The Role of DAOs in Decentralizing Venture Capital

Filip Dimkovski
By Filip Dimkovski
Tamara Fodora - Editor for DeFipedia
Edited by Tamara Fodora

Published January 8, 2023.

Group of silhouettes of people with the title Decentralized Autonomous Organizations (DAO) above them, next to a series of icons linked together

With the crypto space embracing wider adoption and new projects appearing relatively often, it's apparent that decentralized autonomous organizations(DAO) are here to stay. Namely, the DAO market has grown significantly in recent years, with the number of participants increasing by over 400% since 2021. The estimations say that the approximate growth for 2022 would be around 300%.

This influx of new investors has been driven by many factors, with the biggest ones being the recent technological advances, including artificial intelligence (AI) and the Internet of Things (IoT). These new technologies have made it much easier for people to access venture capital investments by significantly simplifying the process. As a result, DAOs have become increasingly important players in the world of venture capital.

» Check out the best crypto DAO projects you could join in the future

What are DAOs?

A DAO is an autonomous entity that operates without any central authority or specific management structure. It is typically composed of a group of individuals who work together via smart contracts on decentralized platforms, like Ethereum, to facilitate various transactions and investments.

The members are usually granted voting rights that allow them to decide how the DAO is managed and which investments it should pursue. Once a new idea is proposed, you can have a bigger or smaller influence on how the project will evolve depending on the size of your stake in the DAO.

The primary purpose of a DAO is to eliminate the need for a centralized decision-making body, such as a board of directors or executive team. This allows for more distributed decision-making and can help reduce costs associated with having an intermediary. Moreover, DAOs can also provide investors with liquidity by allowing them to sell their holdings at any time without having to wait for traditional capital markets like banks or venture capitalists to open up again.

Let's understand investment DAOs better by taking a look at an example. One of the most popular investment DAOs out there is BitDAO—a project that supports a broad range of assets in the crypto space, including cryptocurrencies, NFTs, and DeFi tokens. The members of the project facilitate the research and development of new projects that have the potential to grow. Then, they can provide liquidity and direct investments. As is the case with DAOs, the holders of the project's governance token BIT can vote on the projects the DAO should invest in and provide liquidity to, making it entirely community-driven and democratic.

Investment DAOs

Investment DAOs are specifically designed for investing in startups and other venture capital opportunities. These organizations use algorithms and smart contracts on blockchain platforms to evaluate potential investments and even offer investment advice. By using a distributed network of investors, these DAOs are able to reduce the costs associated with traditional venture capital investments and provide access to opportunities that may not have been available previously.

3 Benefits of Investment DAOs Over VCs

Both traditional venture capital models and DAOs can be good for investing, but it's worth mentioning that a DAO has several benefits over its VC counterpart. Let's take a look at the three biggest ones:

1. They Are Decentralized

Unlike traditional venture capitalist firms, which are bound by certain criteria and conditions before making an investment, members of a DAO operate without any centralized authority. This eliminates the need for cumbersome regulatory structures and also allows for much faster decision-making processes that are less influenced by human biases. There's a saying that, in DAOs, "code is law," so there can never be any conflicts of interest or external pressure. Thus, the result is a more efficient system with far fewer entry barriers for investors.

2. DAOs Are Open to All

Traditional venture capital firms often have high minimum thresholds to enter, and they usually require potential investors to have deep pockets in order to participate. In contrast, the vast majority of investment DAOs don't have any requirements and are open to almost anyone looking to invest. As long as you have a crypto wallet with some assets, you can become a part of the project. This opens up opportunities for individuals with potentially limited resources to take part in venture capital investments.

3. Investment DAOs Enable Greater Liquidity

Investment DAOs allow investors to easily sell their holdings at any time. This is a major advantage over traditional venture capitalist firms, which usually require investors to wait for certain conditions to be met before they can cash in on their investments. The result is a project with much higher liquidity, as the barriers for both entry and exit are non-existent.

» Want to know more? Read about the advantages and disadvantages of DAOs

4 Risks to Consider

Although a DAO offers many benefits over a traditional VC model, it's worth mentioning that DAOs aren't risk-free either. So, let's take a brief look at four potential risks of investing through an investment DAO:

1. Poorly Executed Smart Contracts

Since "the code is law," investment DAOs rely heavily on smart contracts to facilitate their operations. If the code behind these contracts is flawed or buggy, it can significantly reduce the effectiveness of the organization. In some cases, it could result in security vulnerabilities.

2. Lack of Regulatory Oversight

As investment DAOs operate without any centralized authority, they are not subject to traditional regulatory oversight or transparency standards. In rare cases, this can lead to potential issues such as fraud or the mismanagement of funds.

3. Limited Expertise

It's worth mentioning that investment DAOs are still a relatively new concept. So, there may be limited expertise available to assess the viability and success of projects before investments are made. As of early 2023, the sector is only a couple of years old, so there hasn't been much time for the experts to gain the knowledge and experience needed to effectively evaluate and analyze projects before investing.

4. Rapid Market Changes

Investment DAOs operate in a rapidly-evolving landscape, so they may not be able to keep up with the changes in the industry if their technology is outdated. Still, this usually isn't an issue, as DAOs are able to adapt quickly and overcome such barriers.

How DAOs Contribute to the Decentralization of Venture Capital

The impact of investment DAOs on the venture capital industry is significant. By providing access to a range of opportunities and enabling investors to quickly liquidate their holdings, they have significantly lowered the barrier for both entry and exit. As we mentioned above, these DAOs operate without a centralized authority, so they can eliminate certain biases that may exist in traditional venture capital investments.

Most experts in the field believe that investment DAOs have the potential to revolutionize the venture capital industry by providing a much more democratic and efficient way for investors to access new opportunities.

By allowing more people to participate in venture capital, these DAOs can provide a powerful tool for diversifying and distributing capital to businesses that may have otherwise been overlooked by traditional venture capitalists.

Key Takeaways

We can conclude that investment DAOs are a relatively new type of organization that enables investors to pool their resources together and invest in venture capital opportunities. This gives individuals with potentially limited resources a chance to participate in venture capital investments, provides better liquidity for investors, and eliminates certain biases present in traditional VCs. And with the modern accessibility of information, you can even learn how to start a DAO from the comfort of your home.

Still, it's worth mentioning that there are some risks that should be taken into consideration before investing. So, it is important for potential investors to understand these risks fully and know how investment DAOs would fit into their portfolio strategy before participating.

» Try these methods to find new DAO projects