The internet of value and the ecosystem known as "web 3.0", built on blockchain technology, allows for the creation of self-governing communities and organizations in a public, transparent, and secure manner.
This is possible thanks to blockchain technology and with the help of what is known as a Governance Token, a type of crypto asset issued with the aim of democratizing and governing forms of organizations known as DAOs (Decentralized Autonomous Organizations).
Power will then rest with the users of these platforms and not with a small, centralized group – as would happen in a traditional company – which can have positive consequences for the user.
In fact, this practice has been evolving for several years, and many protocols already implement it to decide on their future.
Below, we will analyze what exactly a Governance Token is, what the main benefits of using them are, and what problems or challenges they face.
A Governance Token is a crypto asset that grants its holder the ability to participate in the governance processes of a specific DAO.
A DAO, as we have already mentioned, is a company like any other, with the peculiarity that it is managed in a decentralized manner. In it, different users work from various geographical locations, but with a common goal.
But… how is it possible to reach an agreement in a decentralized organization?
Well, thanks to the voting power granted by Governance Tokens.
These tokens allow their holders to help continue building and improving the organization.
So, a person would create a unique address that would identify them on a specific blockchain network. Through that address, they could acquire a DAO token hosted on that blockchain.
Finally, by interacting with network programs (smart contracts), they would use this token to cast a vote, intended to decide on a change in the organization, based on proposals submitted by community members.
Ultimately, in a DAO, the creators do not have total control over the organization; instead, they delegate its direction to the holders of the Governance Token, which can be distributed or sold according to the rules of each protocol.
To conclude, it's important to note that this governance has nothing to do with the governance of the blockchain itself: on the one hand, we find the governance mechanisms of blockchain networks (an interesting topic that we will analyze in another post).
Instead, this blockchain network can host numerous decentralized protocols, each with its own governance.
As discussed in other articles, there are different types of tokens and various ways to classify them (fungible and non-fungible, cryptocurrency or token, security tokens, platform tokens, etc.).
In this case, the line for classifying Governance Tokens (Utility token, security token...) seems blurry because, due to the flexibility allowed by programming, some of them could even be considered a security, as they can share some key characteristics with company shares.
On the other hand, unlike a Utility token, a Governance Token allows voting on decisions and proposing changes.
But… can we consider voting power as a utility?
If the sole purpose of this token is to vote, we can say that this is its utility, and therefore it is considered a utility token and, at the same time, a governance token.
However, if, in addition to being able to vote, the holders or owners of these tokens receive a monetary reward, either directly or indirectly, we could classify them as security tokens and governance tokens.
This latter classification would imply that the issuance and registration of these tokens would be controlled by each country's market regulatory bodies.
In another article, we will analyze how to differentiate a utility token from a security token.
The difficulty in classifying tokens could lead to several problems for both the holders of these tokens and their issuers, as the applicable legislation will differ depending on how they are classified.
However, considering that these are decentralized protocols, the holders or even the issuers of these tokens might not be physically identified and, therefore, could potentially avoid the consequences of legislation (apart from the fact that actors operating within regulation may not allow interaction with these protocols).
We already know that Governance Tokens are distributed and used for voting, but… how do they use them to reach a consensus?
DAOs typically use platforms as a means of communication and voting for governance.
Some protocols like Uniswap, AAVE, Compound, Decentraland, Optimism, or Arbitrum use external platforms that consolidate them, and through which this process is simplified: discussions are held, and changes and improvements are proposed.
One of the most popular DApps for DAO governance is Snapshot.
Platforms like Snapshot act as decentralized APIs that allow for casting votes and communicating with the blockchain network via smart contracts.
They enable communication among protocol participants without incurring high gas fees for network usage.
It's important to mention that protocols, should these intermediaries be "neutralized," have or should have other mechanisms to continue communicating onchain and avoid censorship.
Subsequently, there is a voting period. The actual voting process involves the user signing a specific transaction that records their vote.
Once a majority is reached or the voting period concludes, the community's most voted decision will be implemented in the project.
As mentioned throughout this article, the main and obvious advantages of using Governance Tokens lie in their ability to grant greater power to users, who gain more control and rights within the organization they participate in.
They go from being mere spectators to participating in the continuous improvement process thanks to the protocol's more decentralized, equitable, and transparent governance.
This leads to greater commitment on their part, and with more people involved, new and brilliant ideas can emerge that otherwise wouldn't have been possible.
Furthermore, the programmability of tokens allows them to be endowed with other qualities, such as dividend distribution or any other function we can imagine that can improve the operations of the decentralized organization.
Regarding the negative aspects, precisely due to their programming flexibility and the current regulatory context, we can highlight the difficulties in accurately determining the requirements for issuing and acquiring these tokens.
This entails advisory expenses for protocols that intend to organize themselves through Governance Tokens.
Decentralization could also lead to chaos in the protocol's direction and ultimately result in losing users.
It's also important to remember that decisions based on majority consensus tend to be much slower than if they were made centrally by a small group of people.
Finally, as they are open protocols, there is a possibility that a large percentage of Governance Token supply could be acquired by a few users, leading them to govern the protocol in a more centralized manner.
Let's not forget that all these disadvantages can carry more or less weight depending on the economic models and rules of each protocol.
Governance Tokens have an uncertain regulatory future.
Currently, they are not considered financial instruments (generally, although in cases like MakerDAO's MKR, they can be considered a Security token), which means the MiCA regulation should apply to them, as it regulates all types of non-financial crypto-assets.
While it's true that there isn't more specific legislation for this type of token at the moment, it is mentioned that DeFi projects (referring to DAOs) developed by companies in the EU must be regulated and undergo KYC/AML processes (identification of potential clients).
Therefore, a defined taxonomy needs to be established to allow for their classification and, consequently, their regulation.
Ultimately, Governance Tokens enable a paradigm shift in the structure of many organizations: it's even possible to create new business models.
Furthermore, the flexibility offered by this ecosystem allows them to be endowed with various qualities that can further unlock their potential.
It's true that decentralized governance isn't necessarily suitable for everyone, and many organizations will need to continue being managed traditionally to maintain their market competitiveness; but those players who know how to leverage the advantages of technology to bring their users closer and turn them into architects and collaborators of the organization itself, will achieve robust communities that will grow exponentially as a result of widespread satisfaction.
However, it will be crucial to build these organizations on sustainable economic and social models to avoid systems doomed to fail, as was the case with the Terra protocol.
We must not forget that, both from a legal perspective and in terms of the project's long-term sustainability, it is essential to have expert advice when working with Governance Tokens.
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Funded
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Target
593.050,00 €
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