As early-stage Web3 startups continue to gain venture capital attention, the relationship between decentralized autonomous organizations (DAOs) and venture capitalists (VCs) becomes more intertwined. 

According to Messari’s “H1 2022 Fundraising Report,” $30.3 billion was raised across 1199 fundraising rounds in the first half of 2022, surpassing the amount of funding all blockchain startups received the year prior. 

This shows that, despite bear market conditions, there is still significant interest in Web3 projects. Early seed stage startups that included DAO participation — which received 71% of all funding — were particularly sought after.

A DAO operates through coded rules, it ensures that governance in the organization remains transparent and that decision-making is shared among all community members. 

The nature of the way DAOs operate when compared to traditional startups has inevitably changed the way venture capitalists are funding early-stage Web3 projects, Hart Lambur, co-founder of UMA protocol told Blockworks. 

“In the history of modern venture, the huge amount of venture capital raised has all used the same deal structures — but what we’re seeing is that DAOs can actually raise money in a completely different way,” Lambur said. 

“DAOs represent a way to rewrite those rules differently, in a way that we haven’t yet created,” he said.

DAOs are primarily member-driven organizations. The majority of DAOs that exist today have one of two membership models: Token-based membership and share-based membership.

In token-based membership — the most common form — participants hold votes on key decisions with voting weight directly proportional to token ownership. To be truly autonomous, those votes need to directly execute code on the blockchain, rather than merely signal intent from the membership on an issue that developers actually go on to implement (or not).

Share-based membership is similar, but participants who want to become a member must first submit a proposal and be approved before joining the DAO, when shares represent voting power and ownership.

Where does venture capital fit in?

Franklin Bi, director of portfolio development at Pantera, a hedge fund focusing on blockchain-related projects, told Blockworks that token-based membership often gives investors an equal footing in building a position in the marketplace.

“If you really believe in the protocol, you’re expressing that conviction through the market by buying, then you’re voting with that same conviction — it’s an equal opportunity playing field,” Bi said. 

The problem, he said, is often early-stage funding in a closed ecosystem or a DAO with share-based memberships.

“Retail investors don’t get to participate at that level [early stage], so it feels unfair,” Bi said. “The way I like to think about it is that the trade-off for raising capital through this method is also bringing in what is hopefully a high-quality participant into that ecosystem.”

This sentiment is shared by Andrew Jones, the head of growth and marketing at Web3 startup Index Coop, a collective aimed at creating and maintaining the best crypto indices on the market, who said that VCs definitely have a space in the Web3 ecosystem. 

“There’s sort of a love-hate relationship with communities and VCs, but I don’t really buy that,” Jones said.

“We wouldn’t be here — we wouldn’t be functioning — if it weren’t for the fact that VCs bought a token,” he said.

“Governance is a process where it starts with founders, over time you build trust and a relationship, then you get a delegation and work towards decentralization and more autonomy, it doesn’t happen overnight — it’s a spectrum,” Jones added.

Reliance on venture capitalists may be justified for early-stage Web3 startups. For later-stage DeFi protocols (often with millions of dollars locked in its protocol), larger traders often backed by venture capitalists and hedge funds — dubbed whales — can have an outsized influence. 

Marco Moshi, DAO lead at Polygon, said in an interview with Blockworks in June, that the biggest challenge with token-based DAO governance is that a community should not be owned by the richest or the ones that arrived before others. 

“[The] organization’s stakeholders will likely change over time, and DAOs should take into account that their organization is evolving and the individuals involved will also be regularly changing,” Moshi said. 

Most recently, MakerDAO, one of Ethereum’s largest DeFi protocols, voted against adding an advisory committee to implement a more streamlined leadership structure within the DAO. This proposal was hotly contested and viewed by some as a clashing of interests between venture capital and independent participants.

Although this is sometimes the case, Bi believes that these disagreements within protocols are actually quite normal.

“It’s a deja vu feeling because when you go inside a startup, that’s what’s happening most days. People are super passionate and argue with each other. The difference is that startups usually have a CEO that tells everyone to go in a certain direction,” Bi said. “It’s just the nature of people who like to take risks and do passionate things.

For Bi, as an investor, at the end of the day, the most important factor is that the protocol can enhance and develop in a self-sufficient way. 

“Good VCs recognize the value of the protocol is having the community on its side. If a VC drives everybody else out of the community, then they screw themselves,” Bi said. “So there’s still pretty good alignment with VCs and communities overall.”

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