The Challenges Facing Venture Capital In Digital Asset Markets

Abstract

Decentralized cryptocurrency markets pose thorny conceptual as well as regulatory challenges for venture capital firms looking to engage with new crypto projects. Focusing on venture capital’s attempts to fund emerging decentralized autonomous organizations (DAOs), we provide an overview of these difficulties. This Chapter makes three points. First, traditional tools used by venture capitalists are ill-suited to mitigate the risks of financing DAOs. A VC’s usual control mechanisms, enshrined in contract or exercised through soft influence, can struggle to gain traction within a DAO’s more communitarian and dispersed membership structure. Rewards may not always align with a member’s funding contribution where the DAO determines a member’s gain by assessing a wider suite of contributions (e.g., providing feedback on new projects, engaging actively in governance and community-building). Further, the typical IPO-based exit is usually not available within a DAO-based model. Secondly, a lack of regulatory clarity within the U.S. has added to the complexity of pricing VC contributions within decentralized markets. While legal risk should diminish as reform crystallizes, the recency of crypto markets, their novel technological attributes and limited history of regulation can still continue to headaches for firms seeking to engage with them cost-effectively and confidently. Thirdly, we note that, even as decentralized crypto markets pose a complex set of questions for venture capital firms, they can still come with considerable reward. Extending to fostering creative technological development, venture capital firms and their relatively unique risk-appetite may be especially well-placed to absorb the uncertainties entailed in engaging within decentralized markets – though with greater tailoring of their usual suite of tools to better manage the risks involved.