- Governance tokens are digital assets that grant holders the power to influence decisions and policies within a decentralized network or platform.
- Token holders can vote on proposals, changes, and improvements, helping shape the project’s future direction.
- Holding a governance token allows you to vote on all matters connected with the control of your blockchain project.
- These tokens play a crucial role in decentralized governance systems.
Centralized governance is the process of concentrating a company’s leadership in the hands of a small group, such as a board of directors. Large firms often have boards of ten people. They devote a lot of time and effort to organizational management. The board of directors has the authority to appoint and remove senior management, choose investment opportunities, and set the overall direction of the organization.
Governance tokens represent a new vision of business leadership. Governance tokens provide a more equal, decentralized, and transparent governance approach, similar to that of decentralized autonomous organizations (DAOs) and decentralized financing (DeFi). In most cases, one vote equals one token. The purpose of these coins is to encourage community cohesion, allowing blockchain projects to achieve success.
How Do Governance Tokens Work?
Governance tokens are essential to the implementation of decentralized governance in DAO, DeFi, and decentralized application DApp efforts. They are frequently presented as a gift of appreciation to dedicated users for their devotion and support of the group. Token holders will then have a say in key choices, guiding the initiatives to a successful conclusion. Voting is often done via smart contracts, after which the effects are automatically implemented.
The MakerDAO Ethereum-based DAO, which supports the DAI crypto-collateralized stablecoin, issued one of the first governance tokens. Holders of the Maker Protocol’s governance token, MKR, have a say in the protocol’s direction. With every MKR token representing one vote, the opportunity with the maximum votes wins out. Token holders have a say in a variety of issues, including who is employed, how much products cost, and whether or not new rules must be imposed. The ultimate goal is to ensure that MakerDao’s stablecoin is both reliable and effective.
Another DeFi system that supports Bitcoin lending and borrowing is Compound. COMP, a governance token, is released to encourage user participation in policymaking. Tokens are distributed based on a user’s level of activity on the blockchain. You will accumulate more COMP tokens if you lend and borrow regularly on the Compound.
Similarly to MakerDAO, every COMP token represents one vote. Token holders can also empower extremely good token holders to vote on their behalf. Notably, Compound discontinued securing the network’s administrator key in 2020. Token holders become the project’s exclusive source of authority, eliminating the need for any other kind of governance.
The decentralized exchanges Uniswap and PancakeSwap, the Aave DeFi finance platform, the ApeCoin DAO community on the Web3 NFT network, and the Decentralized Virtual World platform have all produced notable governance tokens.
Each project’s use of governance tokens is subject to its own set of rules. To distribute tokens to multiple parties, like the project’s creators, investors, and end users, various token distribution techniques are utilized. It’s worth noting that not all governance tokens have equal voting power. Some governance tokens offer rewards at the same time as others do not.
Pros and Cons of Governance Tokens
There are numerous benefits to employing governance tokens. They have the potential to address the issue of conflicting interests that frequently arises in top-down management. Organizations can share management authority among a wide range of stakeholders by employing governance tokens to create decentralized governance, bringing user and company goals into agreement.
Another benefit of adopting governance tokens is that they help increase active, cooperative, and supportive online communities. Every token holder has a vested stake in voting for the project’s success. If every token is kind of equal to at least one vote, it could pave the way for more affordable and equitable decision-making. Any token carrier can propose a voteable proposition. The voting process’s transparency decreases the risk of fraud.
One of the most important and demanding situations for authorities is the so-called whale problem. Large cryptocurrency holders, known as “whales,” own a disproportionate share of the market. The largest investors in a cryptocurrency project can manipulate the token’s voting outcomes in their favour if they possess a disproportionate amount of the project’s governance tokens. Token ownership must be entirely decentralized and distributed evenly among projects.
While extensive and equitable governance token distribution is ideal, it does not guarantee that project stakeholders will always agree on the best course of action. The long history of one-person, one-vote voting systems reveals mixed results at best. Holders of governance tokens have voted in favor of the initial teams and key investors rather than the community at large.
What’s Next For Governance Tokens?
Governance tokens are a crypto-born concept with potential applications beyond finance. Decentralized governance tokens have an area within the Web3 movement. Other industries, including gaming, may follow suit as DeFi and DAOs gain popularity.
Governance tokens will preserve the ability to adapt and cope with new issues. It’s probable that there are unexplored techniques for dealing with the “whale” issue and enhancing the voting mechanism as a whole. There is a chance that new voting systems will emerge. New innovations in this subject are likely to add to the already high level of complexity in the future
Another key problem that might impact the destiny of governance tokens is the ability to regulate changes. Some governments may also consider those tokens to be securities. This may compel them to follow demanding laws that limit their operations.
Governance tokens’ potential has merely scratched the surface. Without them, many DeFi and DAO projects would not have been as successful. These currencies are the foundation of decentralization since they give holders voting rights over project administration.
With a reasonably balanced distribution of tokens, the concept of “one token, one vote” puts users and the community in a prominent position. Governance tokens may also grow in popularity in the coming years. User-owned networks, Web3 initiatives, and video games should combine governance tokens to construct better decentralized ecosystems.