What are Governance Tokens? All you need to know
What are Governance Tokens? Blockchain technology, which has emerged as one of the revolutionary steps in terms of digital currency, has created lots of new possibilities and opportunities. Be it decentralized finance (DeFi), digital scarcity, or ownership through non-fungible tokens (NFTs), Blockchain technology has emerged as a new way of innovation around products, services, and platforms.
With the help of blockchain technology, crypto-economics and tokenization have been exploring new models for organization and ownership. All the products, services, or platforms that emerge from these new innovative models are said to be owned by users and operated, built for, and by the communities that they serve.
These communities include individuals from across the globe, with various backgrounds and skills.
Currently, global communities have been exploring new and innovative ways to establish products, foster community, and exchange value with the help of blockchain technology, besides it deals with the new challenges related to coordination, governance, and most important, decision-making.
In an order to deal with such challenges related to new and novel coordination, these communities have adopted new and novel tools to enhance decision-making skills across time, space, and language.
What are governance tokens?
Governance tokens have been representative of ownership in a decentralized protocol, providing token holders with some rights that influence the direction of the protocol. This may include the new products or features to develop, expenditure of budget, integrations or partnerships that are needed to be pursued, and much more.
Usually, this may take two forms. At first, it will be the governance token holders that may propose changes by submitting a formal proposal. In case, some of the criteria are fulfilled and the proposal goes for voting, the governance token holders may use their tokens to vote for the proposed changes. However, certain mechanisms and the process through which these rights are initiated differ among all protocols.
During the presence of flat and distributed ownership and the absence of leadership, for example, in traditional hierarchical organizations, the governance tokens are considered a key decision-making mechanism for decentralized autonomous organizations (DAOs).
Governance Tokens: How does it work?
In the world of traditional corporations, an executive body— which is usually a combination of a C-Suite, board of directors, and shareholders — has more decision-making power related to the organization’s strategies.
However, decentralized autonomous organizations (DAOs) vary from traditional corporations. In such cases, they don’t have a centralized group of decision-makers; but they are still required to make decisions for the betterment of the organization in the future.
In such situations, the DAOs make decisions via a formally defined governance process that involves proposals and community votes. The DAOs provide several flavors of governance and the common feature that they all share is said to be the governance token. With the help of blockchain technology, the governance tokens connote several characteristics that include immutable ownership and transparent distribution. It makes them suitable for distributed decision-making.
Once a DAO proposal goes for voting, those with the governance token are given an opportunity to vote on-chain, as per their choice. Usually, the weightage of a token holder’s vote is proportional to the number of tokens that they are holding.
For instance, if John is having 100 tokens and Rose is holding 50 tokens, then John is having twice as much voting power as Rose. Some DAOs have different voting schemas that include quadratic voting. With this, voting becomes more equitable.
Governance tokens: What is so special about them?
Notably, the Governance tokens fall under the utility tokens that can be used to initiate some rights or to access the products and services offered by a given protocol. The utility, which is conferred by governance tokens, is considered the right to influence the direction of protocol. There are several examples of this in decentralized finance protocols, for example, Uniswap (UNI) and Compound (COMP).
It is also pertinent to mention that the Governance tokens represent the main utility token of the decentralized finance (DeFi) protocols and are the predecessor to full decentralization. Moreover,
the Governance tokens are said to be the first cryptocurrencies that represented voting on the blockchain technology by distributing the power of decision-making from a centralized structure to the whole community. How can it be possible? It is possible because the token holders not only work as the users but also they are the owners of the protocol.
Some of the protocols provide their governance tokens with special attributes that turn out to be beneficial for the token holders.
Governance tokens: Who’s using them?
It won’t be wrong to mention that almost every project, which is being launched nowadays, contains a governance token. While governance tokens don’t make sense for all the protocols, they turn out to be very beneficial for some. Here are some examples of governance tokens along with their great use cases and amazing utility apart from the simple voting rights:
– Maker, also known as MKR, is said to be one of the first governance tokens in decentralized finance. The MKR token holders get to vote on-chain on topics that include DAO governance processes or confirming new collateral types.
– Uniswap, also known as UNI, is currently having the largest market cap of any governance token. UNI has little utility besides it provides the token holders with the ability to vote.
– veToken Finance allows the decentralized finance users to boost their yield and rewards without even affecting their liquidity besides it allows the users to lock tokens in for the long term, and generate maximum rewards. All of these can be done while participating in the DAO governance and it doesn’t even require a minimal effort.
– RAI Protocol’s governance token FLX provides the token holders with the ability to govern more complex characteristics of the protocol.
– Curve is a decentralized stablecoin exchange that uses its governance token CRV as a reward to provide incentives to the liquidity providers in an order to add stablecoins to liquidity pools.
– Terra, also known as LUNA, is an algorithmic stablecoin protocol and its governance token plays a key role in the Terra ecosystem. Notably, it may be staked to assist validate transactions on the network. It is also a mechanism to regulate Terra’s stablecoin prices.
– Compound and its governance token COMP upgrade the interest rates by either participating in governance directly or entrusting their voting rights to other addresses.
Governance tokens: What are the major challenges?
There are so many reasons to be excited about the governance tokens because of their offerings for a decentralized future. However, there are some key challenges and risks that the users need to be aware of. These include the plutocracy of the token supply, vesting periods, and regulatory uncertainty.
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