TL;DR
An investment DAO is a decentralized organization that invests funds as a group. Anyone who owns the investment DAOโs governance token can participate in the decision-making process. The more of the token you hold, the larger your voting power. Investment DAOs fund their treasury through token sales, issuing NFTs, and rendering revenue-generating services. The legality of investment DAOs will depend on the laws of your jurisdiction.
Introduction
With its decentralized capabilities, blockchain has undoubtedly changed the face of investing forever. Entrepreneurs and startups no longer need to solely rely on venture capital firms, seed rounds, and traditional fundraising models. It's relatively simple to create your own token and use one of the various on-chain methods for selling your project token.ย
It's not just fundraisers who have experienced a significant change either: Investors have too. With investment DAOs, we now have a new approach to funding projects that's easily accessible to even the smallest of investors.
What is an investment DAO?
An investment DAO allows its members to decide when and where to invest its funds. This could be in real estate, DeFi investment vehicles, or any other asset the DAO chooses to invest in. An investment DAO uses the Decentralized Autonomous Organization (DAO) model to democratize and decentralize the whole investment process.ย
Traditional models put investment power in the hands of a relatively small group of money managers of VC funds and family offices, and hedge funds. Alternatively, investment DAOs offer anyone holding its governance token the ability to make decisions regarding its investments. Instead of using the expertise of a narrow group of individuals, this model prioritizes the wisdom of the crowd when making investment decisions.
What is a DAO?
A Decentralized Autonomous Organization (DAO) is an organization governed by smart contracts, self-executing pieces of code that run on a blockchain. DAO members deliberate and make decisions that are then executed using these smart contracts. A DAO, in effect, can function without human maintenance and run continuously. Even if DAO members lose interest or abandon the project, the DAO's framework will still live on due to its immutable nature.
The most common way DAOs make decisions is through voting mechanisms based on governance tokens. The more of the governance token you own, the more voting power you have. Some DAOs allow any member to make a proposal, while others may limit this right to a specific group. DAOs are used commonly to manage DeFi (Decentralized Finance) projects, blockchains, and other protocols in the crypto world.
How do investment DAOs work?
An investment DAO will usually have a general goal or principle it works by. Some invest in specific industry segments like GameFi or DeFi protocols for example. Investment decisions are made according to these principles using a proposal mechanism.
Holders of the investment DAO's governance token have the ability to make proposals. Some DAOs will limit this to holders of a certain amount of token or some other subsection of the group. This could be to stop spam or only allow members with a high enough stake to suggest investment decisions.
Once the proposal is made, users will either stake their tokens or use a snapshot mechanism to exercise their voting rights. Snapshot looks at the number of governance tokens in each wallet and distributes voting rights based on that without locking the tokens. This helps avoid users swaying the vote by buying more tokens once they've seen a proposal. Once voting is over, the decision is implemented according to the results.
Profits from investments are distributed either via airdrops to governance token holders or through a staking mechanism. By staking your governance token, youโll then receive a share of rewards that you can withdraw from the smart contract.ย ย
Investment DAOs often run active community channels on Discord and Telegram to help organize, inform, and facilitate their proposals. A DAO is only as successful as its community, so it needs to maintain a healthy and active membership.
Where does an investment DAO get its funds from?
There are several ways an investment DAO can build up its treasury. The most common method is a governance token sale. A new DAO will mint its token and offer it to the market using one of the various sale mechanisms available. Investors will purchase it either for speculative purposes, voting rights, or both.ย
A DAO set up by experienced investors with a solid investment strategy would likely attract a large community of potential DAO members. After selling their governance token for a cryptocurrency like bitcoin (BTC), ether (ETH), BUSD, or other stablecoin, the DAO would then have funds in its treasury. They may also keep some governance tokens in the treasury for future sales.
Another popular method is the issuance and sale of non-fungible tokens, or NFTs. These can be purely collectible or also offer some other utility. For example, an NFT could be issued that provides extra governance rights.
Finally, some investment DAOs will already have treasury funds and digital assets from previous successes. For example, a DeFi project may already have revenue available from its services offered. Its DAO could then decide to invest the money. However, when we refer to investment DAOs, we usually mean ones that deal only with investments.
Are investment DAOs legal?
The answer here will depend on your jurisdiction. You may also find that there are no specific regulations when it comes to investment DAOs, making their status challenging to determine. To get a rough idea, you should first look if the investment DAO's token is adequately regulated. It could perhaps be categorized as a security in your country and need specific licensing. It may also fall under some other crypto regulation.
The concept of investing together as a collective isn't new, and many countries already have regulations for investment clubs. The IRS, for example, has specific requirements for groups who collectively invest in order to share the profits. Whether or not an investment DAO would be regulated the same must be taken up with your local regulator.
What are the risks of investment DAOs
While investment DAOs successfully decentralize power according to token ownership, risks are still involved. Don't forget that holding any cryptocurrency has risks, and investment DAOs also have specific risks associated with them too:
1. Smart contract failure - The smart contracts running the DAO may fail due to a hack, exploit, or faulty code. This could break the mechanisms needed to run efficiently and manage the DAO's funds.
2. Bad investment decisions - The investment DAO could invest in projects that provide negative ROI (return on investment). After all, there is no guarantee that a majority decision is always the best one.
3. Fund mismanagement - Investment DAOs need to maintain their treasury properly. If they don't diversify their portfolio or manage it well, the DAO's investment funds could be at high risk.ย
Traditional VCs vs. investment DAOs
There are a variety of advantages and disadvantages when comparing VCs and investment DAOs head-to-head. While an investment DAO has opened up a traditionally closed industry, its โgrayโ status makes it difficult for investors and projects raising funds to work with. Due to the stringent requirements in traditional investments, most investment DAOs would only be able to work with other crypto projects in practice.
However, when it comes to Web3, investment DAOs have some significant advantages. Traditional VC firms have shown great interest in the potential of Web3 but typically demand a lot in return for their investment and expertise. But when it comes to Web3 and blockchain technology, VCs often don't know as much as their decentralized counterparts. Therefore, funding from an investment DAO could provide the same principle, crowdsourced expertise, and a more equitable deal.
For more traditional industries, the value added that a VC can bring is huge. These firms often have established networks and a range of supportive services. Above all, they also have the legal and regulatory backing needed to operate with peace of mind.
Closing thoughts
Investment DAOs have become a hot topic since the last crypto boom in 2020/2021. The idea that the longstanding VC model can be disrupted is attractive to small investors and blockchain fans. We're yet to see how the relationship between the two types of players will develop as the concept is still a young one. As always, if you decide to experiment with investment DAOs, understand the risks fully and how that fits in with your portfolio strategy.