Venture capitalists may lose their position as gatekeepers to startup success.
In addition to the deep dive into distributed autonomous organizations, or DAOs, and their future in venture capital, today’s “The Brief” covers:
- The bubble continuing to inflate as markets roll over historical indicators
SushiSwap, the decentralized exchange based on Uniswap, is proposing to sell a portion of its treasury to venture firms as part of a broader diversification plan. The community finds itself torn in half over the announcement, with some advocating for the benefits of seasoned expertise and others vehemently denying the need for institutional investors.
SushiSwap’s “VC-versus-community” debate provides a case study on the growing world and strength of DAOs. VCs have previously held the essentially sole power over the fate of startups, but in the case of SushiSwap, they are now forced to be in open negotiation with the community.
This power shift presents a window into the vitality of DAOs, stemming from their democratic and global nature, dynamism and anonymity. Will DAOs succeed as the internet native form of organization?
The Breakdown is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Only in Time” by Abloom.
Image credit: BrianAJackson/iStock/Getty Images, modified by CoinDesk.
What's going on guys? It is Monday, July 19 and today we are talking about DAOs and whether they have the potential to transform power in venture capital fundraising. First however, let's do the brief and before the brief one quick caveat. I'm actually recording this on Sunday evening because I'll be traveling tomorrow. So, if some crazy thing happened that I'm not covering, that's probably why. But, with that said, back to the brief.
First of the brief, one more quick follow-up to the "Are institutions just off it?" discussion we've been having, CoinDesk is reporting that according to two sources with knowledge of the matter, Bank of America has approved the trading of Bitcoin futures for some clients. This could be a pretty significant move. Spot trading is one thing, it's becoming more normalized. But derivatives are a whole different level. The logic for Bank of America seems to have to do with the large margin requirements for futures, as well as the maturity of the infrastructure from folks like CME. In fact, one of the sources reports that Bank of America will be using CME futures. For their part, BFA has declined to comment but we know that they previously created a team to research crypto and related tech so, pretty interesting if true.
Speaking of ongoing questions, the questions of stablecoins are headed to the upper echelons of the U.S. government. This week, Janet Yellen convenes the President's Working Group on Financial Markets to discuss stablecoins. She says: "In light of the rapid growth in digital assets, it is important for the agencies to collaborate on the regulation of this sector and the development of any recommendations for new authorities." This follows comments from Powell last week in the Senate and the House that stablecoins are an increasingly important issue, especially as they become more used for payments. And this also follows quite the paper released this weekend from the Fed and Yale, which said that the U.S. government needs to take some pretty serious action, including potentially trying to tax stablecoins out of existence. This meeting is slated to take place Monday, i.e. today, so hopefully I'll have more to share with you here shortly.
Lastly, how long can the bubble inflate? This weekend, The Wall Street Journal ran a piece called "Record Stock Rally Ignores Wall Street's Phobia About Optimism." The TLDR is "warnings about overly bullish sentiment have been better left unheated this year. Have times changed?" The gist of the pieces that all these historic top indicators have just been blasted past. Jason Goepfert, the president of Sundial Capital Research said: "We've been throwing up our hands for a while, for whatever the reason, the market is just rolling over all of these historical indicators that before had a very consistent track record."
So, what are some of those top signally stats? Well, American stock allocations reached almost 60% at the end of March of this year. That's just below the all time high of 61.7% and that came during the dot com bubble. Bullishness among investors on E-Trade hit a more than three-year high, going all the way to 65%. The Equity Put/Call ratio, which is a measure of the volume of bearish option bets versus bullish ones, hit a point that hadn't been seen since 2000 earlier this year. Now interestingly, one of the counter signals they point to is crypto deflating and that they say is a sign of some of the excess coming out of the market. Quote, "In places where speculation has been rampant we have seen massive draw downs: in crypto currencies, special purpose acquisition companies, non-profitable tech companies and meme stocks." But ultimately, the point of this article is that right now, no one knows anything. Jason Goepfert again says: 'Markets are just doing their own thing. Something has changed, whether it's unprecedented stimulus, or maybe there's this generational change with young investors, this new surge into the market keeps driving stocks higher."
Alright, but with that, let's shift to our main discussion. And I know that some of you may not be particularly interested in Distributed Autonomous Organizations, or DAOs. There are a ton of you listeners who are really just focused on Bitcoin and obviously based on how much time I spent on that, I completely respect it. For some, DAOs are irrevocably associated with The DAO, which was a community fundraising project early in Ethereum's life that for a while, was the biggest crowdfunding campaign in history and that ended up being hacked, causing the highly contentious blockchain reorg that lead to the split between Ethereum and Ethereum Classic. For others of you out there, any project with any type of native token is going to raise your skepticism due to how many tokens have been used primarily to enrich founders and early investors. And then finally, for others doubts are worthy of skepticism because they feel to be on some inevitable crash course with the law, doomed to just become LLCs in crypto clothes.
I totally recognize all those critiques and concerns. But, as the show's intro says, I'm interested in big picture power shifts. Bitcoin is clearly an internet native money, produced in a way that doesn't rely on any traditional infrastructure or intermediaries. This fact of its internet nativeness makes it an enormously different, new powerful force in the world. What interests me about DAOs is their potential to grow into an internet native form of organization. Think about it. The other structures of formal human organization today, almost all have their roots in a pre-internet era. Corporations, nonprofits, obviously, these are structures that predate the internet.
The internet has a lot of characteristics that make organizing around it or in the context of it just different. One, its global nature, not constrained to one or even a few jurisdictions. Two, its dynamism and fluidity, people moving in and out of communities much more frequently, and with less friction than in the terrestrial world. Three, anonymity, one doesn't have to engage with internet communities as one's real quote unquote, or legal self. All of these things together make it seem to me that there will inevitably be internet native organizational forms, that allow people to do things as groups with more formality than a Facebook or a Discord group, but without just trying to map offline legal models to the digital realm, in that DAOs are a contender.
Now, people are exploring DAOs that do a lot of different things. But so far, the type that makes the most sense to me, are those that are focused on resource and capital allocations. In other words, a bunch of people pooling capital and then deciding collectively how to deploy it, funds DAOs basically, this is a highly specific type of resource coordination with limited variables and clear ways that everyone is incentivized to participate.
So, with all of that context, this weekend, I've been watching an interesting discussion play out. SushiSwap, which is a decentralized exchange based on Uniswap, is proposing to sell a portion of its treasury tokens to big venture firms. They posted about it on the Sushi Forum, the Sushi Phantom Troupe Strategic Raise, here's a little portion of what they wrote. "As part of the broader treasury diversification plan, we propose that a portion of the 51 million SUSHI that is currently being held by the SushiSwap Treasury be used to onboard institutional investors. SushiSwap has been a DeFi Community darling since inception and at this juncture we feel that it’s ready to welcome established crypto funds and cement SushiSwap as a household DeFi blue chip. Deal Size: Up to $60m (25% of Developer Treasury) with up to 10m allocated to community members. Vesting Terms: 6-month cliff followed by 18 month linear vesting. Base Case Price: range of 20% - 30%"
Okay, so that's the gist of it. They're thinking about giving up to 25% of their Treasury to strategic investors, at least the tokens and the treasury. This has caused a huge discussion. This is an extremely active community, and there are some in the community who 100% do not believe these investors are necessary. They've gotten as far as they have, the logic goes, without these types of institutional investors, why on earth would they let them buy tokens at a discount when those tokens are still clearly a value to the market. There are, however, also people who think that these investors could be valuable, particularly the ones who will fight to help get the SushiSwap community access to new opportunities. Of the community members that do think these types of investors could add value, the two major debates are around 1), how long the lockup should be, and 2), how much of a discount to give.
Now, I'm not actually super interested in those details. Although if I were in the community I would be. The thing that I find interesting, really, really fascinating, is the shift in power dynamics between a project on the one hand, and investors on the other. I lived in San Francisco in the heart of Silicon Valley for a decade. That included a stint as a venture capitalist and involved working with tons of venture backed companies, and a lot of time specifically on helping companies pitch to VCs. The power dynamic in that relationship is super, super clear, with the exception of a tiny, tiny fraction of companies and deals that are extremely hot and can set their own terms that have whoever they want in. In the vast majority of cases, the vast majority of the power rests on the venture capital side of the table. Now, some will tell you that more capital coming into Silicon Valley has changed that a little bit. And that's true. But it mostly manifests itself as higher valuations, not necessarily as it being easier to actually access that capital. And I would argue that even if their power has come down a bit, it's still pretty well enshrined.
Meanwhile, come back over to DAO land and VCs who are interested in this Sushi deal are effectively in open negotiation with the community. Here's an example from Amy Wu at Lightspeed. She writes: "Thank you, everyone, for giving us, Lightspeed Venture Partners, the opportunity to participate in this discussion and to potentially co-lead a strategic round for Sushi. We've read all the comments in the thread and are grateful for everyone's feedback." She then goes on to give a brief introduction to Lightspeed, a brief introduction to herself and then she lists "why we are excited to partner with Sushi: we believe this is one of the top teams in DeFi, we believe in the decentralized governance model the community has established, we believe our areas of expertise are complimentary," blah, blah, blah, blah, blah. "What strategic value can we and other venture investors bring? Relationships outside of crypto, expanded awareness of Sushi beyond DeFi, a history of company building. What does it mean for us to act in good faith here? Be aligned with helping build value in Sushi for the long term, work hard to actively help build out the Sushi ecosystem, be a resource when needed. Why would we act in good faith? Do we already hold SUSHI? Should Sushi raise from VCs now? Does the lockup justify the discount?" And so on and so forth.
For some context, in the normal internet world, Lightspeed is as good a brand as you could get, especially around mobile apps. They lead Snap and historically have had just about every social app going after them as an investor. Another long comment came from Michael Dempsey, who runs a venture fund called Compound, who is an individual sushi holder, but who is not one of the venture companies who might be included in this round. He also makes a pitch for why venture capitalists should be allowed to be involved. He writes, "VCs have lots of experience thinking through the long term sequencing of product roadmaps in order to gain market share, while also having the luxury of being removed from the trenches and seeing innovation at the earliest stages, which will be helpful specifically for a project like Sushi that could be a core leader in the maturation phase of DeFi." He also, however, says that they should have perhaps longer vesting, in other words, a longer period before which they're actually distributed their tokens. So, a longer period before which they can actually sell them on the open market. Sam from FTX jumped in at one point to give a framework for how to think about different VCs, arguing for those that believe they can be valuable, the community should divide them into s**t, meh, good and great. That meme stuck and all of a sudden, there were polls and surveys looking at exactly that, of the VCs that were potentially going to be involved in this, which were s**t, which were meh, which were good and which were great. Unsurprisingly, crypto native venture capitalists score way higher on this list in the community, then the people from outside.
Others in the community started to try to solve the issues of arrays like this that would be particularly thorny to many, especially the discount. A number of different folks propose some version of instead of a discount, selling the tokens at market price, but adding additional options to buy more tokens at some predetermined price in the future. This would still be a bonus with upside for the VCs, but it doesn't feel as bad as discounting an asset that many in the community already feel is undervalued. So at this point, we're starting to see the community get a little close to comfort with this whole deal.
But then, Arca, an investment firm themselves, comes in like a thunderbolt and says that they're vehemently against this value-destroying proposal. Those are their words, obviously, and instead, they offer to buy up to $10 million worth of SUSHI at a premium. Jeff Dorman from Arca writes: "Arca is one of the largest ex-SUSHI holders with 7.51% of the circulating supply. We bought all tokens in the secondary market without lockups or discounts. SushiSwap does not need money. We agree that there is merit in diversifying the treasury but not at current depressed prices, and there is no justification for the size of a $16 million raise. The proposed discount and short lockup are not indicative of a vibrant growth project like Sushi. Sushi is currently trading at a massive discount to its fair value, and now is absolutely not the time to be selling. Arca's new proposal: if the Sushi community is intent on selling from its treasury in this environment, then we will happily be buyers at prices that are advantageous to us but much more fair to the community. Since we strongly believe that Sushi is already trading at a significant discount of fair value, we won't require further discounts. In fact, we will pay above current trading levels."
So, how about that? A VC comes in and says these other VCs are crazy. Don't even think about giving it up. And in fact, if you're going to, if you insist on getting different types of assets in the treasury through a sale, we'll buy a slew at a valuation that's higher than what the market says it is right now. Alright, so here's the thing, the specifics of this Sushi sale, whether it's undervalued, what Sushi's goals are, how VCs might help or hinder that. All of that is a bit out of scope for this show.
What is in scope is the power shift this represents, we've moved from a model in which VCs were the quintessential gatekeepers to capital for innovation, and as such had incredible and sometimes, let's be honest, unjustified influence over startups' lives, to a model where a decentralized network around a protocol is actively weighing if those same VCs should be allowed to invest in a way other than just buying tokens on the market like anyone else can. It's not just the power that has shifted from the VC to the quote unquote, startup. It's that the power itself is being distributed in general into this messy, chaotic process where ideas are smashing up against ideas and influence and outcomes are based at least in large part on who can convince the most in the community of the rightness of their position. And by the way, if you notice that it's super inefficient compared to previous processes, you're right. Community processes, any democratic type processes that distribute power tend to inherently be more messy, it's just part of the deal. Also, I would be remiss to argue that all of a sudden, these VCs aren't powerful. There are far more startups organized as traditional companies than as distributed protocols. And even within network protocols, not all are in a position to turn down hungry capital.
But still, there is a clear shift happening and I think that the winners on the other side are likely to be the venture capitalists and capital allocators that can embrace the humility it takes to participate in this new manner and go do what it takes to get the deal done. So anyways guys, a different type of episode today, a slightly more niche area, but one that I think obviously has a huge impact on how innovation comes to market and how that's going to change. So, hope you enjoyed it. I appreciate you listening, until tomorrow, guys, be safe and take care of each other. Peace!