- Governance tokens allow holders to vote on decisions in decentralised autonomous organisations (DAOs)
- DAOs use governance tokens to distribute power and influence among members rather than concentrating it in a top-down way like traditional organisations
What Are Governance Tokens?
Most traditional organisations are based on a hierarchy. A board of directors or other leadership comprised of a few people stand at the top of the organisation, making decisions.
Decentralised finance and other blockchain-based projects take a different approach. Instead of conferring all decision-making power to a small board, decentralised autonomous organisations (DAOs) distribute some of the power to token holders.
This process of directing a project’s future via decentralised voting measures is called on-chain governance. However, the project leaders decide what parameters are eligible for change and stipulate how the approval process works.
Governance tokens are the voting chip in this process. They are ERC-20 tokens tied to a specific project and give holders a say in the future of an organisation or blockchain ecosystem. A specified quota of votes by the token holders determines if and which changes will be made to the project. In other words, the tokens ‘govern’ the protocol.
What Are Governance Tokens Used for?
The population of governance token holders can make decisions collectively, influence decisions, or propose changes. These include e.g. the cost of transaction fees or UI (user interface) changes.
Votable parameters vary from project to project, as well as much influence is given to token holders. This depends on the blockchain’s initial setup which determines the parameters that fall under governance token influence. The most influence is wielded by those who hold the most tokens, which in many projects are the founders, team, or investors.
Finally, governance tokens are not solely meant to confer voting rights. Many blockchain projects also allow governance tokens to be used in a number of other ways, including:
- Staking and lockups
- Lending and borrowing
- Yield farming
- Cash flow from fees
Examples of Popular Governance Tokens
If you want to explore the possibilities offered by governance tokens, you’ve got plenty of options. There are hundreds of blockchain projects with governance tokens.
Here are three of the most popular:
- Maker is a DAO that allows users to lend a variety of crypto assets and borrow DAI
- Token holders can accrue interest fees on loans on the platform and vote on accepted collateral types for loans
- The MKR token saw 350% growth between Q1 2021 and Q1 2022
Watch our AMA with Maker Foundation’s CEO Rune Christensen:
- Compound is a DeFi protocol that allows borrowing and lending for a variety of cryptocurrencies
- COMP is Compound’s governance token which can also be liquidity-mined by holders
- Holders can vote on accepted collateral types for loans and receive interest fees on outstanding loans
- Tectonic is a decentralised lending and borrowing platform that allows users to participate as liquidity suppliers or borrowers
- While starting out with centralised key decisions, its roadmap plans for full transfer of the governance process to the community and stakeholders over time
- Token holders can vote on interest rates, collateralisation ratio, and token allocation
Read our guide to DeFi for beginners to learn more about lending and borrowing platforms and how to use them.
What to Be Aware of When Buying Governance Tokens
Before investing in governance tokens, research the total token supply and its distribution.
In some projects, a large portion of the total supply is locked up in a vesting schedule to stakeholders and hence not available to them yet. This can inflate the project’s value, which can then drop in value when vesting tokens are distributed all at once to the team and investors.
You can find total supply information on the project’s website or in their whitepaper.
Governance tokens offer a form of ownership in DAOs and other decentralised projects and allow holders influence over the future direction of these projects. In addition, they often let holders accrue a portion of the fees they charge for the use of their services.
Due Diligence and Do Your Own Research
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