This is a type of cryptocurrency that allows holders to participate in voting on the governance of a crypto project. Typically, each management token equates to one vote, but there are other options available.
What are governance tokens used for?
The main purpose is to decentralize the decision-making process and give holders a voice in the management of the project. You can also use them for borrowing, staking, providing liquidity and trading.
Example of votes:
- Cryptoproject treasury distribution
- Updating the user interface
- Increasing or decreasing interest rates for loans
- Changing rewards for liquidity providers
How do governance tokens work?
Most often they are launched on the Ethereum blockchain. The features of each token are described in the whitepaper of the project.
For voting, a wallet with management tokens is connected and the necessary amount is sent for this or that proposal. The more tokens a person freezes in a smart contract, the more influence they have on the final decision.
Most decentralized applications use a DAO (Decentralized Autonomous Organization) governance structure for both submitting proposals and counting votes. The DAO includes all project stakeholders, including developers, validators, and investors. DAO also relies on smart contracts to avoid human manipulation.
Advantages of management tokens
1. Preserves decentralization: give every member of the community a voice, increasing the chances that the majority will choose.
2. High efficiency: It is easier to resolve issues by voting with tokens than by methods outside the blockchain.
3. Increased transparency: Votes are not only recorded on the blockchain, but also transmitted to smart contracts, preventing manipulation of the voting process.
4. Stimulation of collaboration: The voting process induces a sense of ownership of the DAO, which leads to new proposals and positive community sentiment.
Disadvantages of management tokens
1. Acting in self-interest: In an ideal world, everyone with governance tokens would vote in the best interest of the community, but in reality people are often driven by personal interests, which can be detrimental to the community.
2. Dominance of a narrow range of individuals: The more control tokens a person has, the more power they have over the platform. There is a risk that whales may direct the project as they see fit. To combat this, a quadratic voting mechanism was created, where the number of your votes is equal to the square root of the number of tokens sent.
3. No clear accountability: It is difficult to hold someone accountable for poor management decisions because the voting process is anonymous.
4. Likelihood of smart contract failure: There may be vulnerabilities in the smart contract that could lead to irreparable consequences.
Examples of management tokens
Uniswap: gave away UNI tokens to everyone who used its platform in 2020. UNI is one of the best management tokens available on most centralized crypto exchanges.
Aave: was developed in 2017 and is the leading decentralized lender on the Ethereum blockchain. People who own AAVE management tokens not only enjoy voting rights, but can also provide their AAVE to secure the application.
Maker: best known for issuing the DAI algorithmic stablecoin on the Ethereum blockchain. The management token is MKR, which holders use to vote on changes to DAI minting, collateral requirements, and interest rates.