Exploring governance tokens and why they matter

Reading Time: 4 minutes

When introduced, DOAs (decentralized autonomous organizations) aimed at revolutionizing and reviving what blockchain, so it seems, has lost – decentralization. But solely relying on smart contracts to make decisions influencing the future development of a project turned out to be insufficient. For complete decentralization, the decision-making power should be fully delegated to the community. And this is when governance tokens come into play.

Let’s explore together, shall we?

What are government tokens?

They are, essentially, cryptocurrencies that give holders voting power and rights to decide how the project is to be run. Token holders can influence the future and direction of a protocol. For example, they can decide on its appearance, which features to develop, which fees to have and how to distribute them, which partnerships to pursue, and so on. And even though the primary function is to distribute power, it doesn’t mean that governance tokens cannot be used to take out loans or earn money by staking them or through yield farming.

How do they work?

Each project can have its own rules regarding governance tokens. Some governance tokens give the right to vote on a limited number of issues, while others have the right to vote on anything, from development updates to fees distribution to smart contract revisions. The way governance tokens work is that they’re distributed among stakeholders – the founding team, investors, as well as users, in accordance with specified calculation models, and the weight of the token holder’s vote is proportionate to the number of tokens owned. Some projects opt for the ‘1 token – 1 vote’ scheme, while others opt for quadratic voting. For example, MKR is one of the earliest governance tokens issued by MakerDAO, and one token values one vote, and thus the majority vote decides on a decision.

Isn’t a governance token just another name for a utility token?

Governance tokens can come under the umbrella of utility tokens, they’re an upgraded version of utility tokens, but the latter don’t have governance power. Most of the time, the use of utility tokens is limited to their native blockchain network or crypto platform since they’re created to serve a specific role in a specific ecosystem. For example, Basic Attention Token (BAT) on the Brave Browser can only be used to tip content creators through the browser.

Pros & Cons

Even though governance tokens are still a relatively new thing, there are some undeniable benefits. One of them is the potential for building close collaborative communities. Since token holders are also the owners of the protocol, it’s clear that they’ll be motivated to actively participate and vote to improve the project. 

Granting the management and decision-making power to a broad community of stakeholders means the project becomes decentralized and the interests of users and the organization become aligned. Distribution of tokens and, consequently, voting rights will eliminate the misalignment of interests, which is a common characteristic of centralized organizations.

Because one token generally means one vote, the use of governance tokens paves a way for fairer and more equitable decision-making. Thus any token holder can initiate a proposal, and the details of such a vote are open for others to see, thus diminishing the chances of cheating.

However, there still exists a whale problem. A ‘crypto whale’ is a wallet that holds a significant amount of cryptocurrency. Their activity can have a massive impact on the cryptocurrency markets in ordinary situations, let alone in the case of governance tokens. Several DAOs have already taken steps to ‘neutralize whales’, but not before facing several difficult ‘battles’, for example, that between the Balancer and the whale known as ‘Humpy’. So more thorough checks are a necessity to guarantee that ownership is truly decentralized and evenly distributed among users.

What do we think about it?

As we’ve seen, governance tokens are a cornerstone of decentralization. And even though they’re in their early stages of development, we see the great potential and are very excited to see what further development will bring. As for now, we think that it’s safe to assume that the systems will become more complex and the holders more active and perceptive in their communities, thus making it possible for groups to decide how to manage crypto networks of the future.

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