Key points
- A governance token is a digital asset whose holders can take part in decisions about a blockchain project’s development.
- Most governance systems built around a token rely on a decentralized autonomous organization (DAO). Tokens grant voting rights and allow holders to submit proposals.
- A governance token is a type of utility token and may have functions beyond voting.
Why are governance tokens needed?
Blockchain technology gave rise to decentralized applications and entire economic niches such as decentralized finance (DeFi).
Yet the way many such applications were organized remained centralized, at odds with their nature. Over time, an architecture for decentralized project governance—DAOs—emerged.
Thanks to DAOs, a project’s community can take decisions on some (and sometimes most) matters related to changes in a product or ecosystem. The instrument of participation in a DAO became the governance token. It also became the main economic incentive for the community and a way to reward active members.
In essence, governance tokens represent a share of “ownership” in a decentralized protocol—akin to equity, but with direct influence.
How did governance tokens emerge?
One of the first governance tokens was Maker (MKR) of the MakerDAO protocol. As the name suggests, it embedded a DAO-based governance system from the start.
MKR is used for DAO votes, including the protocol’s core economic parameters. One feature of MakerDAO is that the results of a vote can be revised even after execution if DAO participants—that is, MKR holders—approve.
The token’s supply is not fixed and changes with the overall collateralization of DAI stablecoins in circulation. If collateralization falls below the set level, some MKR is used to restore collateral (and vice versa). Thus MKR also serves as a recapitalization mechanism.
Another notable DeFi project after MakerDAO was Compound. Its developers effectively invented liquidity mining, as the project’s governance token, COMP, was first distributed to users through this mechanism.
After it reached the open market, COMP’s price surged, briefly making mining on Compound extremely profitable. That brought attention to the project and its governance token.
Today COMP is used to pay yields for participating in the platform’s pools and for DAO votes. With COMP you can put an issue to a vote, but you must hold at least 1% of the issued tokens.
Which blockchain projects have governance tokens?
Today governance tokens are most common in DeFi and adjacent areas such as GameFi. They are also gaining popularity in metaverse and NFT projects, where they often serve as the main means of payment.
According to Coingecko and CoinMarketCap as of June 2022, the largest governance tokens by market capitalization are:
- Uniswap (UNI).
- Aave (AAVE).
- Sushi (SUSHI).
- ApeCoin (APE).
- Curve (CRV).
- yearn.finance (YFI).
- Synthetix Network (SNX).
- Ethereum Name Service (ENS).
- Compound (COMP).
- Maker (MKR).
- UMA (UMA).
- Aragon (ANT).
- Balancer (BAL).
How to get a governance token
Today the most popular way to launch a new governance token is an airdrop—that is, the issuer credits an amount of coins to a large number of users based on specific criteria.
Usually the conditions for taking part in an airdrop are not strict. For example, Uniswap credited the same amount of UNI to all users who had either swapped cryptocurrencies or acted as liquidity providers in the protocol before a specified date.
After issuance, a governance token is listed on trading platforms, where anyone can buy it. Because governance tokens trade openly like other cryptoassets, their prices fluctuate with supply and demand.
Can you earn income from governance tokens?
In many DAOs, participation is implemented by locking governance tokens in a special smart contract. In return, holders receive “wrapped” tokens that can be used only for voting.
Some protocols reward DAO participants by issuing additional tokens on top of the locked ones at a set rate. Others use a different mechanism: those who take part in votes receive activity rewards via periodic airdrops.
What else are governance tokens used for?
Although most governance tokens share common traits and uses, specific functions vary by project.
For example, KNC holders can vote for or against allocating funds to new partners of the Kyber Network ecosystem, as well as on changes to the asset’s staking yield.
In turn, holders of tokens in the Curve protocol can also propose the creation of a new liquidity pool (this requires locking 2,500 CRV). However, the community must approve the proposal through a vote.
Holders of the Synthetix Network governance token not only decide on the protocol’s development but also elect members of the governing council. In Dash, holders of the native coin—which also has governance functions—can submit proposals on how to use 10% of the fees collected by the blockchain. To become a member of the DAO, you need at least 1,000 DASH.
Metaverse governance tokens are often needed to buy valuable digital items and to shape the world. In Decentraland, the MANA token is effectively the currency for buying digital land. Creators inside the metaverse sell their items for the same tokens.