Why Traditional Investors Might Dislike DAO ‘s
Despite the bear market, venture capitalists’ interest in cryptocurrency may be reaching a tipping point. The authorization of Tornado Cash highlights the conflict between the law of the land and the law of decentralization. While this has sparked much debate in the crypto world, it has discreetly raised deeper worries among venture capitalists. During the epidemic, a watershed event happened (and passed with little attention) that represented these fractures.
On June 9 of this year, the Merit Circle DAO community voted Yield Guild Games (YGG) out as their initial investor. By doing so, the community terminated the SAFT agreement that was binding Merit Circle Ltd., its parent company, and its backer, YGG. This was the first time that decentralized autonomous organization (DAO) governance reversed a legal agreement, sending shockwaves through the investor ranks.
YGG is kicked from of Merit Circle.
The simple agreement for future tokens (SAFT) is the de facto legal agreement utilized in early stage crypto project financial transactions. Surprisingly, this method has its origins in the 2017 coin offering boom as a way to bypass security laws. When a project uses a SAFT to acquire funding, it accepts money from the investor without selling, offering, or exchanging a currency or token. However, because SAFTs are non-debt financial products, investors who acquire one may lose money and have no recourse if it fails.
In September 2021, YGG entered into a SAFT agreement with Merit Circle Limited for a 175,000 USDC seed investment in Merit Circle DAO. Merit Circle started a new effort on their forum in April 2022, ahead of the vesting timeline, inviting seed investors to promote their contributions to the Merit Circle DAO.
Several investors were deeply concerned about the occurrence.
Many community members concluded that YGG did not provide value to the DAO. A DAO member proposed ending YGG’s SAFT by refunding their initial investment and purchasing back the tokens. This proposal obtained a majority vote and the DAO community’s endorsement.
This was a very concerning development for the founding team, which had to enter into damage control mode.
They emphasized YGG’s benefits to the society and even warned the community about the moral and legal repercussions of terminating the arrangement. More crucially, they asked the proposal’s owner to submit an alternate plan in order to reach an agreement with YGG. Finally, a counterproposal was approved in which the DAO paid $1,750,000 for YGG’s 5 million MC tokens at 32 cents apiece. While this provided YGG with a huge 10x return on investment, it left it with no governance rights or future role in the project’s progress.
The law of the land versus the DAO’s law
Both YGG and Merit Circle DAO published public comments indicating an amicable conclusion. However, in an interview with journalists under the condition of anonymity, several investors voiced great worry about the occurrence
The unwillingness to openly express worry about such an occurrence is already an unusual tendency for space investors. Legally, YGG has reasons to enforce the provisions of the SAFT and reclaim its governance rights and capital gains acquired during the five-year period specified in the agreement. However, most VCs stated that they would not have taken such action and would have struck a settlement similar to what YGG achieved. For investors in the area, reputation is the most sacred currency, and any evidence of them being antagonistic towards community choices might adversely harm their transaction flow. “In this area, everything is governed by narratives, whether or not the facts support it,” one investor said. We cannot risk a narrative forming against our fund.”
Even if legal redress existed, the episode demonstrated how severely inadequate legal safeguards for investors in the industry are. Despite the presence of a SAFT, it offered little protection when confronted with a community vote. Legal action was also rejected by investors owing to the lack of legal precedence for cases like these, which may result in protracted and pointless legal fights for them.
As VCs become more wary of DAO investments, this will “certainly impact the architecture of SAFTs moving forward,” according to Romit Mehta of Lightspeed Capital India. SAFT agreements may become more watertight in terms of vesting schedules, investor commitments, and the DAO’s internal power structure. In future SAFT agreements, the measurements for an investor’s value contribution may also be clearly established. Investors may also impose extra company structure restrictions, such as establishing the DAO as a Wyoming DAO LLC, a fresh new legal classification.
Can communities make fair decisions?
On the one hand, this case demonstrates the ability of communities to hold freeloading investors accountable. However, considering the often-intangible rewards of investment, It also raises legitimate concerns about whether communities can fairly assess the value added by investors. The investor’s sense of value may differ from that of the founders, the core staff, and the community. The credibility supplied to the initiative by an investor through early-stage finance is difficult to quantify.
Furthermore, in the early phases, investors and entrepreneurs frequently have secret talks that might be highly beneficial to the project. Above all, once the project is sufficiently decentralized, there may be knowledge asymmetry between the founders and the community. Even in the instance of Merit Circle, we noticed that the founding team was supportive of YGG and had a different perspective on their value offer than the community.
Nitin Sharma, General Partner and Global Web 3 head at VC firm Antler Global, feels that global institutional investors or investors with specific understanding in crypto may offer value to crypto companies. While cryptocurrency experts provide topic experience to product development, global investors add fresh networks, advisers, and personnel from all over the world. Their investing experience has a network impact and can be beneficial to the project’s early growth. However, this is a tough value for a society to assess.
In the instance of YGG and Merit Circle DAO, YGG confirmed in an official statement that the SAFT imposed no duty on the DAO to offer any “value-add” services. This increases the This begs the question of what criteria the community may use to violate a legal agreement and remove an investor.
More talks on whether the DAO community should have a say in all DAO affairs will take place in the future. The open governance mechanism may allow every member of the community to have a say on all key DAO affairs. However, they may disregard legal obligations to investors.
At the same time, communities are the foundation of a DAO’s success. Founders must find a tough balance between decentralization and having a voice, and they may choose not to delegate all governance choices to the community. Investors are likely to do supplementary due diligence and will go more into the voting process and community expectations.
This occurrence has established a major precedent in the DAO investment bubble. Given the general growth in crypto regulation and the bear market, we will see changes in how VCs legally structure their future DAO investments.