Explore Governance Tokens: Decentralized Management Tools in Blockchain

Governance tokens have become a core element in the modern blockchain ecosystem. As decentralized projects such as blockchain games, decentralized trading platforms, and decentralized autonomous organizations continue to grow, the need for a fair and transparent governance mechanism becomes more urgent than ever. Governance tokens are the solution that allows the community of users to participate in important decisions shaping the future of these protocols.

How Do Governance Tokens Work?

The basic principle of governance tokens is simple: token holders have voting rights for proposals. Each token typically corresponds to one vote, allowing holders to express their opinions on issues related to the protocol.

In actual decision-making processes, projects must set specific parameters to ensure fairness. For example, some platforms require participants to hold a fixed amount of tokens throughout the voting period to prevent wealthy individuals from accumulating tokens suddenly just to influence decisions.

Voting is conducted on the blockchain, with options for approval or rejection open to all participants. Once voting concludes, the results are automatically executed if they meet the required threshold, without intervention from any central authority.

The Development History of Governance Tokens

From Bitcoin to Ethereum: The Beginning

Bitcoin, the first cryptocurrency, was simply an utility token used for peer-to-peer transactions. However, the emergence of Ethereum in 2014 opened a new chapter. Ethereum token holders not only used it for trading but also gained influence within the community, able to propose improvements to the platform itself.

DAO: A Historical Experiment

DAO launched on April 30, 2016, through an ICO on the Ethereum platform. It was designed as a fully community-led venture capital organization—a completely new model at the time.

However, DAO’s journey faced a significant obstacle when hackers discovered vulnerabilities in the code and exploited them to steal assets. This incident resulted in losses of about $150 million, forcing the Ethereum community to implement a hard fork to protect affected tokens. Ultimately, the attackers only retained about $8.5 million from the proceeds.

Despite its failure, DAO demonstrated the potential of governance tokens to create decentralized decision-making mechanisms.

MakerDAO: A Successful Model

After lessons learned from DAO, MakerDAO launched in 2017 with a more cautious and meticulous design. Its MKR token became one of the most prominent examples of an effective governance token.

MKR holders have voting rights on critical issues related to DAI—a stablecoin backed by cryptocurrencies. As DAI grew and gained market trust, the value of MKR also increased, because the more people participate in the community, the more decisions need to be made.

Governance Methods: On-Chain and Off-Chain

Off-Chain Governance

In this model, a core group of developers reviews proposals, discusses them, and then converts them into code. Ethereum is a typical example, with Ethereum Improvement Proposals (EIP) discussed within the community before implementation.

However, off-chain governance has the disadvantage of centralized power in the hands of a developer group, and users can only “suggest” without always being heard.

On-Chain Governance

This method is entirely more decentralized. Decision parameters are encoded directly on the chain, and once voting concludes, results are automatically executed without manual intervention. This ensures that community decisions are respected in an immutable manner.

Types of Issues Resolved Through Voting

Issues submitted for community voting depend on the nature of each protocol:

• Stablecoin protocols: Voting on adjustments affecting stability, risk mitigation, or changes in collateralization mechanisms.

• Decentralized exchanges: Voting on fee structures to optimize liquidity or introducing new trading pairs.

• Other DeFi protocols: Often voting on how to allocate financial resources across different areas to promote sustainable growth.

The Difference Between Governance Tokens and Other Token Types

Governance tokens are unique in their function compared to other tokens:

Utility tokens: Can be used to pay fees or access services but do not grant voting rights.

Governance tokens: Grant holders the right to participate in decision-making about the future of the protocol.

However, many protocols combine both functions. For example, Curve rewards CRV tokens to users not only for governance rights but also for their activity on the platform. Similarly, protocols like SUSHI and UNI also offer staking rewards for long-term commitment to the system.

Benefits of Governance Tokens

Governance tokens offer several significant benefits:

• Promoting true decentralization: Allowing the community to participate in decisions rather than centralized entities issuing commands from above.

• Enhancing diversity of opinions: Many individuals from different backgrounds have the opportunity to voice their views.

• Building a strong community: Token holders are often those who trust the project, creating a cohesive and active community.

The number of governance token holders from major protocols like Uniswap, Curve, and MakerDAO has increased significantly, demonstrating the appeal of this model.

Challenges and Limitations

However, governance tokens also face notable challenges:

Whale Problems

Wealthy individuals or organizations can purchase large amounts of tokens to influence decisions in their favor. This directly conflicts with the ideals of decentralization. Although difficult to prevent, some recent projects have implemented technical mechanisms to mitigate this issue.

Accountability and Responsibility

Unlike traditional companies with clear leadership figures, many DAOs are managed by anonymous groups. When projects fail, it is often difficult to identify who is responsible and how to seek compensation.

The Future of Governance Tokens

The prospects for governance tokens are limitless. As the number of large organizations adopting DAO models increases, the demand for a clear legal framework also grows. Currently, only Wyoming in the United States recognizes DAOs as LLCs, but this is expected to change in the future.

With the development of the metaverse and virtual cities, governance tokens could be used to manage these complex systems. Cities combining real and virtual worlds could be operated through democratic voting mechanisms enabled by governance tokens.

To address current issues, projects are developing new solutions. Some DeFi platforms have begun implementing anti-whale features directly into their code to prevent unhealthy token accumulation. Meanwhile, on-chain staking mechanisms are being developed to ensure accountability.

Frequently Asked Questions

What Makes a “Good” Governance Token?

A governance token is considered good when it is issued according to the announced tokenomics in the project’s white paper and developed by reputable developers committed long-term to the project.

Do Governance Tokens Have Real Value?

Yes, governance tokens have real value. Their value depends on the quality of services provided by the protocol. If the protocol operates well and addresses real issues, the governance token will have high demand.

Is Cardano a Governance Token?

No, Cardano is not a governance token by standard definition. Cardano’s improvement proposals are managed off-chain by academic researchers, not entirely by token holders.