DAO: a distributed, autonomous corporation.
(A backgrounder can be found here.)
Just more than a year ago, as I was completing work on Augur, a couple of old friends proposed to me a crypto-equity crowdfunding entity. It would be structured similar to “The DAO” currently being flooded with ether right now. I was skeptical, to say the least.
This is a group text I received from them a few days ago. (Edited for clarity):
“The DAO was [our] idea, and it’s going to put your b**** company out of business.
Power of the people, not some dudes that burn everyone’s money into the ground.”
This made me LOL for a few reasons.
But for context: I now work as an investor at a blockchain-focused venture capital firm.
The first reason I was amused by this text was the eternal truth of entrepreneurship: Ideas are 1 percent of a business, execution is 99 percent.
Secondly: Venture-capital funds don’t burn “everyone’s” money (maybe limited partners’) — they invest money into startups who, then, in turn, may burn it. (Notably, “VC-backed ventures have more impactful innovations and experience faster commercialization rates” than angel investors, according to theJournal of Business Venturing.)
Most importantly: Having been immersed in the incredibly intricate business of venture capital for the past year, I am even more unconvinced that a DAO really has a substantial place in the world of investing.
Lastly, as someone who cofounded one of the first DAOs (Augur), please allow me to lay out my thoughts on this extraordinary fundraising phenomenon, because I am mildly terrified by what is happening.
To give my friends credit, thereis a role for DAOs in the world of finance, albeit a small one. Let me provide an anecdote from my own entrepreneurial experience to elucidate:
When we first started building Augur, a decentralized prediction market platform, we quickly came to the conclusion that there was no way we could incorporate an entity building our software as a for-profit organization. Our consensus mechanism relied on the participation of thousands of individuals reporting on the outcome of events using a token.
Thus, a crowdsale (crowdfunding), as opposed to venture capital, was the only game-theoretically viable manner with which to distribute the token. However, without a minimum viable product (MVP), we had no capacity to execute such a financing.
A platform like “The DAO” would have been an excellent way to sell early access to the token, at a discount, before we had an MVP good enough for a crowdsale.
But how many software projects have a similar structure to Augur? Considering it took us only $300,000 to get to a crowdsale, and the $5.5 million we received was more than enough to sustain the software for the near future — it’s hard to see where the $147 million currently raised will be invested.
This is particularly relevant as any business backed by “The DAO” has to be built entirely on the Ethereum blockchain (as opposed to having off-chain, or multi-chain, components). In other words, any money made from the proposal that isn’t earned directly through the backed smart contract will not trickle back to the “The DAO” participants.
When I left Augur to “join the dark side” (VC), it was with the expectation that we could hopefully help finance Ethereum-based companies. To my delight, we have been able to do so.
That being said, I have been less than impressed with the projects that have opted to raise capital through crowdsales since Augur (e.g. Digix, Lisk). Each of these sales raised between $5 million and $6 million, which is substantial, but fortunately not earth-shattering, should they fail.
And this touches on an underlying issue with the “The DAO”: This potentially revolutionary funding mechanism has the capacity to democratize access to capital … assuming nothing goes wrong.
As with any new technology (following The Lean Startup), it would probably be better to test out DAOs slowly, before pouring money into them.
To many, the $18 million crowdsale behind the Ethereum blockchain was ludicrous. However, blockchains (such as Bitcoin’s) provided some precedent, and obviously the investment paid off (ether, which was sold for 30 cents in the crowdsale, is now trading around $12.30). The $5.5 million behind Augur’s token sale was also labeled as crazy, but at least prediction markets have a long history, the mechanisms behind how Augur would work were clear, and there was a working alpha product.
“The DAO” has no clear precedent, nor pressing use case. With Title III of the Jobs Act going into effect recently, despite its burdensome restrictions, there’s even less of a compelling argument to be made for this new crypto-entity. In the relatively brief time I have worked in venture capital I have yet to see a concept I found to be deserving of backing not receive it.
But let’s suppose that “The DAO” is, in fact, a self-evident tool that the world needs ….
One-hundred and forty-seven million dollars is a lot of money. Even to the biggest banks or hedge funds, to Mark Zuckerberg or Bill Gates— that sum is substantial. Even if half, or more, of the “investors” pull out their contributions before their money gets locked up, there are going to be tens of millions of dollars locked in this smart contract.
Should anything go wrong, there will be hell to pay … although who will pay is only vaguely clear.
From Russia to China to the United States, and everywhere in between, hackers, scammers and schemers of all sorts are going to be trying to tap into this massive honeypot.
I am a huge proponent of the wisdom of crowds. I literally spent a year of my life arguing for it while promoting Augur. But the binary or combinatorial option of predicting who will become president is a lot simpler and more straightforward than regularly reviewing and investing in startup ideas.
How on earth are the participants in “The DAO” supposed to conduct, and share, due diligence on entrepreneurs and/or programmers proposing projects? Of course you can have forums and Slack to discuss, but how does one differentiate between noise and valid input? Who is going to do a thorough background check on each submitter? That’s like blindly asking Reddit to make a major life decision for you.
Startup investment is not easy. I have learned this firsthand. Even at a small, boutique venture fund, we spend hours upon hours evaluating a single company. Can DAO members really be expected to do that for the hundreds, or even thousands, of proposals “The DAO” receives? And with the creators of this entity suggesting that projects request funding monthly, which “investors” really have the time for the necessary scrutiny?
Another question is how this will logistically work. “The DAO” totally sounds great in theory. But in practice, it is anyone’s guess. Even with Augur, where the team has gone through MVP, prototype, alpha and beta stages, there’s no saying how the system will truly work until it goes live. Tens of thousands of hours of testing and simulation will help us predict, but only the final product determines a smart contract’s fate. And, of course, there’s the possibility that there may be a bug in the code. In that case, there’s a 100 million dollar-plus bounty for whoever finds it.
I don’t want to dwell on the legal issues here, because I spent too much of my life defending the legality of Augur to now be critical about “The DAO.” However, I would be beyond shocked if the Securities and Exchange Commission, and beyond, have not taken a keen interest in this platform. The legal research I did for Augur makes so much of this platform alarming, and for good reason.
Ultimately, I hope 'The DAO' is a wild success.
The money raised so far has the potential to do no less than radically change the world of bureaucracy, entrepreneurship, venture capital and the very nature of what it means to have a company. It’s a phenomenal idea in theory.
But I wish we had started a little smaller, and a little less ambitious.
If anything goes wrong with this grand initiative, the ramifications for future DAOs (or those such as Augur), smart contract technology and Ethereum will be far greater than what Mt. Gox did for Bitcoin. It would be catastrophic.
I hope that doesn’t happen. Death by a thousand cuts (or in this instance, poor investments) would be far more optimal. But there’s a large financial incentive for matters to turn awry, quickly.
One of the reasons venture capital exists is to take risks other sorts of investors and lenders are unwilling, or unable, to take. In the past 60 years, some of the most important technology, medicine and beyond has begun with venture backing. The crowd will never replace a thoughtful, value-added investor.
Ideally, however, “The DAO” can democratize access to early capital, so the playing field becomes more even for aspiring entrepreneurs, who can then come to professional investors with more fully baked products. That would be truly revolutionary. Alas, only time will tell.
The only action that can be taken now is to cross our fingers and hope nothing breaks.
My heart can’t take another Gox.
Editor's note: This is a guest post by Jeremy Gardner and the opinions represented are those of the author.