The Implications of Web3 in Venture Capital Development

Crypto, DAOs, ICOs, Web3… You have probably heard at least one of these “buzzwords” over the past year since the cryptocurrency bubble at the start of the pandemic. 

If so, you might have also heard talk about a world of “decentralization”: how the economy will shift to a more private, peer-to-peer, and digital structure, and where individuals are empowered and institutions and governments are removed. Digital currencies can change how we transact; non-fungible tokens (NFTs) can disrupt the art and media industry; decentralized finance (Defi) can impact financial institutions– these are some of the widely talked about implications of this new era of decentralization and tech. 

Now, we are seeing more startups emerging with “Web3” based solutions that seek to change society. In addition, VCs, such as Andreessen Horowitz and Paradigm, are now pouring billions of dollars into this new and controversial industry, excited about the opportunities and bullish on its extreme returns on investment. However, what VCs don’t fully recognize is how the crypto industry can potentially disrupt their own businesses. How will these “buzzwords” change the venture development side of the economy? Will there be a shift in how startups will be funded? Let’s discuss. 

But first, let’s clarify what some of these “buzzwords” mean so we don’t get lost in the semantics. Too many people have carelessly thrown these terms around without understanding their technical definitions and their purposes. 

Here are some key definitions to know before we proceed:

• Cryptocurrency (or “crypto”): digital currency or tokens that can be traded through a blockchain network. While each cryptocurrency may serve a unique purpose, the ultimate use case of crypto is to remove large institutions such as banks from controlling your money.
• Initial Coin Offering (ICOs): When companies sell cryptocurrencies to investors to raise money and fund projects. Think of this as the cryptocurrency industry’s equivalent of an IPO (initial public offering). However, investors do not have an equity stake in the company. 
• Decentralized Autonomous Organizations (DAOs): An online organization constructed by encoded transparent rules that are controlled by its members. Through this bottoms-up management system, organizations are democratized and can act in a common interest. Think of them as community-led organizations rather than having a distinct leader. 

“What about Web3?” you might ask. How does this fit into the world of cryptocurrency? 

There are many misconceptions and definitions of what Web3 might be, but broadly speaking, Web3 is really an idea of a new era of the internet that is built upon decentralization, blockchain, and tokenomics (crypto), all with the overarching goal of empowering individuals and combating the influence of institutions. With that being said, it incorporates cryptocurrency, ICOs, DAOs, and many more concepts. 

Now that we got the terminology out of the way, let’s refocus on the potential impacts Web3 has on a specific part of the economy: venture development.

Remember, the idea of Web3 is to give power back to individuals. In the context of funding startups, I can see two ways in which this space can potentially disrupt venture capital.

1).  The rise of investment DAOs. There has been an increasing number of venture capital funds structured as DAOs that are entering the startup ecosystem, especially those focused in the crypto niche. While crypto startups are still predominantly funded by VC giants such as Andreesen Horowitz, perhaps the DAO model can offer additional benefits to founders which traditional funds cannot. 

Firstly, with the tendency of DAOs being built upon a large crypto-native community, startups can receive a wide host of feedback and advisory on their value proposition. Product and/or service prototypes can be tested, critiqued, and improved upon. Startup founders can network and understand the market they are serving with ease. VCs on the other hand, while they may have industry knowledge, may not fully understand the startup’s niche. Nor do they have a community for founders to lean on.

Secondly, having community access means an opportunity to source for human capital. Perhaps a select number of people really like a founder’s ideas, and want a stake in the startup in other ways. Perhaps these people are experts in media, hiring, legal services, etc, and the startup lacks these departments.  

On the other hand, DAOs can also serve to benefit investors through its decentralized nature.

For example, take a classic syndicate fund: in this model, there is a lead investor, who makes the investment decisions and directly interacts with the startups, and there are passive syndicate investors, who simply contribute to the fund and pay the lead carried interest. However, in an investment DAO, every member has a say in the investment decisions and opportunities to interact and network with startup founders. Democratized power.

2).  Seeking funding from ICOs. Alternatively to VC funding, startups can prepare for an ICO and create and sell their own tokens. Over 3 billion dollars have been raised this past year in ICO’s alone, and is looking to compete with venture capital funding. But why sell your own digital token rather than pitch to a VC?

Firstly, ICOs give startups the opportunity to raise from non-dilutive equity. The sale of a token does not equate to buying a share of the company. Instead, investors are betting on the high appreciation in the coin’s value, rather than owning a portion of the company’s profits (the coins may also have special use cases, but I will get to that in a bit). Thus, startup founders can still raise money while still reaping all company profits to themselves.

Secondly, startups are able to build a large community of stakeholders through an ICO. They can list their offering publicly and engage with a host of investors. In addition, perhaps these coins are governance tokens, allowing investors to have a role in the startup and make decisions. With an ICO, startups can build a community. With a community, there is traction. With traction, there is opportunity for growth. VCs don’t have a community of stakeholders to offer founders. 

Great. There are a plethora of potential benefits that Web3 offers to venture development. Why hasn’t society dumped the traditional VC model and moved on already?

Government Regulation and Concerns.

With these elements of Web3 being new and highly unregulated, combined with the fact that its primary purpose is to remove government authority, the US government is pushing for increased litigation on crypto. While the crypto space offers great potential, many are reluctant to adopt it because the space allows for many bad actors and unprotected investors. Individuals can make investments while avoiding taxes. DAOs lack an explicit tax, liability, and treasury management structure. The anonymity of the space allows for illicit transactions to be made. Scammers can put out ICOs for investors that turn out to be pump and dump and “rug pull” schemes. The list goes on. In this sense, government regulation can be seen as beneficial: there can be a safer crypto ecosystem built, investors can be better protected, and a notoriously volatile market can be stabilized by demotivating “get rich quick” schemes. 

On the other hand, remember what crypto’s premise is built on: the elimination of intermediaries, central authorities, and institutions. Government regulation is shifting the balance of decentralization back to centralization, violating Web3’s premise and pushing crypto enthusiasts away from even participating. In fact, we have already seen this last year when China banned crypto trading in its country, leading crypto markets to crash. China today is not the only country to even ban crypto transactions: Egypt, Iraq, Qatar, Oman, Morocco, Algeria, Tunisia, and Bangladesh are some of the other countries that also created strict jurisdiction over crypto. 

Perhaps worldwide government regulation will only injure the sentiment and potential of Web3.

There are many variables at play here. A community of individuals are ready to adopt a decentralized digital based economy. Others don’t see Web3’s practicality and view it as a place for crime. Governments are pushing for regulation. Now, US inflation soars at a 40-year high, causing crypto markets to crash once again and leaving investor confidence mixed– some believe this crash is just a hiccup in an otherwise opportune space for startups, while others see this as the beginning of an end. Personally speaking, to determine whether Web3 will be revolutionary to the economy in the broadest sense, the best we can do is wait and observe. Government regulation is inevitable. The economy will eventually cool down and stabilize. Thought leaders and groups will continue to promote anti-crypto sentiment. Let’s see how the crypto community reacts to all these variables in the next few years, and then we can revisit this again. 

What do you think? Do you think Web3 will change how we conduct business, especially in venture development? Or are we witnessing the beginning of the end of Web3?