As DAOs become more prevalent, their governance systems will play an increasingly important role in shaping the future of projects built upon them.
Governance tokens are a relatively new idea in the blockchain space; they’re a token used to give token holders voting rights and govern the organization’s direction. Aragon, Gnosis, and MakerDAO are currently using them.
In this post, we’ll look at some of these governance tokens and what they do. Holders of governance tokens are granted the ability to vote on matters that affect the direction of a blockchain project’s development and day-to-day operations.
It’s a way for organizations to share decision-making authority with the communities they serve through their programs. This style of decentralized governance helps align the interests of the people who possess tokens with those of the project.
Centralized governance refers to a situation in which power is concentrated in the hands of a small group of individuals, such as a board of directors, as in the case of many traditional businesses. On average, the boards of directors of the largest firms often consist of close to ten individuals.
They wield an incredible amount of control over the management of businesses. The board of directors has the authority to choose which projects the company will fund, appoint or fire key executives, and determine the overall strategy for the business.
Governance tokens represent a new approach to the governance of organizations. The concept that governance tokens represent provides a governance mechanism that is more equal, decentralized, and transparent.
This method is common for use in decentralized organizations (DAOs), also known as decentralized finance (DeFi). The majority of the time, one token is equivalent to one vote. To ensure that blockchain projects may evolve healthily, these coins are intended to strengthen community bonds.
In the case of decentralized organizations, their tokens are not created on a centralized platform such as Ethereum (ETH). They are built on a blockchain and run DAOs, which rely on intelligent contracts. These smart contracts contain computer code automatically executing when participants make specific inputs.
In the case of DeFi, tokens are used to control what happens with capital deployed by investors.
How do governance tokens work?
Governance tokens enable the users of blockchain platforms to gain voting rights in the project’s direction. This power can then be used to vote on specific decisions or changes to a project.
For a governance token to work, it must be made available on a marketplace that lists token sales. The development team and their supporters would then purchase the tokens, which they can use as their voting power.
In the case of Grin, a project underway by developers working on a decentralized blockchain-based social media platform, the development team has stated that members of their community will be able to vote with their GRIN tokens on decisions about future changes to the platform.
This announcement was made in October 2018. The Grin project is compatible with governance tokens, atomic swaps, and other features used by Ethereum (ETH).
Governance tokens also use smart contracts to give token holders voting rights. In decentralized autonomous organizations (DAOs), decentralized financial infrastructure (DeFi) projects, and decentralized applications, governance tokens serve as the foundation for establishing decentralized governance (DApps).
Users who have made major contributions to the community or exhibited loyalty often receive governance tokens as a thank-you.
Token holders can then vote on important topics to guarantee that the projects advance effectively. The voting typically takes place through smart contracts, which allow the results to be automatically calculated and implemented.
Every project has its unique regulations for its governance tokens. Using various computation methodologies, they are distributed among the many stakeholders, including the founding team, investors, and users.
While some governance tokens can vote on a select few governance concerns, others can vote on a wide variety of topics, including smart contract amendments and development updates. In a similar vein, certain governance tokens can provide financial returns, but other tokens do not.
MakerDAO, a decentralized autonomous organization (DAO) built on Ethereum, was one of the first organizations to issue governance tokens. The name of the stablecoin issued by MakerDAO is Dai DAI.
Token holders are in charge of governing the protocol. One vote can be cast per token, and the decisions that receive the most votes will be implemented. It’s essentially a democratic system.
This allows MakerDAO to expand the range of topics on which it can vote in the future, allowing them to integrate new features into the protocol.
Dai DAI tokens do not come with financial returns and do not give token holders voting rights. Instead, holders of Dai DAI decide what happens with the protocol.
The more tokens people hold, the more votes they have in the decision-making process for the DApp platform MakerDAO. Therefore, participants in the Dai voting process have a vested interest in the long-term stability of the MakerDAO system.
When it comes to governance tokens, smart contracts are an essential element of their operation and development. These contracts can be used to debate proposals and vote on specific decisions.
They contain code that automatically executes when participants make certain inputs. MakerDAO, a decentralized autonomous organization (DAO) built on Ethereum that serves as the basis for the crypto-collateralized stablecoin DAI, is credited with issuing one of the initial governance tokens.
Holders of the Maker protocol’s governance token, MKR, are responsible for its administration. One vote can be cast with one MKR token, and the winner is the option that receives the most support.
Token holders are allowed to vote on various matters, including the appointment of team members, the modification of fees, and the adoption of new rules. The MakerDao stablecoin must maintain its stability while completely transparent and operating at peak efficiency.
Another illustration of this concept is the DeFi protocol known as Compound, which enables users to lend and borrow cryptocurrency. It does this by distributing a governance token known as COMP, which enables its community of users to vote on important matters.
The tokens are distributed to users in direct proportion to the amount of on-chain activity they perform. To put it another way, the more money you lend and borrow on Compound, the greater number of COMP tokens you will accumulate.
In a manner analogous to that of MakerDAO, one COMP token is equivalent to one vote. Users can also delegate their tokens to others so that others can vote on their behalf. Noteworthy is the fact that Compound gave up ownership of the network’s admin key in the year 2020.
It indicates that the project is now solely managed by the people who have the tokens, and there are no other governance procedures.
Other significant governance tokens include those issued by the decentralized exchanges Uniswap and PancakeSwap, the decentralized financial lending platform Aave, the Web3 NFT community ApeCoin DAO, and the virtual world platform Decentraland.
Every project has unique guidelines for how its governance tokens should be used. Different calculation models determine how tokens should be allocated to various stakeholders, such as the founding team, investors, and users.
While some governance tokens can only vote on a limited number of governance issues, others can vote on the vast majority of topics. There are two types of governance tokens: those that can earn financial dividends and those that cannot.
It should be noted that developers are responsible for creating these contract templates. The role of governance tokens is to implement these codes into smart contracts.
The future of governance tokens: immutable and programmable
As public awareness of decentralized governance spreads, interest in this area will likely increase. Decentralized organizations that can govern themselves and make decisions that support the long-term success of their community will receive a more favorable response from the market than those that do not.
Governance tokens are used to vote on various topics while allowing contributors with a vested interest in the project to have a say in its development. Governance tokens are an invention that originated in the cryptocurrency field and could find applications in a larger variety of industries.
The Web3 movement is an area where governance tokens can be used to construct a decentralized internet. Other industries, like gaming, may eventually adopt this governance model as decentralized finance and DAOs gain more traction.
Governance tokens will continue to develop new features to address new issues as they arise. There may be brand-new solutions to the whale problem and other methods to make the voting process even better.
There is a possibility that novel voting procedures will emerge. This area may get more difficult to navigate as new technologies are continually introduced.
Alterations that could be made to existing regulations are yet another significant element that will influence the future of governance tokens. These tokens might be considered securities by certain governments. Because of this, they could be subject to stringent rules, which would affect how they operate.
Perhaps the most likely outcome in the future is that governance tokens will be used more and more frequently by projects in both the cryptocurrency and general industries. It’s easy to imagine how governance tokens could be applied beyond decentralized organizations.
How Token Owners Shape a DAO’s Direction?
According to the analytics portal Chainalysis, less than one percent of all holders of governance tokens control 90 percent of the voting power on average. This information was derived from the blockchain.
According to the paper’s findings, there are significant repercussions for the governance of decentralized autonomous organizations (DAO). It explains that a small group of the top one percent holders could outvote the other ninety-nine percent of holders on any choice if they collaborated.
According to the study’s findings, this has several clear, practical ramifications. In terms of investor sentiment, it is likely to affect whether or not smallholders perceive that they can meaningfully contribute to the proposal process.
According to the Blockchain data portal Chainalysis, governance token data reveals that decentralized autonomous organizations (DAOs) ownership is heavily concentrated.
The majority of governance tokens take the form of votes; hence, token holders will combine their tokens with recommendations for structural alterations to cast their votes.
According to the paper’s findings, DAOs are crucial components of web3. They operate as a decentralized form of the Internet and are based on networks that use open-source blockchain technology.
Decentralized autonomous organizations, or DAOs, aim to provide a new, more democratic form of management for enterprises, initiatives, and communities. Within a DAO, any member can vote on organizational decisions simply by purchasing a stake in the project.
Chainalysis demonstrates that on a high level, the creators of the DAO establish a new coin that is referred to as a governance token. They make these tokens available to users, backers, and other stakeholders in the system.
Within the organization, the quantity of voting power that is associated with each token is predetermined. On the secondary market, where tokens can be purchased and sold at will, each token is assigned a price that correlates to that price.
This allows the DAO to create rules that are automatically executed when token holders decide to transfer their tokens. If two or more interested parties held a majority of voting power, they could vote on organizational changes in favor of themselves; however, this would constitute fraud and encourage a breakdown in the system.
To prevent this type of fraud, assigning approximately one percent of voting power to each stakeholder is considered appropriate. After all, such a small amount of voting power would remain the same as the DAO’s direction.
Chainalysis noted that, in practice, this places the power in the hands of an elite group of investors that can pose significant problems to other stakeholders. These large stakeholders can vote or decide on changes and influence key decisions without restrictions if they act collaboratively.
Chainalysis‘ study found that among governance tokens, there are several “whales” (token holders with large holdings). These whales have significant voting power and can make changes or impose limitations on the community that does not reflect popular opinion.
Whale holders prefer to vote together. In theory, if they can agree, they can vote in favor of their interests. They may use the power of their tokens to manipulate decisions that most stakeholders consider unfavorable without resorting to fraud or manipulation.
In addition, they are often not 100 percent transparent and inefficiently record their decisions.
Conclusion: Governance Tokens, Evidence of Their Effectiveness
Despite the paper’s findings, the authors do not consider governance tokens to influence decentralized organizations negatively. They view them as a means for stakeholders to manage resources and make decisions together.
According to the findings, governance tokens are most often used for voting and decision-making by stakeholders in decentralized organizations. They are created on top of blockchain platforms such as Ethereum and allow any individual holder to participate in a wide range of decisions.
The paper’s authors believe governance tokens are critical for developing decentralized organizations. They believe that they are a key component of new governance structures. In addition, they argue that the use of tokens by decentralized organizations has become more popular in recent years.
According to their findings, this is a positive development because it signals increased confidence in decentralization as an emerging industry and increases the likelihood that these types of projects will have a broader impact on society.
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