Governance Token: The Key to Decentralized Power

In the journey of decentralization in cryptocurrency, what is a governance token is a question that an increasing number of investors are asking. The essence of governance tokens plays a core role in enabling the community to share decision-making rights about the future of protocols. From blockchain games to decentralized autonomous organizations (DAO), from decentralized exchanges to decentralized financial platforms, governance tokens have become essential tools for building truly community-led systems.

From Basic to Special: The History of Governance Tokens

Bitcoin And The Early Days of Cryptocurrency

Bitcoin is the first cryptocurrency and mainly functions as an utility token supporting peer-to-peer transactions. However, it did not have a clearly defined decentralized governance mechanism. A major shift occurred in 2014 when Ethereum was launched, ushering in a new era for blockchain technology.

Ethereum is not only a trading platform but also allows Ethereum token holders to become stakeholders with voting rights. They can submit proposals for system improvements, laying the foundation for modern DAOs.

DAO: The First Decentralized Experiment

DAO is considered the first effort to create a fully decentralized governance structure. This project launched on April 30, 2016, based on Ethereum, funded by a community ICO. However, DAO faced a historic incident when bugs in its code were exploited, resulting in a loss of $150 million.

Interestingly, the final loot of the attackers was only worth $8.5 million due to the decision to fork the Ethereum blockchain. This incident served as an important lesson for the blockchain community about the importance of security in governance systems.

MakerDAO: The Success of MKR Governance Token

MakerDAO marked a milestone success in the history of governance tokens. Launched in 2017, the MKR token allows holders to decide on key issues related to the stablecoin DAI, which is backed by cryptocurrencies.

This model proved to be highly effective: as DAI became more widely used, the value of MKR also increased correspondingly because more people became interested and involved in governance. Voting rights became the most important utility of MKR, demonstrating that governance tokens can provide real value to holders.

How Governance Tokens Work

Basic Principles

Owning a governance token, whether through purchase or distribution, grants users voting power proportional to their token holdings. Most decentralized projects carefully design this system to ensure fairness.

Governance token holders have a direct stake in the success of the protocol, similar to shareholders in traditional companies. They also bear risks if poor decisions are made, so most consider their votes carefully.

On-Chain Voting Process

Voting is conducted on the blockchain with participants casting “yes” or “no” votes. Project developers define and update on-chain voting parameters, preventing manipulation by any party.

Some projects apply additional criteria to prevent “whale” attacks, such as requiring users to hold a certain amount of tokens (e.g., OP) throughout the voting period before participating.

Types of Decisions Voted On

Typical issues depend on the nature of the protocol:

• Stablecoins like MakerDAO vote on risk mitigation and stability enhancement
• Decentralized exchange platforms vote on fee adjustments to increase liquidity
• Budget allocations for various categories to ensure sustainable growth

Governance Classification: On-Chain and Off-Chain

Off-Chain Governance (Off-Chain)

In this model, core teams usually convert decisions into code and updates, then publish them for community review. Ethereum is a typical example, using Ethereum Improvement Proposals (EIP) communicated through social channels.

While anyone can submit proposals, it generally requires basic understanding of the project to contribute opinions.

On-Chain Governance (On-Chain)

This model is simpler because translating decisions into code is automated. Parameters are encoded on-chain before voting begins, and after voting ends, the majority votes are automatically executed on the network.

Developers often test parameters on testnets before proceeding with official voting to ensure absolute safety.

Governance Tokens vs. Other Token Types

Fundamental Differences

Governance tokens grant voting rights, while utility tokens are mainly used for payments or accessing services. However, this boundary is often blurred as many decentralized protocols offer both functions.

For example, Curve rewards users with CRV tokens for activity and engagement with the platform. Similarly, SUSHI and UNI also provide staking rewards based on commitment criteria.

Token Value

Governance tokens have real value, and this value depends on the quality of the service or solution provided by the issuing project. When a protocol develops well, its governance token also appreciates in value.

Benefits of Governance Tokens

Promoting True Decentralization

Governance tokens enable developers to build truly decentralized versions of large organizations. They promote diversity of opinions, progress, and inclusiveness in DeFi protocols.

Building Strong Communities

Issuing and distributing governance rights has created some of the largest communities in DeFi. The number of holders of UNI, CRV, and MKR has increased significantly thanks to the governance features each platform offers.

Challenges and Limitations

Whale Problem

The biggest challenge for governance tokens is the presence of organized whales. Wealthy individuals can buy large amounts of tokens to influence decisions in their favor, which contradicts the ideals of decentralization.

While completely preventing this is difficult, projects have started implementing functions to curb whale influence as part of their overall codebase.

Accountability Issues

Some DAOs are managed by anonymous or semi-anonymous groups, making accountability difficult when projects fail. This is a fundamental challenge that needs to be addressed in the future.

The Future of Governance Tokens

Evolution of DAOs and Legal Frameworks

As global interest shifts toward building a better world, large corporations will gradually evolve into DAOs. The next step is to create feasible legal frameworks for these organizations.

Currently, only Wyoming in the USA has regulations allowing DAOs to operate as LLCs. Extending such regulations to other countries will facilitate the development of governance tokens.

Metaverse and the Real World

The expansion of virtual reality into the real world will accelerate the demand for governance tokens. These tokens could be used to manage entire virtual cities and even regions within the metaverse.

Many believe that seamlessly integrating physical and virtual worlds will be the future. Governance tokens will become essential tools for managing these organizations, encouraging political participation and paving the way for fair governance.

Future Technical Solutions

Recent DeFi projects are exploring better ways to address governance issues. Whale prevention functions have been integrated into the overall code to prevent token accumulation that undermines decentralization ideals.

To ensure accountability, most blockchain projects are also developing on-chain proof of commitment methods. More accurate algorithmic metrics for early proof of commitment will be deployed.

Frequently Asked Questions About Governance Tokens

Characteristics of a Good Governance Token

A governance token is considered “good” when genuine developers establish the project and the token is issued according to the tokenomics outlined in the official whitepaper. Transparency and adherence to the original roadmap are signs of a quality governance token.

Do Governance Tokens Have Real Value?

Yes, governance tokens have real value. This value depends on the services or solutions provided by the project, along with the sustainability of the community and governance decisions.

Is Cardano a Governance Token?

No, Cardano is not a governance token by traditional standards because its proposals are off-chain and managed by academic researchers rather than token holders.

Conclusion: What is a governance token is no longer an unfamiliar question for those interested in DeFi and blockchain. They represent a significant step forward in building truly community-led organizations, although many challenges remain to be addressed on the road ahead.