Tokens created by developers that give token holders a way to influence the development of a protocol are referred to as governance tokens. Holders of governance tokens (known as “stakeholders”) have a wide range of options to influence project choices such as submitting or deciding on new feature ideas, and they even have the power to change the governance structure.
What are governance tokens?
A governance token grants its holders voting rights, which enables them to have their voices heard when changes are made to smart contracts and issuing protocols. Investors that own governance tokens, on top of protocol fees, trading costs, and other benefits.
A huge number of governance tokens have been issued in the projects that have become major participants in the decentralized finance (DeFi) market over the past year. Other popular types of digital currency exchanges that have seen increased market capitalization include lending platforms, decentralized exchanges (DEXs), and hedge funds.
The term “governance” refers to the authority to make modifications to the protocol code, such as raising the block size or the inflation rate. In the majority of instances, users may then vote on these choices using their existing tokens (1 token = 1 vote). The introduction of a governance token provides a chance to more effectively engage the community in the decision-making process in a much greater transparent manner.
Benefits of governance tokens:
Prompt and effective development: While developers are not entirely excluded from making decisions, governance models allow them to arrive at a conclusion and implement the changes needed by their community with a lower amount of friction.
Decentralization: With governance tokens, there are countless smart contracts out there that no single party has any control over. The most important aspect of digital assets is decentralization; thus, it is important to integrate them in a concrete form.
Engaging: Communities get more involved as a result of better governance because users have both a purpose and a mechanism to actively shape the route and direction of the project.
Opportunities for collaboration: The benefits of voting include free discussion, which in turn spurs collaboration. Users are motivated to work with other community members and reach a conclusion in the debate because they have the option to vote on issues. What this shows is why online forums that regulate cryptocurrencies are a great social communication channel.
Advantages and disadvantages
It is more than clear that governance tokens are advantageous. But what are their disadvantages, and how do they affect crypto protocols? Let’s quickly summarize the good, the bad, and the ugly.
Decentralization. The only way developers can put the ‘De’ in DeFi is with governance tokens. Without them, projects would be barrens of smart contracts over which no one has any control. Decentralization is the main goal digital assets achieve, so why not include it in a tangible way?
Collaboration opportunities. Voting opens the door for discussion, and discussion opens the door for collaboration. When users can directly vote on the issue they face, they are incentivized to collaborate with other community members and reach a decision through discussion. This is why governance forums are the second-best social channel after Crypto Twitter.
More involved communities. Governance leads to more involved communities since users have both a reason and a method to actively steer a project’s path and direction.
Efficient development. Although developers do not altogether forego their part in the decision-making process, governance models make it easier for them to arrive at concrete answers and implement the changes deemed necessary by their community.
Selfishness. Just because one can vote does not mean that the person votes for the best outcome possible. Simply put, there will always be selfish actors that vote on decisions that only benefit themselves. Remember when the Maker community did not decide to reimburse their own community after the March flash crash liquidation?
Lack of accountability. Following the case above, it is clear that there will never be real accountability with democracy-based governance models. If a decision goes wrong, the community will always blame an invisible group that is not clearly defined. Users will always blame ‘the majority,’ and you will find no one revealing himself to be ‘the majority.’