While traditional venture capital financing modalities are continuing to appeal to the senior investing audience, the truth is that this style of fundraising is quickly becoming obsolete.
Current trends show more and more people are interested in, and educated on, higher risk and higher profit investments, focusing on emerging technology projects in need of funding.
So, it is not surprising that the old financial ecosystem reliant on VC funds is being replaced with a more modern, and flexible investment model. Featuring the core values of on-chain transparency and the democratization of initial funding of the startup ecosystem, decentralized venture capital fundraising is shaking up the startup investing game.
Below you will find the most relevant information about this emerging funding modality and how it's reshaping the investment world into a more accessible and trustful space.
What Venture Capital Funds (VC Funds) Are All About
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Limited partnerships (LPs) are commonly formed by investors, in which the partners invest in the VC funds.
A committee is usually responsible for making investment decisions for the traditional VC fund. Following the identification of portfolio companies with promising growth, the pooled investor capital is used to support these startups in exchange for an equity interest.
A strong management team, a vast potential market, and a distinctive product or service with a strong competitive advantage are all things that VC firms look for. They also look for possibilities in areas they are familiar with, as well as the possibility to own a big portion of a project, and so, have a say in how it is run.
Traditional VC firms are ready to take a chance on such startups since they tend to profit handsomely if they succeed. 25% to 30% of venture-backed companies fail.
Why Is the Traditional Venture Capital Industry Not Working Anymore?
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Taking a look back at the history of money and investments, the venture capital type of capital raising has been around as a model of investing in promising companies since the beginning of the 1900s.
It all began with a couple of wealthy families interested in growing their wealth while funding small local startups.
Until the 2000s Nasdaq crash, this type of investing used to be one of the most popular means in the market to acquire finance for developing a startup.
Up to now, venture capitalists are primarily endowments, family offices, pension funds, and ultra-high net worth individuals.
Parallel to that, the three essential steps that every VC firm must do for their investors to succeed have been centralized in small partnerships, usually sitting on venture capital land, Sand Hill Road.
These are the steps:
- Acquiring capital from limited partners;
- Finding high-potential companies for the future funding (due diligence);
- Choosing the finest ones to provide capital.
At first glance, it might seem reasonable to centralize these processes. It may even appear simpler and faster for the VC firms and the projects.
However, centralization means that this investment system is full of blurred information, mystery, and secrecy. With centralization creating so many barriers to a successful investment flow, it is not surprising that soon a new system is finding its footing within the industry.
How Does Decentralized Venture Capital Work?
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Decentralized venture capital harnesses the power of blockchain technology and smart contracts to revolutionize the funding landscape, emphasizing openness, transparency, and accessibility. Here are key facets of this evolving trend.
Tokenization of Ownership
This venture capital type shifts away from traditional equity-based ownership models to tokenized assets. Startups use smart contracts to issue tokens - often as a utility or security token - to investors, granting them ownership stakes in the project based on the size of their investments. This token is tradable on decentralized exchanges, enhancing liquidity and democratizing ownership by allowing broader participation.
Global Participation
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DVC breaks down geographical barriers, enabling all community members with internet access to participate. This inclusive approach levels the playing field for all startup ecosystem members globally, particularly benefiting startups in regions with limited access to traditional venture capital networks.
Decentralized Decision-Making
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Unlike traditional venture capital funds, which rely on a select group of firms, this new type of venture capital involves a decentralized network of contributors. Decision-making processes concerning funding, governance, and project development are decentralized, community-driven, and managed through smart contracts, empowering token holders or DAO members to collectively steer the course of investments and impact the deal flow. This distributed model reduces reliance on centralized gatekeepers, promoting a more democratic and inclusive ecosystem for innovation and investment.
In essence, decentralized venture capital represents a paradigm shift in the venture capital ecosystem, leveraging blockchain's capabilities to foster a more transparent, accessible, and community-oriented approach to funding crypto-focused startups globally.
DVC vs Traditional Venture Capital Funds
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In short, decentralized venture capital has the same goal as traditional VC firms that provide capital privately for promising businesses.
The core difference is that DVCs are groups of average investors, other investors than in the VC firms. They give small contributions to cryptocurrency-based funds to promote these startups and receive tokens in exchange.
While the VC regulations aim to prevent new members and low-net-worth investors from making poor choices, they have effectively shut out these individuals from profitable private investment options.
However, blockchain technology and decentralized financial platforms along with decentralized autonomous organizations are leveling and drastically altering that same investing landscape.
The decentralized VC principles are simple: thousands of other investors have the option and ability to join together to back, or crowdfund, financial ventures in a blockchain-based ecosystem.
Besides the democratization of the investor persona, the decision-making processes around DVCs are also different. In traditional VC firms, the decision-making is rather vague. There is no standardized method to find a consensus. While some VC firms may prefer a voting method, others might let it be an individual decision. Whatever procedure they choose, the process is often kept secret
So, how is someone to be sure that the company they wish to invest in is non-consensus and has a high return potential, if they can not learn everything about it?
With the decentralization of the three critical steps for venture capital (VC) success—fundraising, investment, and governance—coupled with the inherent transparency of blockchain technology, the entire investment process becomes remarkably clear. This transformation benefits both investors and the startups they support in several significant ways.
First, decentralization in fundraising opens up access to a global pool of investors, removing geographical barriers and democratizing opportunities for startups worldwide. This inclusivity ensures that innovative projects, regardless of their location, have the chance to secure funding from a diverse range of backers.
Second, investment decisions are no longer confined to a small group of venture capitalists. Instead, they are made collectively by a decentralized network of contributors. This shift reduces the influence of traditional gatekeepers and introduces a broader array of perspectives, potentially leading to more equitable and diversified investment portfolios.
Finally, decentralized governance mechanisms ensure that the ongoing management and strategic direction of funded projects are transparent and participatory. Token holders can vote on key decisions, fostering a sense of ownership and community involvement. This collective decision-making process helps align the interests of investors and startups, promoting a more collaborative and supportive ecosystem.
Overall, the decentralization of VC processes, enhanced by blockchain transparency, creates a more open, efficient, and democratic investment landscape for each investor. Community members willing to invest in a crypto-focused venture benefit from an ability to access promising startups and greater involvement in their growth, while startups gain from a wider network of supporters and a transparent, accountable funding environment. This synergy holds the promise of driving innovation and success in the startup ecosystem.
For startups, it is easier to reach for funding through DVCs, as the range of investors has increased, and access to them is less rigorous.
Additionally, DVCs remove all geographic implications that could influence an investor's decision. The project will also be able to gain access to investors as a collective, benefiting from the diverse expertise of the online members, being introduced to staffing and sales opportunities, and overall gaining advisors for the company.
For those willing to invest, as the opportunities open for less wealthy individuals and include more process transparency, individual investors can "tokenize" their piece of the asset using a decentralized VC. This personal stake can be sold, just like any other NFT, and allows the community members to cash out and enjoy their financial gain much sooner than in a traditional scenario.
Why VCs Are Becoming More Decentralized
Source: Freepik
VC platforms must excel at three things in order to thrive:
- Raising funds from general partners
- Identifying projects and companies to invest in
- Selecting the best projects
Each of these three ventures has traditionally been highly centralized. However, this is changing as a result of new networks and models of corporate governance.
One of the most recent, known as decentralized autonomous organizations (DAOs), aims to decentralize all three at the same time.
VC platforms have experimented with decentralized autonomous organizations over the last decade. Several online applications and bounty referral schemes - which include scouts and equity partners - represent a unique approach to identifying fresh investment opportunities for a VC DAO on a large scale.
Examples and Use Cases
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Let's delve into some real-world examples that illustrate the concept of DVC.
Initial Coin Offerings (ICOs)
ICOs represent an early form of DVC. Projects such as Ethereum and EOS pioneered this model by raising significant capital through the sale of tokens directly to the public. These tokens served as ownership stakes in the respective blockchain platforms, allowing investors to participate in the growth and governance of the networks.
Decentralized Autonomous Organizations (DAO)
Decentralized autonomous organizations (DAO) are decentralized autonomous entities governed by a community of token holders (DAO members). They operate without traditional hierarchical management structures, using smart contracts to manage funds and make decisions.
Decentralized autonomous organizations like MakerDAO and Aragon exemplify this decentralized governance model, where members propose and vote on initiatives, shaping the organization's strategies and priorities collectively.
Liquidity Pools and Yield Farming
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DVC platforms such as Uniswap and Sushiswap facilitate liquidity provision to decentralized exchanges (DEXs) through a liquidity pool. Users contribute their crypto assets to a pool and earn rewards in the form of trading fees and governance tokens. The profit depends on the share of the assets contributed to a pool.
Yield farming expands on this concept, enabling community members to maximize returns by strategically deploying their assets across various decentralized finance (DeFi) protocols, where they can earn additional assets or interest on their holdings. All the processes are handled automatically by smart contracts.
These examples showcase the diverse applications of DVC, demonstrating how blockchain technology and decentralized governance mechanisms with the help of smart contracts are reshaping traditional funding and capital investment paradigms.
Challenges and Considerations
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Despite its potential, DVC encounters several challenges.
Regulatory Uncertainty
The regulatory environment surrounding tokens and DVC is still ambiguous. Different jurisdictions apply varying rules to tokens, complicating compliance efforts for startups and crypto-focused investors alike.
Risk and Volatility
DVC tokens are susceptible to high volatility, which can impact both startups, their communities, and investors. Price fluctuations may affect crypto-focused project funding and stability, requiring careful risk management strategies to receive the expected profits.
Complexity of Governance Features of a DAO
Source: Freepik
DAO decision-making processes can be slow and contentious. Balancing community input with efficient decision-making poses a continuous challenge, affecting the agility and responsiveness of DAO.
Decentralized venture capital represents a transformative approach to fundraising for crypto venture startups. By prioritizing transparency, inclusivity, and technological innovation, DVC has the potential to reshape the startup funding landscape and empower a new wave of entrepreneurs.
The Future of Venture Capital Investing
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Although it is a somewhat new funding modality, it's already clear that DVCs will most certainly overtake the role of traditional venture capital firms. If not entirely, at least on a substantial scale.
The vast market for emerging crypto-based products and services creates a high demand for resources and qualified developers. It means that funding for those initiatives is needed and there shall be a place for every type of investor to join.
With this new landscape on the horizon, the truth is that there isn't enough traditional venture capital money to meet the rising market demand.
With venture capital firms, only a small percentage of initiatives that make it to the pitch room have a chance to get the idea off the paper, while endless others don't even get the opportunity to start.
DVCs, on the other hand, can help solve this demand dilemma by tapping into the seemingly endless capital available in the hands of the accumulating prosperous middle-class members.
Industries that are directly or indirectly involved in cryptocurrencies and blockchain are most likely to understand the benefits of decentralized venture capital and be financed with its help.
For example, decentralized venture capital will arguably be one of the essential tools to fund Metaverse and its related startups. Some specific industries of the future, such as gaming, are deeply involved with decentralized venture capital.
But there are shifting focuses on a more broad scale towards funds focused on supporting more passionate projects, such as promising alternative energy startups, minority-owned and female-owned companies, and some projects focused on local community development.
Bottomline
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Decentralized venture DAOS and DVCs are the new wave within the investment landscape. For those seeking more flexible and democratic investing opportunities that are still secure and trustful, it may be one of the best modalities available to this date.
Decentralized venture capital platforms have the primary goal of reuniting and allowing a group of entrepreneurial finance-focused investors to fund any promising initiative that can contribute to society and overall technology advances, along with the crypto community, while still generating satisfactory returns on investments to the collective of investors.
That is also in direct alignment with the BullPerks' mission.
Utilizing the BullStarter platform, the company offers a safe space for investors and entrepreneurs to match anonymously. Promoting an environment that is now easier than ever for startups to reach out for funding and develop their projects with all the necessary resources.
Learn more about how to invest in VC deals through BullStarter by clicking here.
