Tribute Labs CEO Aaron Wright and COO Priyanka Desai (above) at a Williamsburg, Brooklyn, mural of a popular nonfungible token (NFT). Their DAO service operation created Flamingo DAO, which turned a $10 million investment into a $1 billion NFT collection. Photograph by Jamel Toppin for Forbes.
The leaderless investing collectives known as decentralized autonomous organizations are generating a lot of eyerolls. Thanks to high flexibility and low regulation, they’ll also soon generate a lot of profits.
By Jeff Kauflin with Isabel Contreras
“This is an incredibly risky move. I don’t know if I agree with this.’’ Erick Calderon, the founder of a company named Art Blocks in a risk-oblivious field, nonfungible tokens, was nonetheless concerned. It was February 2021, and Calderon was one of 59 investors who had banded together to potentially buy a rare set of 150 popular NFTs, CryptoPunks, directly from their producer, Larva Labs.
The group, a decentralized autonomous organization (DAO) called Flamingo, had pooled $10 million and met weekly via Zoom (audio-only to protect those wanting anonymity) to figure out what to do with it. The CryptoPunk opportunity, at about four ether ($7,200 at the time) per punk, would eat 10% of that, which is partly why Calderon aired his concerns on the group’s Discord channel.
The tension got thicker when members discovered one of their own—someone going by the pseudonym “Pranksy”—had tried to front-run the deal, opening a back channel with Larva Labs to buy 150 punks for himself. In the end, Flamingo members voted to spring for the punks, which were recently valued at $30 million. As for Pranksy, he left the DAO “by mutual agreement,” telling Forbes he was “somewhat naïve [about] the DAO process.”
A few of the CryptoPunks owned by Flamingo DAO.
Most of America is. Sure, you’re probably familiar with the concept: leaderless collectives in which groups democratically make investment decisions, such as when 17,000 members of a DAO tried to buy one of 13 surviving original copies of the U.S. Constitution last year. Aaron Wright, CEO and cofounder of Tribute Labs, which set up Flamingo, calls a DAO “a sub-reddit with a bank account.” But while the headlines tend toward the splashy or the silly, a new model is emerging that has real legs as an alternative investment vehicle.
A quarter-century ago, an Illinois “investment club” run out of a church basement, the Beardstown Ladies, spawned a slew of bestsellers and imitators as stock-picking groups proliferated. DAOs have modernized and digitized the concept, incorporating many of the traits that make the blockchain so potent.
By using tokens, DAOs can efficiently allow votes, empower profit sharing and, crucially, supply liquidity, as tokens can be bought and sold—though for now, trading in tokens is not something the Securities and Exchange Commission is ready to bless.
By limiting membership to 100 people or fewer, some DAOs are also able to skirt SEC rules, since they fall under a quaint 82-year-old “investment club” exemption—so long as the participants are all involved in managing their kitty and don’t publicly offer their securities.
And while the leaderless model can be called, by another definition, anarchy, it also lets those interested in alternative assets play without having to outrun the 20% profit share that hedge fund, venture capital and private equity managers regularly charge for what too often is average performance. Syndicate, which makes DAO-in-a-box software, partners with another startup that can help you do all the legal and tax paperwork for $2,000 a year, while Tribute charges 2% a year of the DAO’s original investment to do all that paperwork and incorporate things like coordinating group calls (not coincidentally, the same upfront vig that funds charge). The difference here is that the profits are all yours.
Combine all that, and you have something that can’t be judged by all the dumb headlines. Instead, think of DAOs as a legal platform, much as nimble LLCs emerged decades ago as an easier way to incorporate than the lawyer-laden C Corp. The early adopters might seem silly. The second wave will make it mainstream.
Exhibit A: Kinjal Shah is a partner at VC firm Blockchain Capital, in San Francisco, which has a traditional fee structure on $1.8 billion under management. Nevertheless, Shah cofounded a DAO called the Komorebi Collective, which has 35 female investors, $400,000 in capital and a goal of investing in crypto startups with female and nonbinary founders. In creating an investment vehicle (leveraging Syndicate services) that isn’t weighed down by institutional investors or high hurdle fees, Shah says the DAO can “have a lot more experimentation and flexibility.” And those are two terms that tend to portend exponential growth.
The early days of DAOs did the model no favors. In 2016, early adopters of ethereum formed “The DAO” to back crypto projects, quickly attracted $150 million—and then lost one-third of that to a hacker before making a single investment. While the attacker was denied most of his spoils after developers controversially “forked” (reissued) ethereum, the point had been made: The DAO disbanded, and all DAOs carried a stink akin to that of early dark web marketplace Silk Road.
Nevertheless, the concept gradually spread. By 2018, roughly 10 DAOs had been formed. By 2020, there were nearly 200 of various types, according to DeepDAO. Yes, embarrassing incidents continued, including numerous “rug pulls”—scammers collect money for a DAO crypto offering and then abscond with the loot, a digital version of The Music Man. Just this January, BadgerDAO, a 24,000-member organization that lets people earn interest on their bitcoin, lost $120 million in a cyberattack.
But the sheriffs are flooding into this Wild West. Today, more than 50 companies offer blockchain security auditing, according to OpenZeppelin. And the number of DAOs keeps surging—it currently sits at more than 4,000, with over $8 billion in their treasuries.
Yes, the populist teams and populist themes attract the headlines. PleasrDAO, which has about $100 million in assets and a mission, according to its “chief pleasing officer,” Jamis Johnson, that varies between doing “dope shit” and building “a portfolio of assets that represent internet culture,” shelled out $4 million for the Wu-Tang Clan’s one-of-a-kind album Once Upon a Time in Shaolin (buying it from the feds, who seized it from Martin Shkreli, the jailed “Pharma Bro”). It also spent $5.5 million for the “Stay Free” NFT minted by fugitive National Security Agency whistleblower Edward Snowden and $4 million for an NFT of the original “Doge” image—the mascot of the cryptocurrency Elon Musk promotes in tweets. But look closer, and you’ll see that this isn’t the “stonks” crowd—investors include the platinum-chip venture firm Andreessen Horowitz (firms, as well as individuals, can invest).
A quarter-century ago, an Illinois “Investment Club” run out of a church basement, the beardstown ladies, spawned a slew of bestsellers and imitators as stock-picking groups proliferated. DAOS have modernized and digitized the concept, incorporating many of the traits that make the blockchain so potent.
While fans may have fantasized through the decades about banding together to buy their hometown sports teams, the Krause House DAO provides a legitimate group with a far more serious path to that unlikely goal, incorporating former players and superfans in a campaign to buy an NBA team.
A lot of this increasing legitimacy can be credited to Wright, the 41-year-old Tribute Labs cofounder and law professor, who has been obsessing over DAOs since the start. After graduating from Cardozo Law School in 2005, he vacillated between entrepreneurship, cofounding sports discussion site Armchair GM, which was sold to Wikipedia’s for-profit arm for $2 million in 2006, and New York corporate law, even representing Jay-Z in an intellectual property dispute.
In 2014, seeking more intellectual freedom and better hours, Wright began teaching law at his alma mater and combined his two careers, founding a legal clinic for tech startups and expounding on crypto and blockchain. In 2015, he advised the cofounders of ethereum on their first “crowd sale”—they sold ether for 30 cents that now trades around $2,500—and later offered his thoughts on The DAO. Wright didn’t invest in The DAO, he says, because “it wasn’t 100% clear what you were purchasing, what the structure would look like and whether that would work.” Vindicating his concern, in a postmortem, the SEC concluded the tokens The DAO issued were securities that should have been registered.
In 2017, Wright cofounded what would become Tribute Labs with Swiss software engineer David Roon to advise companies on how to embed legal contracts into the blockchain, adding new Cardozo grad Priyanka Desai as chief operating officer. In essence, he was selling the pans in the gold rush, but he couldn’t help but prospect too—he’s one of the key figures behind Flamingo.
While Tribute’s DAOs are funded with ether and operate on the blockchain with certain key protections written into their code, they’re organized as Delaware limited liability companies, with investors holding their equity interest in units, not crypto tokens. To further keep SEC watchdogs and reporting requirements at bay, they’re open only to accredited investors—investment funds and individuals with income above $200,000 or investable net worth above $1 million. No investor can own more than 9%, and Wright limits his own holdings to 1% of each DAO.
The Tribute DAOs’ bylaws require only a majority of those voting on any deal (not a majority of all members) to approve a purchase and provide for a mechanism for disaffected participants to get their money out—or, as it’s known in the DAO world, to “rage quit.” Despite all their interaction, members can choose to remain anonymous from one another. Tribute Labs, with 12 lawyers, engineers and financial types all working remotely, vets all participants, fulfilling federal “know your customer” requirements and issuing annual K-1 tax reports required by the IRS. Flamingo participants hail from New York, California, Puerto Rico (a crypto investor tax haven) and Australia, among other places.
Wright points out that the U.S. legal system is more DAO-hospitable than those in Europe, since in the U.S. you can create member-managed companies that don’t designate a single manager or CEO. He helped write a new Wyoming law that allows for LLC DAOs but says the Dela-ware law is just as flexible.
Additional Tribute-fueled DAOs have sprouted almost organically. Last October, Neon DAO raised $20 million in just 45 minutes to invest in the metaverse and has already bought undeveloped virtual land. Two months later, Noise DAO, focused on music NFTs, closed in 30 minutes and raised $7 million. Red DAO raised $12 million in September to focus on digital fashion (both NFTs representing ownership of a physical piece of clothing and outfits in the metaverse). One member is already advising fashion brands on NFT strategy—not unusual, as DAO members often see themselves as players and not just passive investors. Flamingo, for example, commissioned NFTs by unknown artists who have gone on to digital fame—in part via the credibility conveyed by Flamingo.
How big could investing DAOs get? The global money management industry now tends more than $100 trillion in assets, and Syndicate cofounder and CEO Ian Lee predicts DAOs will hold at least 2% of that in 10 years, increasingly moving into big money pools like stocks and real estate. A former VC and head of crypto at Citigroup, Lee has some big-name backers for Syndicate, including Andreessen Horowitz, Coinbase Ventures, Snoop Dogg, Ashton Kutcher and Reddit cofounder Alexis Ohanian.
The ecosystem matures quickly. In a house 90 minutes from Vancouver, British Columbia, 39-year-old Jess Sloss is a leader (or, as he calls it, “instigator”) of Seed Club, which aims to be the Y Combinator of DAOs, running eight-week startup workshops for cohorts of 15 that win acceptance into the program. It gives them advice on topics like marketing and how to launch a token.
Sloss got into digital marketing, then went to work for crypto startups. Along the way, he joined the ranks of those frustrated by the power of the big web companies. “The value that we were creating for these networks was massive, and our ability to have a say in those networks, or have an ownership stake, was minimal or zero,’’ Sloss says. “Are we just going to be living with these feudal overlords and farming for them?”
Feudal overlords? Sloss isn’t quite as out-there as he sounds. Last year he raised $2 million from dozens of angel investors including a Tribute Labs DAO; Union Square Ventures partner Nick Grossman is a backer. Plus, Seed Club is just one of many DAOs animated by a determination to make sure creators and those who come up with ideas—as well as investors—keep a fair share of the wealth. DAOs, says the 50-something Frank Rotman, a managing partner of fintech venture capital firm QED who has recently started studying DAOs, are “playing to an ethos and a zeitgeist that has hit the next generation.”
The global money management industry now tends more than $100 trillion in assets, and Syndicate cofounder and CEO Ian Lee predicts DAOs will hold at least 2% of that in 10 years, increasingly moving into big money pools like stocks and real estate.
Out in Silicon Valley, Syndicate is looking to scale up the DAO model far faster, with a service that allows up to 99 investors to instantly turn an ethereum wallet into a DAO—a “Web 3 Investment Club’’ that votes and tracks its holdings on the blockchain. The basic setup is under $300; the service launched in late January, and in under a week, 200 DAOs had signed up.
Pitfalls abound. Scammers continue their pestilence. If assets do swell into the trillions, it’s hard to see the SEC adhering to rules designed for the financial equivalent of knitting circles. The regulators already consider tokens to be securities if they can be bought and sold—as opposed to merely used for voting and then burned (destroyed) when an investor withdraws. And an entire decentralized trading exchange, Uniswap, already exists. “It really is mass civil disobedience,’’ Rotman muses.
Finally, there’s the matter of performance. If the wisdom of the crowds better mimics the meme-stock bozos than the enlightened ideals of Aristotle, DAOs will have a short shelf life. After their bestseller drew scrutiny, those Beardstown ladies were ultimately revealed to be market underperformers, rather than Buffetts in the basement. Then again, the faceless hordes behind Flamingo have done far better than just CryptoPunk NFTs—their ahead-of-the-curve calls have helped them turn $10 million into nearly $1 billion in 15 months. A 1% stake in Flamingo, which originally cost $23,000, now goes for 3,000 ether—about $8 million. And new members are screened for the knowledge and influence they can add—not unlike a blue-chip VC or hedge fund seeking partners, but without the crazy fee structure.
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Source: https://www.forbes.com/sites/jeffkauflin/2022/02/03/daos-arent-a-fad-theyre-a-platform/