What are governance tokens?

More and more crypto projects are incorporating governance tokens into their concept. This is where a cryptocurrency is used in whole or in part to make strategic decisions via voting.

If you’re interested in trends and advancements in the crypto industry, like you are, you’ll quickly come across the term Governance Token. Translated, “governance” means “leadership” in German and thus it is clear: Such tokens have the function of organizing leadership and direction in a project in a decentralized manner. Governance tokens then serve as ballots in referendums. The concept is usually implemented in a DAO (Decentralized Autonomous Organization), in DApps or in Decentralized Finance (DeFi) projects.

Maker (MKR) is known as an early successful governance token. Directly linked to Maker is the stablecoin DAI, which as of April 2023 has an impressive market cap of over $5 billion. Strategic decisions for DAI such as on reserves, fees or personnel are made by vote with Maker. Here, the concept has worked out and MKR has remained interesting for investors as a governance token. Maker is itself among the 100 most capitalized cryptocurrencies.

Maker, Compound, AAVE and other typical governance tokens.

Another prime example of governance tokens is Compound (COMP). Here, investors have already decided in 2020 to hand over even control over passwords for administrators to the protocol determined by COMP – so the DeFi project Compound cannot even exist without governance tokens.

Other well-known and well-funded governance tokens from the DeFi division are Uniswap (UNI), AAVE and PancakeSwap (CAKE). Often, other incentives are provided here in addition to participation, such as reduced fees or profit allocations for governance token holders.

Pros and cons of governance tokens

However, typical problems of governance tokens sometimes become apparent there. There is a risk that individual large investors or project founders have a majority of the circulating tokens and voting results are thus predetermined. It is also conceivable that investors try to buy a majority of Governance Tokens and thus take over a project.

On the plus side of governance tokens is that they increase investor engagement. This is because, as holders, anyone who wants to can of course submit proposals for the future of the project in question to a vote themselves, and will be interested in outside proposals. For some Governance Tokens, votes on detailed issues are scheduled almost daily, while others hold referendums only for major strategic decisions and leave the day-to-day business to an (elected) team.

Forecast Governance Token

Governance tokens are gradually moving into lines of business other than DeFi. For example, the Metaverse Token Decentraland (MANA) also includes the function of a governance token, and the same is true for ApeCoin. The NFT platform Blur has also successfully launched its own governance token BLUR.

In theory, DAOs and governance tokens are a perfect fit for the ideal of decentralization, which is supposed to set the crypto industry apart from traditional companies. Without co-determination or self-governance, it will be difficult for new crypto projects to build an engaged community. As Maker has exemplified: When a project proves itself in the free market, the value of the governance token associated with it rises almost automatically. However, this creates an external problem: regulators such as the U.S. Securities and Exchange Commission (SEC) often suspect hidden “securities” behind crypto projects, i.e. investment objects with profit expectations. Should the SEC or similar bodies set out to legally pursue Governance Tokens, this will worsen their future prospects.

Conclusion: governance tokens have potential

In practice, DAOs and governance tokens often do not yet run smoothly; fine-tuning is necessary. Investors like you will definitely pay attention to distribution when making investment decisions on governance tokens and whether individual parties have not already secured majorities. But in order to implement decentralization in decision-making processes, there is no way around governance tokens.

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