- Luca Prosperi went from Wall Street to DeFi with the belief that DAOs will be the future of finance.
- They are decentralized structures that have much lower operational costs than traditional banks.
- Investors should see them as similar to small-cap tech startups with high risk, he said.
There’s no doubt that blockchain technology is shaping up to disrupt many industries, including the banking and investment worlds.
Traditionally, centralized institutions like companies and banks are tasked with providing trust for transactions. Moving forward, these entities may face increased competition from protocols built on blockchains, including decentralized autonomous organizations (DAOs).
DAOs are made up of a community of participants that support a protocol in various ways, such as through governance and programming activities. They can take all forms, including platforms that support DeFi, NFT marketplaces, and metaverses.
Before getting involved with DAOs, Luca Prosperi spent 15 years in traditional finance and on Wall Street, with over three years at Morgan Stanley as an associate in the investment banking division. He also worked at a few buy-side shops where he focused on investing in banks. His interest in DAOs came from his understanding of how they could restructure finance.
Today, he’s still very much involved in finance but in a different way. He handles lending oversight at MakerDAO, a lending protocol built on Ethereum. He’s also an independent researcher for his own outlet called Dirt Roads, a newsletter about DeFi.
Prosperi was attracted to MakerDAO because he saw it as an efficient and transparent version of a bank with a low cost of capital, and a very fluid balance sheet.
MakerDAO lends capital in the form of a stablecoin called dai. Borrowers put up their crypto as collateral. The protocol allows 18 collateral options, including ethereum (ETH), Wrapped Bitcoin (WBTC), Tether (USDT), and Chainlink (LINK).
For MakerDAO, the ratio of collateral to loan varies based on the crypto staked but it is always over collateralized. For example, to borrow $100, a user may need to lock up $150 worth of value. This ratio is increased based on how risky a token is deemed.
Borrowers also pay a fluctuating “stability fee” to the network, which can shift dramatically based on governance votes, but has historically gone from 0.5% to 16.5%. The fee is similar to the interest rates paid to banks for loans. Prosperi said that the value generated from fees supports the ecosystem because it’s used to pay participants, hold reserves, or buy back tokens, similar to a share buyback model.
Today, DAOs hold about $9.5 billion of value in treasuries across more than 4,800 platforms, according to DeepDao, a live value tracker. This is up by more than 94% since June 2021 when the total value held was about $607 million.
“Most probably in the next 10 years, you will see DAOs that are intermediating more business volume than JPMorgan. So I think it really matters,” Prosperi said.
Borrowers may find DeFi platforms more attractive than banks because they can skip credit checks and income verification, and in many cases, remain anonymous.
“In some ways, DeFi is already competing with traditional banks,” says Grace Rachmany, a DAO consultant and co-author of, “So you’ve got a DAO.”
Whenever new technologies come into place, they wipe out inefficiencies in current systems, she said. A great example of this is Amazon, which revolutionized retail.
Investors and DAOs: The good, the bad, the ugly
A digital, decentralized world can be murky. In particular, DeFi projects can often have unknown founders, random users weaved together by social media platforms and public forums, and projects that often have no legal structure. If things go sour, there’s often no one to call.
The recent blow-up of Terra’s ecosystem after its stablecoin de-pegged from the dollar, further plagued DeFi’s already trending negative reputation.
So why should investors care about DeFi, in particular, DAO-based ones? Despite all the kinks, Prosperi believes there’s a bright future for these structures.
Take a top exchange like Coinbase for example, it’s a publicly-traded company that had a valuation reaching $80 billion in 2021 with thousands of employees. Recently, it suffered a hit because of market dynamics within the crypto sector, Prosperi said.
Coinbase shares (COIN) plunged by about 69% year-to-date down to about $79 as of Tuesday. The company told staff it would slow hiring and reassess its headcount needs.
On the other end, you have a protocol such as a DAO which has a smaller number of “employees” or rather participants. They can intermediate more volume than these mega-companies through smart contract automation. Because of this, Prosperi believes these structures are well-positioned to compete with old business models.
Indeed, due to the absence of high labor and operational costs, DeFi has the lowest marginal costs relative to traditional banks and nonbanks, according to the Global Financial Stability Report by the International Monetary Fund.
However, the same report also highlights numerous issues with these platforms. These include exposure to riskier borrowers and higher liquidation due to crypto
, which occurs when the loan-to-value ratio drops below a certain margin, cyberattacks, money laundering, and legal and jurisdictional uncertainties.
Additionally, investing in a DAO isn’t as straightforward as investing in stocks. Investors don’t get quarterly earnings reports nor is there a government agency tasked with oversight and investor protection for this jurisdiction.
In publicly traded companies, you can purchase a share. In crypto, things aren’t as standardized. In general, a governance token is the closest comparable to purchasing a share in a company, Prosperi said. A token can grant its holder the ability to participate in the decision-making process and receive returns if the value of the token increases. Often, the more tokens a user holds, the higher their governance power is, Prosperi said.
“An investment in a governance token is very similar to an investment in equity. So it’s a residual claim on the cash flows of a project. So it might go to zero, like equity,” Prosperi said.
But buyer beware. Rachmany says unlike a share, the value of these governance tokens is only based on the demand for the token, rather than the underlying asset of the company.
MakerDAO’s governance token is MKR. As of Wednesday, it was trading at around $1,322, down almost 78% from its all-time high.
In short, think of it as a small-cap tech start-up, Prosperi said.
There are three overarching risks Prosperi says investors need to understand about this type of structure.
First, like any startup, a lot of future value is priced into the value of the token and that value can fluctuate quite a bit, he said. Therefore, investors should consider its risk level similar to that of a small-cap tech company.
Keep in mind, Some DAOs are more centralized while others are completely decentralized and are purely governed by smart contracts, he noted. MakerDAO fits the latter model, which means it’s purely decentralized.
Second, there’s operational risk. Like software, new projects often have bugs and loopholes that could open the door to hackers. It takes time for these structures to mature and improve.
is also a sore spot. Even though you’re holding a certain amount of value in the form of a token, there still needs to be market demand to exchange it. If demand drops for any reason, such as a loss of trust in the ecosystem or competition, that value may be lost very rapidly. For example, when Terra’s stablecoin slipped by about $0.10 from the dollar, it took about 3 days for the value to plunge even further, falling below $0.20. To date, it’s barely worth $0.02. It also dragged its sister coin LUNA down with it.