Governance tokens as an integral element of decentralization

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A governance token is a cryptocurrency that allows you to participate in the life of a decentralized project and influence its future. In this article, we take a detailed look at governance tokens, their significance for the owner, and their disadvantages.

What are governance tokens?

Governance tokens are closely related to the DeFi, so let’s start with this sector's specifics to understand better what a governance token is. 

Decentralized finance is an area where companies need to share power and responsibility with users who are genuinely interested in the product’s success. But how do we identify the people who are involved? And here’s how: they are willing to invest money and actively participate in the project’s development.

For this purpose, a type of collective association called DAO, which stands for Decentralized Autonomous Organization, was created. Participants invest in the product through the DAO and receive governance tokens that give them voting rights and represent their stake in the organization. Usually, the person who invests more strongly influences the transformation processes.

Thus, governance tokens are a cryptocurrency with which users can shape the future of DeFi, GameFi, or another cryptocurrency project through voting. First of all, a governance token gives holders the right to propose changes to the protocol. In the case of DEX (decentralized exchanges), it also enables them to receive rewards, a share of commissions, and trading fees. 

Other powers of governance token holders may include:

•        influencing the implementation of new features;
•        determining companies to collaborate with;
•        voting for the introduction of new products;
•        reviewing the development fund;
•        voting for coin burning.

With DAO tokens, members of the organization can regulate the vector of blockchain project development in the direction they consider promising. In turn, for DeFi projects, it is a method of distributing influence among the entire community, as the principle of decentralization demands.

Governance tokens are not only an instrument of influence but also require a responsible attitude from the interested people. The success of a project is primarily determined by the community that influences and manages it.

Why are governance tokens necessary for DeFi?

While smart contracts play a significant role in a peer-to-peer financial system, the only way to get a complete distribution is to make the user’s voice meaningful. It is considered decentralized if the community can participate in the project’s development.

This is why many people in the crypto space refer to the governance token as an essential part of a DeFi project. It helps an organization get rid of centralized management by giving a voice to interested people and facilitating decision-making.

Governance tokens are perfect for peer-to-peer networks: they are characterized by unchanging ownership and transparent distribution due to their operation in the blockchain.

They provide more equitable and democratic governance.

The main problems of governance tokens

It may seem like governance tokens are perfect and perform flawlessly, but that’s not true. First, the founders of projects implementing governance tokens claim that these assets have no intrinsic value. They attract investors with the ability to influence the future of the product and, in some cases, the rewards that await their owners. However, the same argument holds true for bitcoin, as we can see this factor does not influence its value much.

Second, there is still the risk of tokens being redeemed by a specific group of large contributors, which can lead to unilateral decision-making. This devalues their purpose of promoting decentralization. It happens from time to time in the history of the cryptocurrency community. By the way, 50% of Compound’s governance tokens were distributed among its team.

Third, the aspirations of some members of the community can be harmful to the project or the community. Not all governance token holders may prefer favorable initiatives or support the project’s development. For example, in 2020, Maker, the company that pioneered DAO, went bankrupt, resulting in losses for most investors. At the time, the community voted to compensate the funds, but the new community canceled that decision six months later 

And finally, if management is in the hands of the majority when it comes to finding the culprit, it is impossible to find a specific person who is responsible.

Which projects use governance tokens?

Many blockchain projects have governance tokens. Let’s list the most famous ones.

Decentraland. The largest metaverse integrates a DAO with a native MANA token. Holders vote on changes to be made in Decentraland, control virtual world policy, moderate content, and generally feel more at home.

Maker. The very same platform that was the first to introduce DAO. MKR token investors are involved in everything from management to ratification of the new kind of software.

Polkadot. A project based on retransmission of blockchains to increase interoperability with each other. It also uses a governance token. In addition to basic governance, its owners vote on how people need to interact within the team for the long-term effectiveness of the platform.

Uniswap. The decentralized exchange offers UNI token holders classic voting rights without unnecessary add-ons. Uniswap’s governance token has the largest capitalization of its kind ($3.3 billion). 

Aave. The owners of the governance token of this DeFi lending and borrowing platform decide the fate of the company’s protocol: they are responsible for its security and functionality.

Compound. COMP cryptocurrency holders vote on regulation and interest rate market protocol updates. They also take over management tasks or delegate their responsibilities to other holders. In addition, Compound encourages its users to be more confident in lending and borrowing in order to get more tokens and quality insurance. 

Curve. Stablecoin exchange uses CRV tokens as a reward system to encourage users to add stablecoins to liquidity pools.

The influence of governance tokens on the blockchain industry

Due to the new direction of cryptocurrencies used for project management, DAO has become another ecosystem based on blockchain. Now token holders can form a real community, feeling their importance to the sector and a particular platform.

Although the future of governance tokens depends partially on the external regulatory conditions and the expansion of the DAO sector, they are an integral element of decentralization.
Looking at DAO, metaverses, and DeFi, we want to believe that governance tokens are the beginning of something greater.