What are the essential differences between Web3.0 VC and Web2.0 VC?

Original Author: Tom Shaughnessy, Co-founder of Delphi Digital
Original Compilation: 0x137

Delphi Digital is a leading global research and consulting firm in the cryptocurrency space. This article summarizes the views of Tom Shaughnessy, co-founder of Delphi Digital, shared on his personal social media platform, and is organized and translated by Rhythm BlockBeats as follows:

The VCs in Web3.0 are completely different from those in Web2.0, and the stakeholders in Web3.0 are also better than those in Web2.0. Jack Dorsey (former CEO of Twitter) is wrong in his belief that VCs have disrupted Web3.0. In my view, Jack's worldview is based on Bitcoin as the ultimate cryptocurrency and the entrenched structure of Web2.0 VCs, which is very different from Web3.0 VCs. I believe his perspective on venture capital is biased because he has not actually spent time building or investing in DeFi and Web3.0 applications, which can be attributed to his rigid and economically costly "Bitcoin fundamentalist" stance.

In Web3.0, capital allocators and community members should be the same group of people, inseparable. However, over time, those venture capital firms that are merely capital allocators will be eliminated, as in this world capital is abundant, and project founders need to find stakeholders who are engaged community members. Jack views VCs as controlling entities of projects, but in reality, it depends on the VCs themselves and the specific investment structures they use. At best, Web3.0 will be a space led by elites and completely driven by the community, where the life and death of each project are based on its community. If a project does not listen to or adapt to its community (i.e., its users and owners, who are the same), then its traffic and capital will dissipate.

In a well-structured project, only the community can control the direction of the project, not the VCs. Web3.0 VCs can submit governance proposals, while a university student from Mumbai can also publish his ideas, both of which will be reviewed and evaluated by the community. Currently, in non-L1 Web3.0 applications, the execution of proposals may be semi-centralized (multi-signature, access codes, etc.), but the community actually controls the entire project, as they can vote with their wallets or sell their assets to voice their opinions.

In Web2.0, users could not even vote with their wallets because they could only buy stocks at ridiculous valuations after an IPO. Nowadays, stakeholders in Web3.0 projects can receive airdrops, stake tokens, and participate in new projects earlier. The situation for Web3.0 stakeholders (who may be VCs or retail investors) is much better than that of Web2.0 because:

1. Web3.0 has incentives from early ownership, while Web2.0 can only purchase stocks after an IPO.

2. In Web3.0, anyone can propose changes on governance forums, while VCs in Web2.0 have special access to company boards.

In summary, compared to Web2.0, ownership and transformative capabilities in Web3.0 come earlier and are open to everyone.

Back to VCs, whether in Web2.0 or Web3.0, they must provide all original value-added services. This includes legal support, operations, recruitment, and talent retention, even engaging in long-distance calls like a psychologist to discuss development visions and resolve internal issues with the team. However, in Web3.0, to remain competitive, VCs must also be active daily members of the community. These activities include considering token economics and incentives, future products or application scenarios, active governance discussions, and promoting projects, among others. In Web3.0, VCs are also stakeholders, just like everyone else, but let’s not forget that now their partners can also play an active role in supported projects, while Web2.0 VC partners cannot participate in board discussions for Uber and propose large-scale changes.

In any case, "doing it perfectly" is a moving target. I believe the best Web3.0 venture funds will undergo significant changes in the coming years, and my prediction is that these venture funds will become more like DAOs!

Currently, I see this as an internal process to expand inclusivity, incentivize procurement, and restructure company structures. All members of the fund are active, while passive investors will not be welcomed. So why haven’t funds opened their doors to allow anyone who wants to participate to invest freely through open Web3.0 investment DAOs? Simply put, it’s because U.S. regulations make it very difficult to operate compliant and unlicensed investment DAOs.

First, venture funds seeking capital in the U.S. must register as investment advisors with the U.S. Securities and Exchange Commission (S.E.C.), unless they meet specific private advisor or venture fund exemption standards (private: assets under $150 million; VC: more than 20% of investments cannot be non-qualified assets, i.e., not securities). Most crypto venture funds cannot meet these requirements, cannot become Exempt Reporting Advisors (ERA), and must register with the government immediately. Keep in mind that if a DAO wants to use some of these exemptions, it cannot help them escape the constraints of the rules (KYC or AML, establishment of GP and I-advisor entities, leverage restrictions, and redemption rights, etc.). Furthermore, since most people believe that crypto assets will be classified as securities, the venture fund exemption standards may even become a false proposition. If a fund becomes large enough, the exemption will no longer be effective, and they must become registered investment advisors, but a decentralized fund can hardly meet the current legal restrictions, operational requirements, and reporting quantities. Here’s a data point on part of the cost difference: a 2017 study by the National Venture Capital Association estimated that the annual compliance cost for ERAs is about $60,000, while for RIAs (Registered Investment Advisors) it is $330,000.

Second, in addition to investment advisor exemptions, funds also need to comply with investment company registration requirements or file with the S.E.C. Most funds use Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. Funds that do not use passive capital typically rely on the 3(c)(1) exemption, which means no more than 100 people own shares in the fund (entities composed of multiple people investing and holding will count towards that total). Funds can also attempt the 3(c)(7) exemption, but that is for "qualified purchasers" (you must be an institutional investor and significantly wealthier than qualified investors). Funds wish to use these exemptions to avoid ongoing information disclosures, activity requirements for managers, controls on affiliate transactions, and restrictions on trading activities, such as short selling and derivatives trading. However, the reasons these exemptions do not work for investment DAOs are:

1. When you have 100 or fewer partners and do not publicly offer partnership interests, then 3(c)(1) is valid. A typical DAO (which generally has a large number of members and lacks KYC) will not be able to meet the above registration requirements, and currently, it is even uncertain whether traditional funds based on smart contracts can comply with these requirements.

2. 3(c)(7) requires all partners to be "qualified purchasers," meaning they must have over $5 million in assets, which contradicts the global open participation concept of DAOs.

I firmly believe that ultimately all funds will seek to become on-chain clubs and will be more like DAOs in the future, making it easier to obtain permissions for purchases and redemptions, and more effectively rewarding people for specific work done (procurement, port collaboration, etc.) or added value brought (operations, legal, coding, etc.). Why? Simply because crypto projects are community-driven, and large funds that cannot adapt will not be able to compete with the entire community, just as five venture committee members cannot compete with millions of people worldwide.

Forward-looking funds are already researching these topics. We can see that many projects are making on-chain funds viable: Syndicate DAO, Enzyme Finance, Babylon Finance, Spar Protocol, and some current cases: VENTURE DAO, The LAO Official, etc. Historically, DAOs have always been far ahead of their time.

Conclusion

I believe Jack's views on VCs are incorrect; he is too focused on Bitcoin and lacks experience in building DeFi and Web3.0 applications, as well as collaborating with VCs. VCs in Web3.0 are just community members like everyone else, and Web3.0 funds are continuously evolving. I expect that most of them will be on-chain in the future, with complete community ownership and participation. Although so far funds have not accepted becoming DAOs, they can make forward-looking changes internally. I would be very willing to sit down with Jack to discuss all these topics, and I believe it would be a productive conversation.