TL;DR
Governance tokens serve as a way for the community/holders of a project to vote on certain proposals that affect the development, objective, and operations of a blockchain project.
Governance tokens are the way that blockchain projects distribute their decision-making power to their communities. This decentralized governance model helps align the interests of the token holders with that of the project.
Introduction
Many traditional companies are governed by a board of directors or a small group of people, in what can be categorized as centralized governance. However, because blockchain technology has the potential to make trust and collaboration easier, decentralization offers a new way of thinking about corporate organizations.
Governance tokens represent a new way to govern an organization. These tokens are a common staple for Decentralized Autonomous Organizations (DAOs) and many other Decentralized Finance (DeFi) projects. Some of the core features that governance tokens provide include greater decentralization, more equitable, and greater transparency when compared to centralized forms of governing systems.
In the case of these governance tokens, one token is usually equal to one vote. These tokens are used by community members to vote on the trajectory of a project.
What Are Governance Tokens?
Governance tokens are essential for delivering efficient and transparent decision-making processes. They help platforms to facilitate voting on major issues, which is essential for allowing participants to collaborate and make decisions about the future of the blockchain. This way, all token holders can play an active role in shaping the project, making sure that it continues on its path toward success.
Governance tokens allow the holders to be part of the decision-making process and allow them to vote on proposals that community members vote on. In addition, they can also propose new changes and it will be up for voting. As an example, think of tokens for a certain project as shares of a company. The more shares you own the more you voice and vote matter in a company.
How Do Governance Tokens?
A popular example that recently gave way to a decentralized form of governing is the famous NFT project the Bored Ape Yacht Club. Starting as an NFT, they airdrop APE tokens to the holders of any of their 3 NFT projects. APE is the Bored Ape Yacht Club’s official governing token. Holders of this token can vote on proposals or changes to the project. For instance, a holder can make a proposal for there to be a Bored Ape Yacht Club comic book. As a result, this proposal would go up for a vote and any token holders can partake in the voting process.
In order to understand how governance tokens work let's take a look at an example. MakerDao is a decentralized autonomous organization on the Ethereum blockchain that issues a stablecoin called Dai. The objective is to create a decentralized stablecoin that’s totally pegged to the U.S. dollar, yet resistant to volatility. The Maker Protocol is governed by holders of its governance token called MKR. One MKR token equals one vote, and the decision with the most votes is adopted. Holders of the MKR token can vote on many things including appointing team members, adjusting fees, and adopting new rules.
The world is changing, and with it the way we use cryptocurrencies. Governance tokens allow stakeholders to collectively manage, vote, and determine the future of projects through their own voting system. Other popular projects with governance tokens include decentralized exchanges such as Uniswap and PanacakeSwap, NFT community Apecoin DAO, DeFi lending platform Aave, and virtual world platform The Sandbox.
The terms of a project's governance tokens are set in their whitepaper. Though each project will have its own rules, governance tokens are typically distributed to stakeholders, including the founding team, investors, and users via different calculation models. Some tokens are simple voting tokens. These tokens only vote on governance issues and have no other functionality. Some tokens can earn dividends and vote on governance issues; others simply vote on governance issues without earning any money back to their holders.
Pros and Cons of Governance Tokens
Governance tokens make managing true decentralized organizations more efficient. With a governance token, everyone in the community of stakeholders can have their say and vote on important decisions. These decisions are made transparently, and they are recorded on a public ledger, so every member can see where money is being spent.
Pros
Interests are Aligned with the Users and Organization
Decentralized governance distributes governance to the community of stakeholders, thus aligning the interest of the project with the users and the organization itself.
Build Communities
Another great advantage is the ability to build a community with a common goal, to move the project forward. Every token holder is incentivized to vote and continue building the project, because as the project succeeds so does there investment.
Cons
Crypto Whales
Whales are any token holders who hold a large percentage of crypto in a particular project. If this is the case, then the projects future rests entirely in the direction this particular individual votes. Projects need to make sure they are decentralized and not allow one single entity or individual to overtake the decision making process.
Results
You can think of governance tokens as one token equals one vote. The only issue is that it does not always guarantee that the best decisions are the ones voted on. There has been instances where the founding team benefits from decisions at the expense of the wider community.
The Future of Governance Tokens
Governance tokens, created to reward network participants or the community with rewards, can be used to provide organization and governance of the platform. Governance tokens could find wider usage in more sectors as an innovation born out of the crypto space. As DeFi and DAOs gain momentum, other industries such as gaming could adopt this governance model.
Governance tokens are an evolving space, and these systems will continue to adapt to deal with emerging problems. Novel methods of voting could occur, and the ways in which voters delegate votes is likely to change in order to deal with the whale issue. New innovations in governance could be implemented as we learn more about how this space works.
Regulatory changes could be a major factor shaping the future of governance tokens. Some governments may deem these tokens as securities, which means they could come under regulation. This could have a big impact on how these tokens function, so it's an important area to watch as we move closer to mainstream adoption of governance tokens.
Final Thoughts
Governance tokens, including those of DeFi and DAO projects, are still in the early stages of development, with some characteristics that need further improvement. The governance tokens are an important milestone in the development of these projects and have facilitated the robust growth of many DeFi and DAO projects.
One token, one vote. This principle is currently being used by many blockchain-based projects. Governance tokens allow users to participate in the governance of a decentralized platform by holding and casting votes with their own tokens. User agencies are key in creating a just world - so let’s bring them out!
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