Cracking the Code: A Comprehensive Guide to Governance Tokens

Governance tokens
Understand how governance token distributes power in the blockchain to token holders

A governance token is a cryptocurrency that allows its holders to vote on proposed blockchain network improvements. This invention of a governance model is viewed as a vital step toward maintaining some crypto projects decentralized, notably those in the decentralized finance (DeFi) ecosystem. The notion is that rather than a single person or organization dictating the course of a platform, a community of users may influence choices in a process called governance.

These tokens, while not unique to DeFi, have become an important component of this ecosystem. This post will explain everything you need to know about them – what they are, how they work, and why they’re so important. 

What are governance tokens?

Governance tokens that come under the purview of governance models of functioning are cryptocurrencies that reflect voting power in a blockchain system. They are the primary tokens of decentralized finance systems since they transfer powers and rights to users through tokens.

This method of distributing control among stakeholders is known as “on-chain governance.” The governance models represent traditional management positions that hold the authority to modify the project’s protocol, i.e., its basis in code. One token equals one vote in most circumstances. Therefore, users’ votes are weighted according to the size of their governance token holdings.

As mentioned, these tokens can be used by community members to impact the direction and characteristics of a decentralized system actively. Using these tokens, users can create and vote on governance proposals. Besides this, they serve the following purposes:

  • Vote on various fees.
  • Change the user interface.
  • Modify the fee reward distribution.
  • Review the development fund.

Furthermore, governance token holders may also stake, borrow, and profit from yield farming. Nonetheless, their primary function is to distribute power.

Why are governance tokens necessary, and how do they work?

Decentralized initiatives, as opposed to centralized organizations, have a distinct governance paradigm based on native governance tokens. Decentralized Autonomous Organizations (DAOs) and Decentralized Finance (DeFi) are typically used to provide a more equal and transparent governing system. To guarantee the healthy growth of blockchain initiatives, these tokens connect communities together.

Governance tokens are the primary means of realizing decentralized governance in DAO, DeFi, and dApp initiatives. They are frequently given to active users to recognize their dedication and contributions to the community. To ensure the projects’ healthy growth, token holders vote on critical topics. Voting is often done using smart contracts, and the results are automatically applied.

Governance tokens vs. Utility tokens

Both are crucial highlights in the world of blockchain and will play an essential part in developing the Web3 ecosystem. So, what sets them apart? Since we have already discussed governance tokens, let us quickly dive into utility tokens.

Simply put, utility tokens are digital assets with some utility. Utility tokens serve various purposes, including paying fees, voting on new token listings, and purchasing tickets as ‘entrance fees’ for events and features of the project. Most of the time, this functionality is limited to the original blockchain network or crypto platform.

Governance tokens on the other hand are standing pillars of the governance model and are a more advanced kind of utility tokens. As previously said, they may also be utilized for other activities like staking and loan creation. 

Examples of Governance models

Maker DAO

MakerDAO, an Ethereum-based DAO that underlies the crypto-collateralized stablecoin DAI, released one of the first governance tokens. Maker is a well-known example of a governance token (MKR). This currency lets holders vote on decisions concerning the decentralized finance (DeFi) system based on DAI.

MKR holders, for example, can vote to modify the complicated economic rules that control the decentralized lending that enables DAI to maintain its price stability. 

RARI Token: NFT Marketplace Governance

Rarible is an Ethereum-based NFT marketplace where users can create, sell, and buy ownership rights to digital works of art using non-fungible tokens (NFTs). RARI is an ERC-20 governance token that holders can influence Rarible’s progress. RARI token holders, for example, may propose and vote on ideas to adjust trade costs or introduce new features, serve as community moderators, and select artwork on the platform.

Governance tokens released by decentralized exchanges Uniswap and PancakeSwap, DeFi lending platform Aave, Web3 NFT community ApeCoin DAO, and virtual world platform Decentraland are also significant.

Bottomline

Governance tokens are the building blocks of anything decentralized. However, they are not without flaws. Malicious actors may still carry out 51% attacks by simply accumulating tokens. A whale with enough financial power may derail the entire project and make and approve choices on its own.

However, experts feel that governance tokens have a bright future. As an invention originating in the crypto realm, they may find broader use in additional areas. The Web3 movement is where they can contribute to creating a decentralized internet. Other gaming sectors may adopt this governance model as DeFi and DAOs gain traction.