Governance tokens are used to help users in taking an active part in the management of decentralized projects. These tokens can be used by participants of a crypto community to vote on specific policy changes.
Let’s take a brief look at what governance tokens are, how they work, and a few pros and cons of these tokens.
What are Governance Tokens?
Governance tokens are used to govern DAOs and DeFi projects. These tokens are part of a decentralized and transparent governance system.
One token equals one vote, and participants can use their tokens to vote on new proposed changes to specific crypto platforms. These tokens are the reason why many crypto and DeFi communities are glued together and are seeing healthy development.
Governance tokens are created and distributed by developers to the token holders in many projects. These tokens have the power to influence the future of a project. That’s because token holders can always use their tokens to vote for or against proposed changes to the platform.
Decentralized protocols give away a part of their ownership in the form of governance tokens. Users with more governance tokens have more voting power. These tokens can be used to influence every decision made by the developers.
How Do Governance Tokens Work?
Governance tokens are the very foundation of decentralized governance in the case of DeFi projects and DAOs.
Developers often reward loyal and active community members with governance tokens. Whenever an important decision is to be taken by the developers, token holders are invited to vote and have their say in the whole process.
Since voting with governance tokens includes the user jobs smart contracts, they are applied automatically, and full transparency is provided by the decentralized protocols.
The process of distribution and rules of governance tokens are specific to every project. These tokens are distributed to major stakeholders, distributors, and developers of a project depending on a specific calculation formula.
There are different types of governance tokens as well. Some types of tokens allow their holders to only vote on specific issues, while other types provide voting power over every decision. Some tokens can even be used for financial returns.
MakerDAO, which is an Ethereum-based DAO, was the first-ever project to issue governance tokens. This DAO has Sai as its stablecoin. Token holders of Maker (MKR) also govern the protocol. When a user uses one token to vote, one vote is cast. Decisions are taken based on majority votes.
Holders of MKR tokens mostly vote on issues like rules, important team appointments, and fees. This helps maintain transparency and stability in the DAO.
Advantages of Governance Tokens
Governance tokens are good for any platform that plan on using them for the sake of transparency and accountability. However, there might also be a few disadvantages of these tokens under certain circumstances.
Let’s take a brief look at the advantages of governance tokens.
The decentralization of DeFi (Decentralized Finance) depends entirely on governance tokens. Without these tokens, no one would have any authority or power over the projects, and they’ll just be a bunch of smart contracts and nothing else.
Since decentralization is the main goal of every decentralized finance project, developers have decided to make it tangible for the users as well.
Since many community members have to vote on the same issue, opportunities for discussion and collaboration are made. With the help of government tokens, users are allowed to vote directly on the issues they face on the platform daily.
This way, voting opens up the gates of decision-making through comprehensive discussion between community members. This is the main reason why governance forums are so popular.
Risks Associated with Governance Tokens
There is a clear lack of accountability in the governance system. That is because if a decision goes wrong, one part of the community will blame the other part who voted for that decision, and no one will be held accountable in reality. Since the voting is anonymous, no one can be held accountable in this model.