Investment clubs first gained traction in 1940 with the Mutual Investment Club of Detroit. George Nicholson and Thomas O’Hara created the club to reduce brokerage costs. Quickly they discovered that the real value of the investment club was the connections, conversations, and tips members were able to trade with each other. Today, that club has become the National Association of Investors Corp (NAIC, also known as BetterInvesting) with almost 15,000 individual members and over 100,000 associated members in around 7,000 clubs across the world.
Critical to the investment club’s success is its regulatory status. Members are required to actively participate in every decision that their club makes. This means that ownership in an investment club fails the third part of the Howey Test, since profits are made from member’s own efforts and not the efforts of others. It’s a structure that is well understood by regulatory agencies, with the SEC publishing clear guidelines on what qualifies as an investment club and what investment club-like organizations may need to register or file an exemption.
So, for investors, investment clubs make sense for the following primary reasons:
- Economies of scale from pooled investment,
- Educational resources from fellow members,
- Long term outlook due to membership commitments,
- Reduced costs from investment transactions,
- No financial managers who may have misaligned incentives, and
- Clear, simple regulatory structure.
The main disadvantage for investment clubs is that, without newly developed advances in distributed technologies, coordination and communication between large numbers of members slow or even prevent effective and quick decision making. The need for coordination is the primary reason most startups have charismatic founders. These founders often make decisions that damage their firms (see Elon Musk’s trouble with the SEC) but the benefits of increased coordination by having one person act as the face of the firm greatly outweigh the costs.
But what if we could have the benefits of investment club coordination without the centralization risks of single charismatic founders? Blockchain technologies seem especially suited to resolve the conflict. SwiftDao, for instance, is currently developing clear and effective rules based on the best practices of corporate governance on the Ethereum blockchain. But we don’t have to look to the future to see the potential of investment clubs on the blockchain. A strong argument could be made that MolochDao is an investment club in disguise, since members who are inactive are forced to exit.
One of the key factors for an organization to be considered an investment club is that members who do not participate exit. The reasons for what may seem a draconian requirement make common sense on closer inspection. Inactive members are relying on others to do the hard work and are freeloading. So why would the other members allow freeloaders to participate? Frequently, the reasons are not altruistic. As we have seen with the ICO craze, over 92% of blockchain projects have failed, frequently with the founders and early investors running off with the money leaving the later participants holding giant bags of worthless tokens. The double whammy of freeloading and fraud makes only the most unusual projects able to succeed.
Some argue that the solution is government regulated ICOs. An observant individual might notice that most individuals arguing for such regulation work for centralized token exchanges and other centralized or pseudo-decentralized projects, people who benefited from blockchain without understanding the importance of decentralization. The power of blockchain lies in our ability to leverage it to define rules that are self-regulating, self-improving, and community driven without the need for any central overseer to enforce best practices. The solution is not a return to the past.
Truly decentralized organizational structures, if designed properly, will naturally outcompete centralized structures. Centralized regulation is slow, inefficient, and costly. Not only are agency costs externalized onto taxpayers, but organizations in the US in 2012 alone spent over $1.8 trillion on compliance. Of course, many of these regulations are necessary. The massive fraud during the unregulated ICO bubble is Exhibit A in the minds of blockchain investors who often suffered losses of over 90% of their investment. But when organizations can self-regulate with smart contract-based systems, these organizations will have massively lower costs unlocking trillions of dollars of inefficiencies into the economy.
Decentralized organizations also have the potential to benefit from better governance than traditional organizations. In centralized investment clubs, the member’s ability to make decisions is highly limited except for the very smallest groups. Coordinating thousands of members can do no more than up or down vote the purchase of a particular security. Even with such a simple decision, deliberation and communication can take massive amounts of time. Advances in centralized digital technology have allowed the largest investment clubs to grow to over a thousand members, but without better coordination mechanism they are unable to grow further.
For decentralized investment clubs such as SwiftDaos decisions can be much more complex. SwiftDaos, in addition to purchasing securities, can make direct investments in private companies, hire consultants, and even build products. These decisions can be made quickly, on the order of days instead of months. A rapid feedback cycle allows the organization to adapt to changing market conditions. With the ability to quickly make complex decisions, decentralized investment clubs have the potential to displace many types of traditional centralized organizations.
Furthermore, the union of investors with managers solves many issues related to fraud. For the current state of blockchain project development, fraud is the primary obstacle to future development. The post “Solving Adverse Selection In Capital Markets” by swiftdao.com goes into some of the advantages that preventing fraud creates. Not only does fraud prevention have the primary advantage of protecting investors, it has additional external effects that improve the health of capital markets and the quantity and quality of good ideas that are able to raise capital.
Decentralized investment clubs also protect blockchain projects from the regulatory issues that have haunted the space. As governments use fraud to justify crackdowns on both illegitimate projects that hurt investors and legitimate projects that threaten the axis of power, securities regulation has become the edge of the sword directly placed on the neck of blockchain founders and investors. While centralized governments and corporations will always attempt to preserve their power, perhaps more so in certain countries than others, removing a critical tool from their arsenal buys the ecosystem extra time to develop new, more powerful privacy technologies to protect individuals from institutions. Furthermore, fraud prevention removes a major PR tool institutions utilize to justify their violation of personal economic liberties.
Currently, the project with the most promise to deliver the fraud resistant decentralized organizations of the future is the SwiftDao standard. SwiftDaos leverage blockchain to extend the investment club concept far beyond its original capabilities, all while removing regulatory and minimizing compliance costs. Anyone concerned with personal liberty should take notice of the standards as they develop and provide input, testing, and any other aid they are capable of. But for those with a more cynical outlook, the economic advantages of SwiftDaos make a compelling case for early involvement. Reduced fraud and costs, increased capabilities and speed, better access to capital, all make a strong case for faster economic growth. As SwiftDaos become the global standard for raising capital, investors who learn the tools and build a deep understanding of their function will have a critical advantage in the next stage of decentralized capitalism.