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Owners of management tokens receive the right to vote on issues of regulation and development of blockchain projects. Using this method, projects transfer decision-making power to their communities. This decentralized management model helps to achieve consensus in the community and efficient development of the project.
Introduction
Many traditional companies are governed by a single centralized management body, such as a board of directors or a small group of people. Typically, the board of directors of large companies consists of 10 people who wield enormous power. Directors can appoint or dismiss executives, select projects for investment and determine the direction of the company's development.
Governance tokens offer a fairer, decentralized, and transparent method of governance that is widely used in decentralized autonomous organizations (DAOs) and decentralized finance (DeFi). Typically one token equals one vote. Such a mechanism unites communities and ensures the effective development of blockchain projects.
How governance tokens work
Governance tokens are the basis of decentralized governance in DAO, DeFi, and decentralized application (DApp) projects. Typically, users receive governance tokens for being loyal and active in the community. This way they get the opportunity to vote on issues of development and improvement of the project. As a rule, voting is carried out through smart contracts - in this case, the results are implemented automatically.
One of the first governance tokens was issued by MakerDAO, an Ethereum-based decentralized autonomous organization that created a crypto-backed stablecoin called DAI. The Maker Protocol is controlled by the holders of the MKR governance token. One MKR token provides the owner with one vote. The solutions with the most votes are implemented in the project. Token holders vote on various issues such as appointing team members, adjusting fees, and adopting new rules. This ensures the stability, transparency and reliability of the MakerDao stablecoin.
Another example is a DeFi protocol called Compound, which allows for cryptocurrency lending and borrowing. It issues the governance token COMP for voting on key decisions. Tokens are distributed in proportion to user activity on the network. In other words, the more a user borrows and borrows on Compound, the more COMP tokens they will receive.
Like MakerDAO, one COMP token equals one vote. Users can also delegate their assets to validators. Notably, in 2020, Compound relinquished control of the network admin key, and the project came under the full control of token holders, with no replacement controls.
Also worth mentioning are governance tokens from decentralized exchanges Uniswap and PancakeSwap, DeFi lending platform Aave, Web3 NFT community ApeCoin DAO, and virtual world platform Decentraland.
Each project sets its own rules for how governance tokens work. According to settlement models, these tokens are distributed among founders, investors and users. Some governance tokens only allow voting on certain governance issues, while others allow voting on almost everything. At the same time, some governance tokens can generate dividends, while others cannot.
Advantages and Disadvantages of Governance Tokens
Governance tokens have a number of important advantages. They help avoid divergence of interests that can arise under centralized control. Governance tokens enable decentralization, where power is transferred to the wider community and the interests of users and the organization are taken into account.
Another advantage of governance tokens is the ability to create active and loyal communities. Each token owner is motivated to vote and improve the project. A system where one token equals one vote lays the foundation for fairer decision-making. Each token owner can put forward a proposal, and information about the results and progress of each vote is publicly available, which reduces the likelihood of fraud.
The biggest problem with governance tokens is the so-called “whale problem”. Whales are users who own a large percentage of a particular cryptocurrency. If large whales own a significant share of the governance token in a project, they can significantly influence the voting results. Projects must control the decentralized and equal distribution of tokens.
But even with a fair distribution of tokens, there is no guarantee that the decisions of the majority will benefit the project. Electoral systems in the “one person, one vote” format have existed for a long time, and their effectiveness cannot be assessed unambiguously. There have been cases where governance token holders have voted in favor of developers and large investors, but to the detriment of the wider community.
The Future of Governance Tokens
An innovation in the world of cryptocurrencies such as governance tokens will definitely find wide application in many sectors, especially in the decentralized Internet of the Web3 concept. As DeFi and DAOs mature, other industries, such as the gaming industry, may adopt this governance model.
Governance tokens will continue to evolve and address emerging issues. Perhaps in the future there will be new mechanisms to solve the whale problem or other ways to improve the voting process. New methods of voting delegation may also emerge. With many innovations being introduced, the crypto space will continue to become more complex.
Another important factor influencing the future of governance tokens is potential changes in legislation. Some governments view tokens as securities, causing them to be subject to strict restrictions that affect the operation of the project.
Summary
Although governance tokens are still in their early stages of development, they have contributed to the strong growth of many DeFi and DAO projects. These tokens are the main guarantor of decentralization, as they provide the right to vote in matters of project management.
The “one token, one vote” principle allows for fair voting results, provided that tokens are evenly distributed among community members. In the future, more and more projects will implement them. For example, user-run networks, Web3 projects, and games will be able to use governance tokens to create more dynamic and decentralized ecosystems.
