Next Up – Decentralized Venture Capital
Combine ABC’s Shark Tank, crowdfunding, and decentralized apps using blockchain technology and you have a pretty good idea of the concept behind decentralized venture capital (DVC) markets also referred to as venture DAOs (decentralized autonomous organizations).
DVCs function with the same intent as a venture capital (VC) fund, which privately invests in promising startups. The main difference is that DVCs are collectives of average investors who contribute relatively small amounts to cryptocurrency-based funds to create a pool to support these ventures.
Given their democratic nature and blockchain-enabled transparency, DVCs are going to substantially replace a major portion of our traditional VC system within a decade.
The End of the Insider’s Club
For years, many startup companies and entrepreneurs relied on private sources of capital (as opposed to public equity markets, for example) for the capital resources they needed to scale their companies and take them to the next level.
Twitter, Facebook, Airbnb, Amazon, and others went this route, bringing their early VC investment opportunities to wealthy individuals and pension funds, endowments, and other institutions, who eagerly invested in these companies and reaped remarkable returns.
It’s been an insider’s club. By law, only “accredited” investors and institutions can participate in a traditional VC fund. Accreditation is subject to U.S. Securities and Exchange Commission (SEC) regulations and is based on wealth, income, and measures of financial markets experience.
Democratizing Venture Capital
While the SEC accreditation rules are intended to protect inexperienced and less wealthy investors from bad decisions, they’ve locked out these average investors from lucrative private investment opportunities. But like so many aspects of our lives, blockchain technology, and decentralized financial platforms are leveling the playing field and changing that in a big way.
The recent experience of the ConstitutionDAO shows how this could work. ConstitutionDAO, a decentralized autonomous organization, was a group of 17,000 investors that pooled crypto funds to collectively bid on a privately held copy of the U.S. Constitution.
While their pool of Ether cryptocurrency ultimately wasn’t quite enough to outbid another solo investor, the experience validated the principles behind a DVC fund: thousands of small investors could band together to back, or crowdfund, financial projects within a blockchain-based environment.
Advantages for the Entrepreneur
Moving forward, DVCs will prove to be a boon for startups.
Just as special purpose acquisition companies (SPACs) have provided an arguably easier route to public securities listing for a new company, DVCs will provide a possibly less rigorous pathway for attracting private venture capital.
Also, these days the physical location of a company headquarters is becoming less relevant to its operating success. While traditional VC firms tend to focus on financial mega-centers on the East Coast or world financial capitals, DVCs will remove that geographic bias.
A startup with a strong business plan and model, whether the company is in Des Moines or an island in the Pacific, will be able to compete for venture capital on a more level playing field and attract cryptocurrency financing based on merits, not location.
Further, this future entrepreneur will benefit from the collective, diverse expertise of the online members of the DVC. They’ll have the opportunity to make suggestions to improve the business model, introduce the company to staffing and sales opportunities, and generally serve as ambassadors for the company – all transparently and openly on-chain.
For the Investor
Investors will benefit from DVCs too.
Most importantly, DVCs will democratize these private investment opportunities. It remains to be seen whether the SEC will ultimately step in to apply some type of accreditation requirements to a person’s involvement in DVCs.
Additionally, while traditional VC companies tend to maintain a long-term stake in the companies they invest in, with their investment locked in and illiquid for a period of time, a DVC can allow individual investors to “tokenize” their portion of the asset. As with any other non-fungible token (NFT), this personal stake could be sold, allowing the member to cash out and realize their capital gain much earlier, almost creating an informal security exchange.
Of course, we’ll have to see how the SEC feels about that as well!
The Hazards of DVCs
There’s no doubt that along with the greater democratization from DVCs comes a greater risk of scams or exploitation of small investors.
VC firms are quite thorough when it comes to vetting a business opportunity. And while there’s some safety in crowd-vetting through a DVC, there’s also a legitimate concern about crowd frenzy, misinformation, and investor-spread mania as we saw with various “meme stocks” in the past two years.
Just as with cryptocurrency speculation and investing, we’ll likely see country-specific regulations and guidelines, which could serve to send the activity underground or to a more forgiving location thanks to the global nature of cryptocurrency.
Which Industries will Participate?
Industries that engage directly or indirectly in cyber currency and/or the blockchain will be the most likely to see the benefits of DVCs and pursue these capital assets. For example, startups in the Metaverse demand a new way of doing things, and DVC will be one of the new tools for bringing the Metaverse to life. That comes with a risk to investors, though, as their passion for all things blockchain might be manipulated so they latch on to questionable investments.
We’ll also see DVC funds formed around personal causes, priorities, and passions. For example, there will be DVCs formed to support promising alternative energy startups, minority-owned businesses, women-owned businesses, and region-based development. We’ll see DVCs specializing in certain industries like gaming or alternative transportation, hopefully with investors experienced in those areas.
Will tomorrow’s DVC-financed companies be the better for it? The kind of transparency, open debate, and investor engagement that’s possible in a DVC investing community is certainly different from the singular profit focus we’re more likely to see in a traditional VC.
You have to wonder if Facebook and Twitter would be facing the same kind of criticism and scrutiny today if their business models had been subject to the scrutiny of thousands of small investors in a DVC setting a decade and a half ago.