Logo
Carla Moretti
Carla Moretti
With almost two decades of experience in the fast-paced financial industry, Carla has established herself as a powerhouse and an innovative leader.
Table of Contents
    Add a header to begin generating the table of contents
    1. Home
    2. /
    3. Guides
    4. /
    5. Intermediate
    6. /
    7. What is a Governance...

    What is a Governance Token and How does It Work?

    What is a Governance token

    Governance tokens are the game-changers of the decentralized world.

    What is a Governance Token?

    empower holders to have a direct say in the decision-making process of a blockchain or platform. Imagine having a stake in a project and not only being able to watch it grow but also actively participating in its development.

    Governance tokens represent not just a new addition to your crypto portfolio, but they give you a sense of ownership and control over the project’s future. Get ready to join the ranks of decentralized decision-makers and take control of your investments with decentralized governance tokens.

    How Governance Tokens Work

    Governance tokens work by giving holders the ability to vote on important proposals and decisions for the blockchain projects or decentralized platforms they are associated with. These proposals can include changes to the protocol, the allocation of funds, or the addition of new features. Community members of governance tokens, hence, play an active role in shaping the future of the project by exercising their voting rights.

    Holders of governance tokens can vote on proposals using their tokens, with the weight of their vote being determined by the number of tokens they hold. The more tokens you hold, the greater your voting power. This ensures that buyers with a larger stake in the project have a proportionally larger say in its direction and development. Voting power is a key feature of governance tokens, as it allows holders to make important decisions that affect the future of the project. This allows for a more decentralized and democratic decision-making process, as opposed to a traditional centralized system.

    Additionally, some platforms have a minimum threshold of tokens required to vote, thus, making sure that the vote is only taken by a significant part of the community.

    Once a proposal has been submitted, holders have a designated period of time to cast their vote. Once the voting period has ended, the proposal is evaluated based on the number of votes in favor or against it. If a proposal receives enough votes in its favor, it is implemented and the blockchain or decentralized platform is updated accordingly.

    It’s worth noting here that not all governance tokens are created equal. Some platforms have different voting mechanisms, for example, some use a single vote per token, others use a token-weighted voting system, and still others use a reputation-based system.

    These different mechanisms help ensure that the community’s initial support for proposals is accurately reflected in the final outcome.

    Holder of Governance token have the right to vote

    Types of Governance Tokens

    Governance tokens come in a variety of forms, each with its unique characteristics. Some of the most common types include:

    1. Native Governance Tokens: These are tokens that are built into the protocol of a blockchain project. They are typically used to make decisions about the direction of the project. Examples of native governance tokens include Ethereum’s Ether (ETH) and EOS’s EOS.

    2. Token Curated Registries (TCR): TCRs are a form of tokens that allow holders to vote on the inclusion or exclusion of items in a list. This can be used for a variety of purposes, such as curating a list of high-quality projects or creating a decentralized marketplace.

    3. DAO Tokens: DAO stands for Decentralized Autonomous Organization, and these provide the holders the ability to vote on proposals and make decisions within the organization. The most well-known example is the DAO (Decentralized Autonomous Organization) that existed on the Ethereum blockchain.

    4. Staking Tokens: Staking tokens are used to secure a blockchain network by validating transactions and adding blocks to the chain. In return for staking their tokens, holders are rewarded with additional tokens or a share of the network’s transaction fees.

    5. Reputation-Based Tokens: These tokens are awarded to users based on their contributions to the platform and are used to determine the weight of their vote. The more reputation tokens a user holds, the more influence they have in the decision-making process.

    Each type of token has its own unique set of characteristics and can be used for different purposes. It’s important to understand the specific use case and mechanics of such a token before deciding to invest or participate.

    Use Cases for Governance Tokens

    Governance tokens have a wide range of potential use cases, and some of the most popular ones are discussed next.

    Decision-Making in Decentralized Organizations

    These tokens allow token holders to have a say in the future and progress of a decentralized organization. This can be used to create more democratic and transparent decision-making processes through community votes.

    Community-Driven Development

    Governance tokens can help align the interests of the community with those of the development team, resulting in more community-driven projects through off-chain governance and community votes.

    On-Chain Governance

    Governance tokens can be used for the involvement in the protocol or governance structure of a blockchain through off-chain governance. This can include changes to the consensus mechanism, the addition of new features, or even a change of the leadership of the organization through token holder votes.

    Decentralized Finance (DeFi)

    Governance tokens can play a crucial role in decentralized finance projects. They allow governance token holders to vote on proposals to change the platform’s smart contract code, introduce new features, or change tokenomics through off-chain governance.

    Token Curated Registries (TCRs)

    Governance tokens can be used to create and vote on lists of high-quality projects or products in a decentralized way through community votes. This can be used in various industries such as gaming, real estate, and many more.

    Studyng blockchain in a office

    Examples of Governance Tokens in the Market

    There are several examples of governance tokens in the market, including:

    1. MakerDAO (MKR): MakerDAO is a decentralized platform that runs on the Ethereum blockchain and uses the DAI stablecoin as its native token. MKR token holders can vote on important decisions related to the platform, such as changes to interest rates and risk management.

    2. Aragon (ANT): Aragon is a decentralized platform that allows users to create and manage their own decentralized organizations. ANT holders can vote on important decisions related to the platform, such as changes to the Aragon Network Token (ANT) treasury.

    3. Compound (COMP): Compound is a decentralized lending platform that allows users to borrow and lend various cryptocurrencies. COMP token holders can vote on important decisions related to the platform, such as changes to interest rates and collateral requirements.

    4. MolochDAO (MOLOCH): MolochDAO is a decentralized autonomous organization that helps fund and support Ethereum-based open-source projects. MOLOCH token holders can vote on proposals for funding and other important decisions related to the organization.

    These are just a few examples of the uses of governance tokens in the market. Many other projects and tokens are also implementing governance tokens in their ecosystem, a trend that is expected to continue in the future.

    Governance Token Regulations

    Regulation and Compliance

    With their increasing popularity, Defi protocols are gaining attention from governments and regulatory bodies who are beginning to implement regulations for these tokens.

    1. Governance Tokens and Feature Proposals: Some governments have classified governance tokens as securities, which means that they are subject to the same regulations as traditional securities such as stocks and bonds. This includes registration requirements and disclosure obligations for issuers, as well as limitations on who can purchase and hold the tokens. The governing power, including new feature proposals and UI changes, is often distributed among the token holders through a transparent, one-vote-per-token arrangement.

    2. Anti-Money Laundering (AML) and Know Your Customer (KYC) Regulations: Governance tokens are also subject to AML and KYC regulations, which are designed to prevent money laundering and terrorist financing. This means that issuers and exchanges may be required to verify the identities of Defi users and report suspicious activities to the relevant authorities.

    3. Tax Regulations: Governments are also beginning to impose taxes on the sale, purchase, and holding of governance tokens. This can include capital gains taxes, sales taxes, and value-added taxes.

    4. Smart Contract Regulations: Smart contracts are the backbone of many governance tokens and blockchain-based projects, and governments are starting to regulate them. This can include regulations on their design, development, and deployment, as well as regulations on how they can be used and what types of activities they can facilitate.

    It is important to note that the regulations for governance tokens, also known as on-chain governance tokens, are still in the early stages and vary greatly from country to country. As the technology and market for on-chain governance tokens mature, regulations will likely continue to evolve to adapt to the changing landscape of this new form of decentralized decision-making mechanism.

    Future of Governance Tokens: Empowering Governance Token Holders

    The future of governance tokens looks promising, as more and more decentralized projects are turning to this model to allow their communities to determine the direction of the project, particularly in the crypto space where decentralized finance (DeFi) and decentralized autonomous organizations (DAOs) are rapidly gaining traction.

    One of the key advantages of governance tokens is that they allow for more efficient decision-making and help to ensure that the project remains aligned with the interests of its community, rather than being dominated by a small group of individuals or organizations. Additionally, governance tokens can help align the incentives of all stakeholders in a project by giving token holders a stake in the project’s success and distributing control among them.

    The most promising area for the future of governance tokens is in the DeFi space, where decentralized platforms are being developed to provide financial services such as lending, borrowing, and trading on the native blockchain network. These platforms are often built on blockchain technology and are designed to be more transparent and accessible than traditional financial institutions. Moreover, governance tokens also have the potential to be used in other areas such as social media and content platforms, virtual worlds, and gaming ecosystems.

    As more and more decentralized projects are launched, we can expect to see a growing use of governance tokens to give communities more control over the direction and management of these platforms and protocols and help create self-sufficient DAOs. The primary purpose of governance tokens is to give communities the ability to make decisions pertaining to the direction and management of the project which is beneficial to the development and growth of the project.

    Furthermore, Defi protocols are also using governance tokens to ensure the transparency and accessibility of their platforms. Overall, governance tokens play an important role in the blockchain ecosystem and have the potential to revolutionize the way that decentralized platforms and protocols are managed and governed in the future.

    Final thoughts

    Governance tokens, such as voting power tokens, offer a novel level of community engagement and empowerment, allowing for decentralized decision-making and a truly democratic experience on the blockchain. By investing in a governance token, one not only potentially secures financial gains but also becomes a vital stakeholder in shaping the future of blockchain technology.

    FAQ

    Most frequent questions and answers

    Creating a governance token typically involves several steps, such as:

    1. Defining the purpose and structure of the token, including its total supply, inflation rate, and any other relevant parameters in the governance systems.

    2. Writing smart contract code for the token using a blockchain platform like Ethereum, including the Ethereum Name Service (ENS). The smart contract should include the logic for minting, transferring, and burning the tokens, as well as any other functionality that is specific to your governance model, such as a vesting schedule for early adopters or long-term holding, to prevent malicious actors from manipulating the system.

    3. Deploying the smart contract to the blockchain and testing it to ensure that it is functioning as intended.

    4. Launching the token and distributing it to the intended stakeholders, such as through an initial coin offering (ICO) or airdrop.

    5. Establishing a governance mechanism, such as a decentralized autonomous organization (DAO) or an Investment DAO.

    It’s important to note that creating a governance token is a complex process and requires a deep understanding of blockchain technology and smart contract development. It’s also important to consult with legal and financial experts to ensure compliance with relevant regulations.

    Yes, governance tokens can be sold on various cryptocurrency exchanges, just like other types of tokens. However, it is important to note that the value of a governance token is often tied to the success and adoption of the project or protocol it governs.

    Therefore, the value of the token may fluctuate depending on the performance of the underlying project, as well as market conditions and investor sentiment.

    A utility token is a type of digital asset that is used to access a specific product or service within a blockchain-based ecosystem. Utility tokens are often used to represent access rights to a platform, a specific feature, or a certain amount of storage or processing power.

    Utility tokens are not considered to be securities and are not subject to securities regulations. The value of a main utility token is derived from its utility rather than its potential for appreciation like other digital assets such as cryptocurrencies.

    UNI is the governance token of the Uniswap protocol. It gives buyers the ability to vote on proposals to change the protocol, such as adding new features or adjusting fee structures.

    Governance tokens, such as UNI, are typically distributed to users of the protocol or platform that the token represents. For example, UNI tokens were distributed to users of the Uniswap protocol who held Ethereum (ETH) in their wallets at the time of the launch.

    The distribution method can vary, but it is usually based on a specific snapshot of users or their activity on the platform at a given time.

    Subscribe and Receive a Free Copy of Our E-book
    Bitcoin E-book on a tablet

    Skrumble.com provides all its content for informational purposes only, and this should not be taken as financial advice to buy, trade, or sell any investment instruments or products, including but not limited to cryptocurrencies, or use any specific exchange. Please do not use this website as investment advice, financial advice, or legal advice, and each individual’s needs may vary from that of the author. Investing in financial instruments, including cryptocurrencies, carries a high risk and is not suitable for all investors. It is possible to lose the entire initial investment, so do not invest what you cannot afford to lose. We strongly advise conducting your own research before making any investment decisions. This post includes affiliate links with our partners who may compensate us.

    To view our privacy policy read here.

    You may also be interested in:
    Scroll to Top

    Get Your Free Bitcoin Trading E-Book!

    Simply insert your info, hit the button subscribe and you will receive an e-mail with a link to view and download the E-book. Remember to check your spam if you do not see our e-mail.