Governance token is an integral feature of Defi projects. These special tokens allow owners of these tokens to participate in the decision-making process on the network. In this article, we’ll be learning all about governance tokens.
Cryptocurrency has proven that it is a superior upgrade to fiat money. The digital currency shows more resourcefulness beyond investing and transacting. One vital usage of tokens is in governance; this is one important feature of a decentralized system that gives power to the token holder of a network it enables individuals to take their future into their hands and determine changes and proposals to decide the outcome of the protocol. The tokens used in these types of actions are considered utility tokens, a special type of cryptocurrency called governance tokens.
What is a utility token?
A utility token refers to those cryptographic assets that are used to acquire funds to develop a cryptocurrency. They are tokens that are also used to access a particular service that cannot be accessed with regular tokens. Holders of these tokens can participate in special activities or use particular products. Unlike financial assets, these tokens most times do not possess a strong market demand or presence.
What are governance tokens?
In a centralized system, the decision-making process rests on the project’s upper echelons; regardless of what those participating in the network say, the final judgment is always up to the top guns. This is the system cryptocurrency seeks to offset. Like a democracy, decision-making in a decentralized system is given to all token holders.
Governance tokens are proof of ownership that gives a member power to participate in a protocol’s decision-making process; the more tokens a holder has, the more power can be exerted to push or discontinue a motion. These tokens promote the inclusion of all parties, and each unit can express its standing on a particular notion to enable developers to know how the community feels about a particular proposal or a problem and how it should be solved.
How do governance tokens operate?Â
Decisions have to be made even in a DAO (Decentralized Autonomous Organization). These decisions will impact how far a project will go in the long run, and a huge population of individuals on the project must agree with a certain proposal before it is acted upon. This is where governance tokens come into play. When a particular proposal or alteration is being made, parties involved can vote on it using government tokens. This voting is not exclusive to new proposals, as owners can vote on specific features they want to change or remove from the protocol.
What kind of decisions can be made using governance tokens?
There is a wide range of actions that can be determined through the use of governance tokens, a few of which are:
- Implementing changes to the project’s UI
- Revision of the developers’ funds
- Alteration of the reward structure
- Voting on the networks’ transaction fee.
- Modifying the structure or conditions on a smart contract.
Governance Structures
DAOs can use two different methods when it comes to how the protocol is governed in a decentralized system. These structures are the following:
- On-chain governance model
- Off-chain governance model
On-chain governance model
On-chain governance is a system where the proposal or rules that are intended to be implemented are coded into the protocol’s blockchain. This is done in situations where quick implementations of alterations need to be made to the protocol. Once the proposal is acknowledged, participants carry out voting to determine if the change will be implemented, and once it has been approved and reviewed, the proposal is acted on, and a new block is added to the network.
Off-chain governance model
This style takes a more informal approach, and it is a system that allows decisions to be made off the blockchain. Participants are alerted of proposals through various external apps like emails and Github. Owners can then decide if they approve or not before the developers enact the changes on the blockchain.
Examples of governance tokensÂ
While these tokens may not be necessary for every protocol, their usefulness is observed in situations like:
Curve: This stable coin uses a system to reward users by gifting them the governance token CRV. This is to encourage providers to add the coin to their liquidity pool. And the token is also resourceful in executing automated market orders
Compound: With the COMP coin, token holders can control the interest rate protocol by casting their votes during proposals. This helps facilitate the distribution of interest across assets of participants on the network; this token also helps actualize crypto lending.
Decentraland: The LAND token in the Decentraland metaverse is used to govern virtual land across the metaverse. These tokens help the participants suggest and decide the project’s future and let the developers know what is required of them.
0x: 0x is a very interesting token. It does not offer holders the power to control the network’s direction but is used to maintain the treasury fund and offer peer-to-peer transactions through Ethereum.
Friends with Benefits: The project behind the FWB token has to deal with making web3 a more sociable space; it is a rather delicate subject which is why the network is a membership-only club. Users on the network can buy FWB tokens that will allow them to drive the activities of the project and gain access to certain events.
Advantages of governance tokensÂ
Decentralization: The first and obvious reason, governance tokens promote equity. Each user has a voice and an opinion; this ideal is executed in voting when a huge percentage of those participants agree or disagree in regards to a notion.
Development: The usage of governance tokens has shown to bring about observable growth of a network. A huge turnout of participants who believe this is the right direction for the project often leads to growth.
Unity: Governance tokens help align interest under a network, which means many participants support the motion before action occurs.
Disadvantages of governance tokensÂ
Hoarding token supply: In some cases, founders, developers, and team members may share a huge portion of tokens among themselves to control the outcome of a proposal.
Accountability issue: When using a decentralized system, it is very hard to pinpoint who exactly is at fault for making the wrong decision. The blame is easily thrown around, and no one is really held responsible.
Conclusion
Decision-making processes see everyone’s involvement in a decentralized system using governance tokens. These tokens are being implemented in many DeFi applications; while they might seem useful, they can also prove detrimental if their supply is being monopolized. Regardless, governance tokens remain an essential tool in a fair space to unite participants under one mind to drive a project to a certain goal.
