What is a governance token?

Table of Contents

What is a governance token? 

Governance tokens allow tokenholders to help shape the future of the protocol. A platform that allows itself to be shaped by its users using the governance token is called a Decentralized Autonomous Organization – DAO. Holders of a governance token can agree on changes within the protocol. 

The governance token is key characteristic of Decentralized Finance – DeFi projects because it gives users rights and control, something that is a basic tenet of the entire crypto revolution.

How does blockchain governance work?

When changes are proposed, people can vote ‘on chain‘, via smart contracts. These changes will be applied automatically as soon as the majority is reached. Sometimes the changes will be applied by the team or by third parties.

The basic principle is that users participate and have a say in the system and it is decided in favor of the majority. On most protocols, binding proposals & votes are conducted through the Snapshot platform. Where snapshots provide the ability for users of a particular protocol to decide the fate of the protocol via underwritten messages on the blockchain.

What is a governance token - How does blockchain governance work

What can people vote on?

The changes on which people will be able to vote can vary greatly. For example, people will be able to vote on different decisions, ranging from minor adjustments to major collaborations. Below are some examples of possible changes:

  • Change of user interface (UI).
  • How many fees are allocated and to whom?
  • Distribution of development funds (Devfund)
  • Roadmap for products
  • Recruitment of developers

What is the use case of governance tokens?

The main purpose of governance tokens is to govern the protocol and the amount a user owns will correspond to the weight in making decisions. 

But governance tokens are not only used to participate and vote but also to get some yield. This can be done by lending out governance tokens, using it as collateral or using it to earn passive income.

What is the value of governance tokens?

Because the community can co-decide using the token, “no one” will feel unheard. The decisions are made by the people who are invested in the platform, meaning if the project fails, everyone will fail. If the project wins, everyone will win.

Also developers are no longer alone in making decisions, they will be made in consultation with the community. This way no modification will not go through the community first, which automatically increases the transparency of the protocol.

What are examples of governance tokens?

Some examples of Governance tokens are Curve, SushiSwap and Maker Dao.

Difference between utility tokens and governance tokens explained

So what’s the difference with a utility token? A utility token is a token that has a utility ^^. This utility is usually limited to its own blockchain or platform. For example, Binance Coin – BNB utility is to lower fees, choose new tokens and so on…

But this will will not give you a say in the future of the platform. So with Binance Coin, you will not be able to vote on future decisions concerning the Binance team.

In this case governance tokens are an upgrade from utility tokens. You literally have a say in the future of the platform.

What are the advantages and disadvantages of governance tokens?

Using governance tokens has many advantages, but there are also some downsides to consider;

Advantages

  • Putting power not centrally but in the hands of users.
 
  • Governance creates many opportunities to work together. This will inevitably lead to new insights.
 
  • Governance leads to more engagement.
 
  • Faster development. You go from changes proposed only by developers to an changes where an entire community is thinking.

Disadvantages

  • The human ego will sooner or later get in the way of making moral decisions.
 
  • No one is responsible. Users will always be able to shift the blame to the majority.
 
  • Manipulation by big stakeholders. When voting, the majority will win, thus the extremely wealthy of the protocol will have more say than the large crowd. Votes in favor of the big owners can happen.

Conclusion

The birth of governance tokens puts the ‘decentralization‘ into the DeFi. It gives them a central role in many protocols. Yet this is not without its dangers. This ability can result in executing decisions in favor of the few and not in favor of the the big majority.

“He who controls the governance tokens can control the future of the protocol”