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What are Governance Tokens? How Token Owners Shape a DAO’s Direction

March 29, 2022
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What are Governance Tokens? How Token Owners Shape a DAO’s Direction
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Blockchain expertise has opened up a world of recent potentialities. From decentralized finance (DeFi) to digital shortage and possession by means of NFTs, there’s been an explosion of innovation round merchandise, companies, and platforms.

Cryptoeconomics and tokenization are unlocking new fashions for group and possession. The merchandise, companies, and platforms rising from these new fashions are user-owned and operated, constructed for and by the communities they serve. These communities are composed of people from all components of the globe, with numerous backgrounds and skillsets. 

These world communities are exploring new and modern methods to construct merchandise, foster group, and trade worth utilizing blockchain expertise, whereas confronting new challenges round coordination, governance, and determination making.

So as to handle these new and novel coordination challenges in earnest, these communities are adopting new and novel instruments with which to make significant choices throughout time, house, and language. 

Enter governance tokens.

What are governance tokens?

Governance tokens characterize possession in a decentralized protocol. They supply token holders with sure rights that affect a protocol’s path. This might embrace which new merchandise or options to develop, tips on how to spend a price range, which integrations or partnerships ought to be pursued, and extra. 

Usually talking, exercising this affect can take two types. First, governance token holders can suggest modifications by means of a proper proposal submission course of. If sure standards are met and the proposal goes to a vote, governance token holders can use their tokens to vote on the proposed modifications. The precise mechanisms and processes by means of which these rights are exercised differ throughout protocols.

Within the presence of flat and distributed possession, in addition to the absence of outlined management like that of conventional hierarchical organizations, governance tokens are a necessary decision-making mechanism for decentralized autonomous organizations (DAOs).

How do governance tokens work?

In conventional firms, a concentrated govt physique—usually some mixture of a C-Suite, board of administrators, and shareholders—has sole discretion over choices pertaining to the group’s strategic path. 

DAOs differ from conventional firms in that they don’t have a centralized group of decision-makers; however they nonetheless have to make choices that affect the group’s future.

DAOs make these choices by means of a formally outlined governance course of involving proposals and group votes. Whereas DAOs make use of many flavors of governance, a typical function that all of them share is the governance token. By advantage of dwelling on the blockchain, governance tokens connote sure traits, similar to immutable possession and clear distribution, that makes them ideally suited to distributed determination making.

When a DAO proposal goes to a vote, governance token holders have the chance to position their very own vote on-chain. Usually, the burden carried by a token holder’s vote is proportionate to the variety of tokens they maintain. For instance, if Alice holds 100 tokens and Bob holds 50 tokens, Alice carries twice as a lot voting energy as Bob. Some DAOs make use of completely different voting schemas similar to quadratic voting, with the intention to make voting extra equitable.

What’s so particular about governance tokens?

Governance tokens fall underneath the umbrella of utility tokens. Briefly, a utility token can be utilized to train sure rights or to entry merchandise/companies supplied by a protocol. The utility conferred by governance tokens is the fitting to affect a protocol’s path. There are a lot of examples of this in DeFi protocols, similar to Uniswap (UNI) and Compound (COMP). 

Governance tokens characterize the primary utility token of DeFi protocols and are the precursor to full decentralization. Governance tokens are the primary cryptocurrencies to characterize voting on a blockchain by distributing the facility of creating main platform choices from a centralized construction to a whole group. It’s because token holders aren’t solely customers, but in addition homeowners of the protocol.

Some protocols give their governance tokens particular attributes that profit the token holders. The next part lists a few of the hottest governance tokens and the particular attributes related to them.

Who’s utilizing governance tokens?

It looks as if each venture launching these days has a governance token. Whereas governance tokens don’t make sense for each protocol, they make a complete lot of sense for some. Under are examples of governance tokens with nice use instances and fascinating utility past easy voting rights:

  • 🧱 Maker – MKR is broadly thought-about one of many first governance tokens in DeFi. MKR token holders vote on-chain on matters starting from DAO governance processes to ratifying new collateral sorts.
  • 🦄 Uniswap – UNI has the most important market cap of any governance token ($3.8B on the time of writing). It’s a pure governance token within the sense that UNI has little utility past giving token holders the power to vote.
  • 💸 veToken Finance – permits DeFi customers to spice up their yield and farming rewards with out sacrificing liquidity, lock tokens in for long-term holding, and generate most rewards – all whereas taking part in DAO governance with minimal effort.
  • 💲 RAI Protocol – the decentralized, non-pegged stablecoin protocol’s governance token FLX is a backstop ought to the protocol go underwater, and offers holders the power to control extra advanced features of the protocol.
  • 💱 Curve – the decentralized stablecoin trade makes use of its governance token CRV as a reward to incentivize liquidity suppliers so as to add stablecoins to liquidity swimming pools. 
  • 🌕 Terra (LUNA) – the algorithmic stablecoin protocol’s governance token, LUNA, performs a vital position within the Terra ecosystem. It may be staked to assist validate transactions on the community (and, in flip, earn extra LUNA) and can also be a mechanism for regulating Terra’s stablecoin costs. 
  • 💰 Compound – COMP token holders govern and improve the rates of interest markets protocol by both instantly taking part in governance or delegating their voting rights to different addresses.

The challenges of governance tokens

There are many causes to be enthusiastic about governance tokens and what they provide for a decentralized future. That being mentioned, there are some key challenges and dangers to concentrate on.

🎩 The plutocracy of token provide

In lots of instances, a big allocation of tokens is distributed to founders/group members and buyers, which grants them majority management of decision-making. To keep away from this, some tasks have opted for a “honest launch” the place governance tokens are wholly distributed to the customers of the platform; sadly, this may occasionally nonetheless lead to whales gaining an outsize affect over governance by means of their sizable positions.

⌚ Vesting intervals

Most group and investor tokens are usually locked in a vesting schedule. Which means that when a token first launches, the diminished float can inflate a venture’s Totally Diluted Worth. On prime of this, when this vesting interval has handed, there may very well be a shock to produce which impacts the affect over governance votes and total market value. 

⚖️ Regulatory uncertainty

Most of the time, regulators are two steps behind innovation. That is very true with crypto, which is notoriously difficult to manage and, in some instances, a explanation for rivalry amongst the regulators themselves. 

For instance, US-based regulatory our bodies such because the Securities and Alternate Fee (SEC) and Commodity Futures Buying and selling Fee (CFTC) have each instructed that crypto is underneath their regulatory purview. Though SEC Commissioner Hester Peirce has argued for a “protected harbor” to offer crypto tasks the chance to decentralize over time, the specter of being labeled a safety nonetheless hangs over tasks with governance tokens, because it stays unclear what strategy the SEC will take to those tasks sooner or later.

The way forward for governance tokens

The way forward for governance tokens, like nearly the whole lot else in crypto at the moment, is stuffed with risk and uncertainty. What the longer term holds will depend on essential elements similar to laws (e.g., which kinds of tokens are thought-about securities), the adoption of DAO working fashions (e.g., the extent to which essential actions occur on-chain), and expertise improvements (e.g., new token requirements). 

However, governance tokens will undoubtedly be a mainstay and important part within the proliferation and adoption of decentralized, user-owned networks. 

Governance tokens are serving to DeFi tasks attain their full potential by changing into actually decentralized. They’ll probably proceed to be a key ingredient in defending the group and investor curiosity within the system, by means of decentralizing and democratizing Web3 protocols, platforms, dapps, and video games for the foreseeable future. Protocols similar to Aave (AAVE), Uniswap (UNI), Terra (LUNA), and Curve (CRV) are paving the way in which for this within the DeFi house.

As time goes on, governance programs will probably turn out to be extra advanced. Homeowners will turn out to be extra energetic and participative of their communities. Governance protocols will make it doable for a bunch to collectively determine tips on how to handle the brand new crypto networks that will probably be on the core of the decentralized finance and manufacturing constructions of the longer term.

Source: Decrypt

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