What Is a Governance Token?

A governance token is a digital asset developers issue to investors who want to participate in shaping the future of their project. Governance token holders can vote upon decisions regarding the project, like recommending or approving new feature proposals and even totally modifying the governance model itself.

The amendments and new features are mostly suggested, evaluated, and voted on via on-chain governance using governance tokens. The changes are executed automatically by smart contracts. However, project developers are responsible for implementing the changes.

Governance token proponents strongly believe the model is community-driven, stemming from Satoshi Nakamoto's vision of decentralization and democratization. In many instances, projects that allow users to shape their decision-making process and development are known as decentralized autonomous organizations (DAOs).

Maker (MKR) is the most popular governance token in the DeFi space. The token allows its investors to vote on decisions concerning Maker Protocol—the smart contracts that power DAI.

Summary of Important Points

  • Governance is the way systems are controlled. You can think of it as the top-down system dominant in governments and corporations.
  • A governance token allows token holders to participate in the decision-making process of a project.
  • Governance tokens hand investors the voting rights to the protocol, creating a community-driven system that boosts active participation.
  • MKR is the most popular governance token in the DeFi space.

Profitability of a Governance Token

While most DeFi tokens in the crypto space are governance tokens, this does not imply that voting is their sole defining feature. Governance token holders can make money with their holdings by staking, lending, borrowing, and yield farming.

Compound, for instance, is considered a forerunner in the DeFi space as it rewards holders with COMP tokens. The model inspires investors to lend and borrow more tokens and adequately cover themselves against loan default.

You can also profit from a governance token by speculating. in both traditional and cryptocurrency finance, interest in a governance token is cultured by the belief that its ecosystem will continue to grow and appreciate in value.

Remember, decentralization has been the hottest crypto trend since 2020. Crypto enthusiasts are keen to be part of and possibly profit from how DAOs are run.

Advantages and Disadvantages of Governance Tokens

While it's evident that governance tokens are beneficial, they have their pros and cons. This section will summarize the good and bad sides of governance tokens.

Advantages of Governance Tokens

  • Decentralization The ideal way developers can actualize the 'De' in DeFi is through governance tokens. Without them, most DeFi projects will be authoritarian code lines, which are not community-driven. Decentralization is the original vision of Satoshi, so why not apply it in the right way?
  • Collaboration opportunities Community voting creates an accommodating environment for liberal discussions, leading to collaboration. When investors directly vote for projects they have invested in, they are likely to do so out of their hearts and for the project's welfare. Even if they have different opinions, they are also likely to achieve consensus through holding sober discussions.
  • Active communities Decentralized governance encourages active investor participation as their opinions are valued. A community-driven project is more likely to hit deadlines and raise the necessary funds than a centralized governance project.
  • Actual progress Governance models encourage progress by active participation and group decision-making from core investors.

Disadvantages of Governance Tokens

  • Selfishness The fact that token holders can vote doesn't imply they all share the project's best interest. There will often be some selfish individuals proposing or passing decisions that only benefit them. For example, the Maker community failed to reimburse the victims of the March market crash liquidation.
  • Lack of accountability From the March flash crash liquidation case study above, it is undeniable there will never be proper accountability with decentralized governance models. When a decision doesn't work out, the community will blame invisible individuals. The blame is often directed to 'the majority token holders' who are anonymous.
  • Whales Almost all governance protocols have whales that keep buying more tokens with unknown agendas. The 'small holders' fear that one time, the whales will own enough tokens to suggest and approve proposals solely and achieve their hidden agenda.

How to Buy Governance Tokens

You can buy any governance token by visiting the CoinMarketCap website to see the marketplaces that have listed it. CoinMarketCap offers a list of available market pairs and marketplaces for every crypto.

Visit the CoinMarketCap and enter the name or initials of the governance token you want to buy (e.g., Maker or MKR) in the search bar.

Click the " Market " tab next to the price chart to view a complete list of marketplaces to buy from and the available token pairs.

From there, visit your preferred exchange and make your purchase.

Final Thoughts

A governance token helps a DeFi project reach its true potential by embracing decentralization and democratization. These tokens will continue to be a primary feature in protecting the crypto community and investor interests. Projects like Maker, Uniswap, and Terra are leading the way for decentralized governance in the DeFi landscape.