The user-owned protocols that populate the Web3 landscape rely on novel mechanisms for determining the rules and parameters of decentralized applications (dapps). Unlike traditional business structures, many decentralized finance (DeFi) protocols use community-led voting mechanisms for determining the future direction of a project. When changes have to be made to Defi protocols, most decisions are open to a token-holding community. Governance coins and tokens provide an equitable alternative to traditional governance structures. Also, token economies and reward distributions require a robust decentralized governance framework for ensuring that dapps and blockchain networks benefit all users proportionally. If you’re new to crypto and DeFi, you may be wondering, “what is a governance coin?” or “how does a DAO work?”. If so, read on!
In this “What is a Governance Coin? article, we’ll dive deep into the world of governance tokens and coins. We’ll explore the concept of a decentralized autonomous organization (DAO) and on-chain governance. Also, We’ll discuss how governance tokens facilitate equitable decision making for blockchain projects and Web3 companies. Additionally, we answer common questions such as “what is a governance coin?” and “what is a DAO?”.
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What is a Decentralized Autonomous Organization (DAO)?
Before we address the question of “what is a governance coin?”, let’s first take a look at DAOs. A decentralized autonomous organization (DAO) is a governance model that is popular among many of the leading DeFi protocols. It allows Web3 communities to create a framework for voting on important decisions that affect the interactions they have with their favorite dapps. Also, this occurs without the need for a central authority.
Rather than concentrating the decision-making power of a company within the hands of a small group, DAOs allow entities to organize themselves in a way that aligns interests between multiple parties. Each member of a DAO shares a common goal and vision for the future of a project. However, DAOs allow various parameters of a protocol to be fine-tuned to meet the needs of the majority. This bottom-up approach to organizing blockchain protocols allows them to remain decentralized and make decisions that will benefit the whole community.
Thanks to the use of blockchain technology, all DAO votes are immutably recorded and visible to everyone. Also, DAOs use smart ocntracts to remove trust from the voting process and automate the outcomes of each improvement proposal. Additionally, many DAOs have treasuries that hold funds for community initiatives and ecosystem development. In many cases, DAOs vote on how treasury funds are spent and which projects receive funding.
Moreover, because DAOs facilitate community governance without relying on a central authority, they require a framework to ensure that voters act in the interest of the community. This is where governance coins and tokens come in.
What are Governance Coins?
So, what is a governance coin? Governance coins and governance tokens allow holders to vote on various areas of development within a blockchain protocol or DeFi project. They facilitate the type of community decision-making that is essential for decentralized governance, while aligning the interests of the project and token-holding community.
Most companies or organizations require a central authority or governing body to make critical decisions about the future. A small handful of individuals wield incredible power over some of the biggest companies in the world. Often, company directors are highly-influential in the hiring and firing of staff. These same executives also get the final say in how money is invested into the company and new projects. As such, most companies rely on a small group to decide the fate of an entire company.
In the world of Web3, projects tend to rely on alternative governance mechanisms to those adopted by traditional companies. The decentralized autonomous organization (DAO) model provides an equitable and transparent alternative to traditional governance using governance tokens. Often, one governance coin or token equals one vote and allows crypto communities to come together and vote on proposals that change the underlying technology in a way that serves the entire user base.
How Do Governance Coins Work?
So, now that we’ve addressed the question of, “what is a governance coin?”, let’s take a look at how they work. In most instances, governance coins and tokens allow holders to vote on proposals to make changes to a decentralized application (dapp) or blockchain network. Governance tokens are awarded to users in different ways. However, it’s common for projects to distribute tokens to dedicated users of the technology and the most active community members.
Most on-chain governance requires token holders to interact with smart contracts. Once the results of an improvement proposal have been established, these smart contracts can automatically execute the results of the vote without any rogue party or central authority interfering. These improvement proposals can cover various topics. Some of the most common proposals include voting on reward schedules, fee adjustments, appointing new team members, and amending the rules of a platform.
Pros and Cons of DAOs
DAOs provide a transparent alternative to central governance models. They allow Web3 projects to evolve in a way that meets the needs of their users. Also, DAOs allow decisions to be implemented almost immediately after voting. Anyone participating in a DAO has an incentive to learn about blockchain and Web3 technologies. Plus, DAOs help form communities around blockchain technologies.
However, DAOs often have drawbacks that can be limiting for Web3 projects. For example, DAOs are open to manipulation. Whenever there is a concentration of governance token holders, DAOs are at risk of centralization. Also, DAOs can be hacked. When this happens, the perceived reliability of a DAO can negatively impact the price of the native governance token. Additionally, DAOs can make it difficult for communities to form coherent strategies and communicate goals effectively. Plus, they often require a strong knowledge of blockchain and smart contracts.
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What are the Advantages and Disadvantages of Governance Coins?
Governance coins and tokens provide an equitable alternative to centralized decision-making processes. Also, decentralized governance prevents small groups of people from acting in their own interests. Instead, the power to make changes to the technology lies in the hands of users and stakeholders. Accordingly, governance tokens are an effective tool for building decentralized communities.
Governance token holders have an incentive to actively participate in the improvement of a project. All decisions can be implemented transparently in a way that every community member can observe. As such, it’s pretty difficult to cheat a decentralized blockchain voting mechanism.
However, despite the many benefits of governance tokens, there are still several factors that prevent them from being as equitable as they could be. For example, when a small number of whales hold the majority of the governance tokens in circulation, they can swing the results of votes in their favor rather than that of the broader community. To prevent this, crypto projects need a robust token distribution model. Also, DeFi projects must ensure that the parameters of their protocols cannot be exploited at the expense of their communities.
Additionally, some governance tokens have more utility than others. In many cases, governance tokens are an essential component in maintaining almost every aspect of a community-managed project. However, some governance tokens have little real-life utility. This is particularly true of governance tokens that only grant holders the right to vote on arbitrary parameters and proposals.
What are the Top Governance Coins?
Now that we have addressed the question of “what is a governance coin?”, let’s take a look at some examples of governance coins and tokens. Governance tokens vary between platforms. However, the majority of them allow holders to have their voices heard within their respective communities. Below, we explore the top five governance tokens by market capitalization, according to CoinGecko.
Uniswap is the leading decentralized exchange DEX on Ethereum. The native UNI governance token was airdropped to users of the platform in 2020. It enables holders to determine the overall trajectory of the project by voting on proposals to adjust trading fee rewards and determining which community initiatives should receive grants and funding. At the time of writing, the UNI token is trading at $5.54 with a market cap of $2.5 billion.
Aave is a decentralized borrowing and lending protocol. It uses a series of smart contracts to automate overcollateralized lending and borrowing for a range of crypto assets. Although Aave is a for-profit company, the AAVE governance token enables holders to vote on the parameters of the Aave protocol to align the interests of the company and the broader community. At the time of writing, the AAVE token is trading at $66.72 with a market cap of $929 million.
MakerDAO is a decentralized borrowing and lending protocol on Ethereum and one of the leading decentralized finance (DeFi) protocols. It provides financial instruments that use smart contracts instead of intermediaries. There are two crypto assets at the heart of the Maker ecosystem. Firstly, the users can deposit ETH or other crypto assets to take out an overcollateralized loan using the DAI stablecoin.
Furthermore, the MKR token plays several roles throughout the MakerDAO ecosystem. Primarily, the MKR token is a governance token. However, it also serves as a utility token and collateralization token. At the time of writing, the MKR token is trading at $854.46 with a market cap of $770 million.
eCash is a cryptocurrency project that aims to redefine the concept of wealth using an electronic cash system. The native XEC coin serves as a medium of exchange and unit of account throughout the eCash ecosystem. Holders can use it to pay for goods and services. Also, XEC is a governance token that grants holders the right to vote on proposals that determine the future of the project. At the time of writing, the XEC token is trading at $0.00003798 with a market cap of $725 million.
Synthetix is a derivatives liquidity protocol on Ethereum. It facilitates the creation of synthetic assets and provides exposure to a variety of real-world assets on the blockchain. Also, holders of the native SNX token can vote on proposals to determine which derivatives products will be voted into existence. At the time of writing, the SNX token is trading at $2.43 with a market cap of $553 million.
Deep Dive: What are Governance Tokens? – Summary
Governance tokens allow cryptocurrency projects and decentralized applications (dapps) to create community-oriented voting mechanisms on the blockchain. On-chain voting mechanisms that use governance tokens ensure that the future direction of Web3 protocols remains in the hands of its users.
After reading this article, you should be able to answer confidently the next time someone asks you “what are governance coins?”. Also, you should have a firm understanding of on-chain voting and how it can prevent the concentration of power among small groups of powerful individuals.
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