn’t be DAOs. There is already a writers DAO mirror.xyz that is gaining more and more attention (we’ve been following it for a while, folks). It hosts a regular $WRITE contest where writers want to join Mirror every week, and the community votes for writers they want to see on the platform.

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

Meanwhile, Decrypt recently created its own NFTs and issued tokens to reward readers for participating. According to Sousa Pinto, DAO is an effective way to increase reader participation, while also deploying Decrypt to write every day. He emphasized: "Voting will be the essence of participation" and "Voting is the new form of 'like'."

Sousa Pinto believes that after asset tokenization, the next wave will be company tokenization. But ordinary stocks will not be used. Instead, there will be tokens that can be traded on different markets, which is equivalent to another form of participation or equity in the company. "This is very important because it incentivizes people to participate," he said.

Amid the renewed interest, developers have brought DAO-focused tools such as decentralized automated payroll systems to act like human resources departments and ensure that every contributor is rewarded for their efforts.

But not everyone is enthusiastic about this. MIT Technology Review believes that entrusting important financial decisions to the public is a bad idea and is likely to fail to bring returns. It believes that if DAO-related projects want to succeed at any scale, changes need to be made.

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

DAOs are still relatively small in terms of the size of assets under management. Image source: DeepDAO

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

Finally, DAOs are still a nascent niche in the wider world of crypto, and of course in finance, with the top DAOs managing just $931 million in assets, according to analytics tracking tool DeepDAO. But they’ve quickly attracted many new “converts,” with more than 65,000 PEs now called DAO members. Whether they’re interested in owning a piece of a much-anticipated NFT, an article on Decrypt, or a seat in a giant virtual conference room, their ranks are expanding by 400 people a week.