What are Governance Tokens? A Guide
As the world is moving from Web2 systems to a web3-enabled internet, blockchain projects are increasingly becoming user-centred. Thus, blockchain platforms are adopting practices that allow their users to have a say in how they run their systems. One of the major ways to achieve these user-centred protocols is the use of governance tokens.
This article explains what governance tokens are, their benefits, and how they are distributed.
What are Governance Tokens?
Governance tokens are tokens used to achieve decentralized governance in blockchain projects like Decentralized Apps (DApps) and Decentralized Autonomous Organisations (DAOs). These tokens give members the power to vote on issues that affect the project’s system. For example, DAO members can hold tokens to vote on issues like changing the system’s underlying code or adopting new community members.
Most times, one token only gives the power of one vote. Also, the voting process is executed by smart contracts. Blockchain projects like Compound have transformed their systems into a completely decentralized model. This transformation means that token holders get to vote on every decision that affects the project.
How are Governance Tokens Distributed?
The distribution of governance tokens may differ according to each blockchain project. For example, some projects distribute governance tokens according to the monetary investment of each member. In this case, members purchase the tokens with their money, and members with the most tokens are most likely to have higher voting power. However, other projects simply reward active community members with tokens.
Examples of Governance Tokens
- MKR: MKR is a governance token that MakerDAO issues. In fact, the first set of governance tokens to ever be issued were MKR Tokens. MakerDAO is a blockchain community that seeks to support technological development by enabling crypto saving and lending. MKR holders can vote on issues like adopting new rules or interest rates on the Maker Protocol.
- AAVE: AAVE tokens are used to govern the AAVE system. AAVE is a Decentralized Finance (DeFi) protocol that facilitates crypto lending. AAVE holders are allowed to vote on issues like funds management and new members’ admittance. Holders can also use AAVE as collateral to get loans on the AAVE protocol.
- CAKE: CAKE is the governance token issued by Pancake Swap, a decentralized exchange. CAKE holders can vote and make proposals for other holders to vote. Additionally, CAKE holders can only acquire voting rights after staking an amount of CAKE.
While governance tokens often encourage members to contribute to a project’s direction, these tokens also raise some challenges. One of such challenges is the risk that people with more tokens (and voting power) will influence voting outcomes. This manipulation recently played out on the Pancake Swap protocol. According to reports, a holder of over 94,500 tokens successfully manipulated a recent vote on the protocol. These manipulations can compromise the integrity of blockchain projects that have adopted the decentralised governance model.