Governance tokens are a type of cryptocurrency that allow token holders to vote on the direction of a blockchain project. The main purpose of governance tokens is to decentralize the decision-making process and give the owners a say in project management.
Governance token holders typically invest more in the success of a project, as they stand to gain or lose more depending on the outcome. Community members can use tokens to directly influence the direction and functions of the blockchain protocol. Thus, you can make changes related to the user interface, vote on fees and distribution of rewards, or even change the base code of the project.
While most decentralized finance (DeFi) tokens are governance tokens, voting is not their only defining feature. People who own these management tokens can use them to take out loans, bet and make money through income farming. Given all this, their main function is still to distribute power.
Governance tokens are a relatively new invention, and there is still debate about their effectiveness. Some believe they are the key to true decentralization, while others fear they will lead to a centralization of power among a small group of token holders.
How do governance tokens work?
Governance tokens serve as the basis for establishing decentralized governance in decentralized autonomous organizations (DAOs), DeFi projects and decentralized applications (DApps).
Users who have made significant contributions to the community or shown loyalty are often rewarded with Stewardship Tokens. The token holders then vote on key issues to ensure efficient development of projects. Usually, people vote using smart contracts, so the results are entered into a table and take effect automatically.
Each project has its own set of token management rules. They are distributed among stakeholders, including the founding team, investors and users, using different calculation methods.
Some governance tokens only vote on a limited number of governance issues, while others vote on everything from development updates to smart contract revisions. Likewise, some governing symbols can generate financial returns; others do not.
MakerDAO, an Ethereum-based DAO, was one of the first issuers of governance tokens. MakerDAO’s stablecoin is called Dai (
) token holders manage the protocol itself. One chip corresponds to one vote, and the decisions with the most votes are taken.
Maker of voting portal
Among the types of matters MKR token holders have voted on are fees, rules and team member agreements. Ultimately, the goal is to maintain the stability, transparency, and efficiency of the DAI.
Another example of a governance token protocol is Compound, a DeFi protocol that allows users to borrow or lend cryptocurrencies. The protocol has a control token called Compound (
) that token holders can use to make decisions on important issues related to the protocol.
Composite Protocol Management Portal
The number of COMP tokens that users receive depends on their level of activity on the Compound network. However, users who lend and borrow more often will be rewarded with more COMP tokens. The COMP token is equivalent to one vote on Compound. Tokens can also be delegated to others to vote on your behalf.
In 2020, Compound handed over control of the network admin key, and the project is now completely managed by token holders with no other management methods.
What is the difference between governance tokens and utility tokens?
Utility tokens are digital assets that can be used for a specific purpose, such as paying taxes or accessing a product or service. In contrast, management symbols give the holder a say in the management of the project.
The purpose of a utility token is usually associated with the original blockchain network or crypto platform where it was purchased. GDP (
) is a good example of a helper token. It is used on Binance to pay fees, vote on new token listings, and pay tickets or “entry fees” for features like the Binance Launchpad.
The main difference is that utility tokens have no governing power. Utility tokens are a great option for many purposes, but in some cases it is better to use management tokens. As mentioned earlier, management symbols can also be used to bet and get loans. This makes them more versatile.