Blockchain technology has brought up a plethora of unique opportunities. Ranging from decentralized finance (DeFi) to digital ownership via NFTs, there has been a boom of innovative products, platforms, and services.
Cryptoeconomics and tokenizations are unraveling new patterns of ownership and organization. All platforms, services, or products stemming from these patterns are owned and operated by the users. They are specifically created by and for communities they serve. These communities consist of people with different backgrounds, skill sets, and places of residence worldwide.
They are constantly investigating new and ingenious ways to create products and exchange values implementing blockchain technology. At the same time, they are encountering challenges regarding organization, governance, and management, as well as decision-making.
To tackle these challenges, the communities have been embracing new tools that will help them reach significant decisions across language, space and time. Those tools are referred to as governance tokens.
What Are Governance Tokens?
To put it simply, governance tokens stand for ownership in a decentralized protocol. They give a token holder specific rights and authorities that can impact a direction of the protocol. It may refer to new products or features to develop, spending a budget, integrations and partnership to seek, etc.
In general, exerting this power may come in two forms. First, governance token owners can suggest changes via a formal process of submitting a proposal. In case particular criteria are satisfied and the proposal is put to the vote, the holders can utilize their governance tokens to vote for suggested changes. The ways and mechanisms via which these rights are exerted may depend on the protocol.
In situations when there is flat and distributed ownership, along with the lack of defined leadership as is the case with ordinary hierarchical organizations, governance tokens represent a vital mechanism for making decisions within decentralized autonomous organizations (DAOs).
How Do Governance Tokens Work?
In conventional corporations, an executive body, commonly consisting of C-suite, shareholders, and a board of directors, have the right to reach decisions regarding strategic directions of the organization. DAOs are different from classic corporations in terms that they aren’t centralized. As such, they don’t have a centralized “club” of decision-makers. However, there is still the need to make decisions that impact the future of the organization.
DAOs reach such decisions via a formally determined governance process that involves suggestions, proposals and community voting. Even though many types of governance are used within DAOs, the typical feature shared by all of them is the governance token. As a result of being a part of the blockchain, governance tokens imply specific characteristics like unchangeable ownership and transparent distribution. These features make them ideal for distributed decision-making.
Whenever a DAO proposal is put to the vote, governance token holders have a chance to place their vote on-chain. Commonly, the weight of their vote is equal to the number of tokens they have. For instance, if Jenny owns 100 tokens while Jack has 50, Jenny carries twice as much voting power as Jack.
What Makes Governance Tokens so Specific?
Governance tokens belong to the group of utility tokens. A utility token can be implemented to exert particular rights or to gain access to products or services that a protocol offers. The utility provided by governance tokens is the right to impact a direction of a protocol. Some of the examples of this in DeFi protocols are Uniswap (UNI) and Compound (COMP).
Governance tokens are the primary utility token of DeFi protocols. As such, they are forerunners of complete decentralization. They are also the first crypto to represent voting on a blockchain by granting the power of making crucial platform decisions to a whole community. This is due to the fact that token holders are not users only; they are owners of the protocol as well.
Who implements governance tokens?
It may appear that every single project launched recently has a governance token. These tokens may not make sense for every single protocol. However, they do make great sense for some.
The following tokens are some of the instances of governance tokens with excellent use cases, as well as compelling utility outside ordinary voting rights.
Maker is deemed to be among the first governance tokens in DeFi. Its holders can vote on topics that range from DAO governance processes to authorizing new collateral types.
Among all governance tokens, UNI has the greatest market cap amounting to over $3.8 billion at the time of writing. It is a typical governance token in terms that it has little to no utility outside giving its holder the ability to vote.
veToken Finance allows DeFi users to increase their yield and farming rewards without losing liquidity, to lock tokens for long-term holding and investing, and to reap maximum rewards. All of this is achieved while taking part in DAO governance with very little effort invested.
FLX, the decentralized, non-pinned governance token of the stablecoin protocol serves as a support if the protocol plummets. It also enables its holders to govern more complicated protocol aspects.
Governance token CRV is implemented as a reward by the eponymous decentralized stablecoin exchange in order to motivate liquidity providers to add their stablecoins to the liquidity pool.
LUNA, the governance token of the algorithmic stablecoin protocol, has a key role in the Terra ecosystem. Users can stake LUNA to help validate transactions on the blockchain network, and earn more LUNA as a reward. Also, LUNA serves as a mechanism for regulating the prices of Terra stablecoin.
Crypto holders who have COMP in their balances manage and upgrade the interest rates markets protocol in two ways: either by taking part in governance directly, or by delegating their rights to vote to other addresses.
Benefits and Challenges of Governance Tokens
There are numerous reasons to be enthusiastic about governance tokens, as well as about what they can provide for the decentralized future. Nevertheless, there are specific challenges and risks crypto holders should take into consideration.
The first and foremost advantage of governance tokens is obvious in the decentralization facility. Owing to the governance token integration, developers are able to introduce decentralization in web 3.0 projects. With no specific governance token, DeFi solutions would be just a pile of smart contracts packed into a single platform. To put it simply, the upside of governance tokens in the crypto industry concentrates on the manner in which they demonstrate tangible proof of true decentralization.
With the ability to vote with governance tokens, it is possible to figure out how they expand collaboration opportunities. Voting enables discussions, thus leading to further productive collaborations. Holders can use their governance tokens to express their opinion and vote on current issues for the network. Simultaneously, they can be motivated to collaborate with other community members.
Last but not least, efficiency of governance tokens should definitely be highlighted. Community members use their tokens to collaborate with each other, and thus create a sense of involvement. Furthermore, active collaboration in the decision-making process, as well as finding new definitions of governance models, helps to boost efficiency.
The very first challenge that pops up is closely related to malicious and greedy actors. Such individuals who participate in a project would always act in accordance with their interest instead making decisions that would be beneficial to the whole community.
Next, the greatest loophole of governance tokens is limited responsibility. What could be done if the project happens to fail? Who would be accountable for the failure? Expectedly, none of the voters would admit they voted in favor of a proposal doomed to collapse.
Lastly, whales are also among the daunting challenges for governance protocols. Whales refer to individuals or institutions who possess a huge number of tokens. As such, they are able to get hold of a majority of coins, and, consequently, dictate their will regarding the future of a project. Inevitably, this could result in a nightmare for decentralization.
Future of Governance Tokens
As is the case with everything related to cryptocurrency nowadays, the future of governance tokens is unpredictable and uncertain. What the future will hold depends on vital factors like regulations, enactment of DAO operating models, and technology innovations.
Still, governance tokens will be the backbone and key component in the increase and enactment of user-owned, decentralized networks. They help DeFi projects to reach their full capacity and become completely decentralized.
Governance tokens may continue to be an essential component in safeguarding the community and investor interest in the system via decentralizing Web 3.0 protocols, platforms, dApps, and games. Protocols like Uniswap (UNI) Terra (LUNA), Curve (CRV), and Aave (AAVE) are helping prepare for this in the DeFi world.
As the time passes by, governance systems could become more complicated. Crypto holders will be more active in their communities. Governance protocols may enable a group as a whole to decide how to govern new crypto networks that could be the foundation of DeFi and production structures of the future.