Governance Token – Road to Decentralization

Web3 jungle is full of new terms and concepts that regular Joe and Jane are unfamiliar with. To reach a greater level of user adoption, the Web3 world should put themself in their shoes and help them find their place in the Web3 space. To do that, we need to explain basic Web3 terminology. We can hear many buzzwords (such as a governance token for example), but are we sure everyone understands them?

Hey Jane and Joe, this blog post is for you.

This blog post aims to explain what the governance token is and how it is helping Web3 projects on their road to decentralization.

Web3 ecosystem is full of various tokens – utility token, security token, asset token, fungible or non-fungible token, asset-backed token, it looks like a never-ending list. One type of token we missed mention would be our focus in this week’s blog spot – the governance token.

Governance token 101

Usually, projects in the Web3 world are initiated by a small group of people or teams with a vision to disrupt various industries (finance, supply chain, insurance, and many more) by leveraging blockchain as a technology.

With different Web3 fundraising mechanisms (Initial Coin Offering, Initial Stake Pool Offering, Security Token Offering, Initial Exchange Offering), they are raising initial capital.

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During their development and various versions of their product, at some point, to reach a greater level of decentralization, they would need to actively involve the community in the decision-making process for the future development of the product. They usually find the best ally to succeed in that transition in the governance token. 

Governance tokens give voting power to token holders and include them in the process of deciding in which direction further development of the Web3 project is going.

This allows them to influence decision-making processes like – deciding on the new feature proposal, coin listing or delisting, allocating funds, changing the fee structure of some protocol, or maybe totally changing the governance mechanism and voting system.

These are just some examples – they vary from project to project. 

Token holders can propose protocol changes through the proposal submission process – different Web3 projects have different proposal submission processes. If specific criteria are met, the proposal becomes eligible for voting, and governance token holders decide whether they want to support or not the proposed change.

This is a massive difference compared to traditional systems and organizations where centralized groups decide the organization’s future.

Creating a fair governance mechanism within some Web3 ecosystems is challenging. Many variables have influence, and inevitable trade-offs have to be considered. As usual, it is always a question of design choices.

To better understand the complexity and variables we have to consider in deciding about governance mechanisms, we can call for help blockchain governance framework.

Through a combination of six governance dimensions (formation and context, roles, incentives, membership, communication, and decision making) and three governance layers (off-chain community, off-chain development, and on-chain protocol layer), we can take a better and more complete look at the governance model of one blockchain. 

The main question we should always have when constructing some governance model is what problem we are trying to solve for the end-user and general community – keep the focus on the problem space. After we have a clear vision, we can consider other important aspects of governance mechanism like:

Voting rights

  • What are the areas of blockchain where governance token holders will be able to participate in the decision-making process?
  • What would post-voting execution look like?
  • What is the voting procedure?

Token Distribution

  • What distribution mechanism will be chosen for end-users eligible for governance tokens?
  • Will we combine distribution mechanisms?
  • What is the tokenomic of the governance token?

Voting power

  • Will the token amount be the only relevant measure for governance, or should other things also be considered?
    • Typically, the weight carried by a token holder’s vote is proportional to the number of tokens they hold. For example, if Marko holds 200 tokens and Pera holds 100 tokens, Marko carries twice as much voting power as Pera
    • There are also some other voting schemes like quadratic voting. Also, there are many more, but let’s try not to flood Joe with too much information at this point

Community proposal

  • How can community members propose various changes on the protocol or other levels?
  • What is the workflow and procedure for this process?

Delegating voting power

  • Is there a possibility to delegate your vote to other prominent community members?
  • What would that process look like?

Treasury fund

  • Will governance token holders have a vote also in managing funds of some Treasury?
  • How will the Treasury operate?
  • Will funds be distributed to a broader community (like promising projects on the particular blockchain) or only within the governance token holders group?

Those were just some of the aspects we have to think about when building some blockchain governance model mechanism. We can not mention DAO – Decentralized Autonomous Organization when talking about governance tokens. Fasten your seatbelt Joe, we are about to speed up a bit.

DAO

A Decentralized Autonomous Organization represents an organizational structure without a central authority that operates on rules written inside smart contracts. Smart contracts bring trust among the organization members since they are open and transparent, so anyone who possesses enough technical knowledge can review them. All rules are known to every member of the DAO.

The success of a DAO lies in the strength of its smart contracts. Mark the previous sentence, Jane and Joe, and have it on your mind when deciding whether to participate in some DAO project.

Holders of governance tokens can participate in all relevant decisions for a particular DAO by voting for proposals or submitting them if they have an opinion on future development direction. In contrast to traditional organizations and their top-down approach to decision-making, DAO usually follows a bottom-up approach. 

It empowers and engages the community in actively shaping the future of particular Web3 projects by putting them in the driver’s seat. Be aware that changing some rules or concepts might last longer than centralized organizations due to their decentralized nature. Everything comes with some price, be aware of that.

If you are more interested in DAO and DAO-related terminology, then, this blog post by Vitalik Buterin could be the right place for you – it is old but gold. 

Things can be pretty complex like everything in Web3 space, and DAO is no exception. Concept DAO of DAO’s is some example of that but let’s stop here (it looks like someone watched Inception movie). We want to simplify things here for you, Jane and Joe, but be aware of more complex ideas in the blockchain governance model space.

Participating in and managing DAOs can sometimes be pretty tricky. However, there are plenty of tools that can help us with various aspects of the governance model. 

DAO tooling represents the tool created to enhance decentralized autonomous organizations. This space is also quite vibrant – you can see that in the following picture:

If you would like to learn more about them, I would suggest visiting this link.

Let’s also mention that there are various types of DAOs like:

  • DAO Operating System
  • Grants DAOs
  • Protocol DAOs
  • Investment DAOs
  • Service DAOs
  • Collector DAOs 

If you are interested to learn more about them, check this blog

Governance in practice

We talked more about theory, but now let’s focus on the practical implementation of some governance models and tokens.

Compound

The Compound is a decentralized protocol that establishes money markets with algorithmically set interest rates based on supply and demand. The protocol is governed and upgraded by the COMP token holder, which is the governance token. They have a really active governance process.

Compound follows a delegated model. Proposals can only be made by users that have more than 1% of the total tokens delegated to their addresses. Users can delegate their tokens to their own addresses or pick other users’ addresses to delegate their tokens to.

Synthetix

Synthetix is a derivatives liquidity protocol that enables the creation of synthetic assets. As Compound, it has really active governance. The Synthetix governance structure is composed of Councils, Committees, Core Contributors, and a DAO. Each governance component is assigned a specific aspect of protocol governance.

Councils are directly elected by SNX stakers, while other governance bodies are appointed according to the existing governance procedures. All of the components work together to ensure that the protocol is governed in a fair, transparent, and legitimate way in accordance with the direction provided by token holders.

Curve

The Curve is an exchange liquidity pool on Ethereum designed for highly efficient stablecoin trading. On Curve, users and holders of CRV tokens can lock up their tokens to obtain a voting token called veCRV, allowing them to participate in Curve’s governance.

veCRV can be used to vote on network proposals submitted, and those holding high amounts of veCRV can even submit their proposals.

Uniswap

Uniswap is a cryptocurrency exchange that uses a decentralized network protocol and, UNI is its governance token. Uniswap follows a similar model as Compound.

A minimum threshold of 1% of the total UNI supply is required to submit governance proposals. UNI holders may delegate their voting power to a representative. The governance process consists of 3 stages: Temperature Check, Consensus Check and Governance Proposal.

Conclusion

Many Web3 projects have a multi-phase approach for their road to decentralization. They gradually introduce governance tokens, carefully creating governance mechanisms for their ecosystem while having all-important governance aspects we mentioned in this blog post.

The end goal is to transition to governance models where the community and stakeholders collectively decide and avoid situations where decision-making is in the hands of a few small groups of people. 

Some projects on their road to decentralization get stuck or take a wrong turn. It is not rare when the team and VC investors own a disproportionate amount of power in the early stages of governance since they own 30% of the total supply of governance tokens. Besides that, even some nasty exploits happened.

That’s why I told you Jane and Joe to label that sentence while reading this blog post. Those are challenges that governance tokens and DAOs have to deal with. There are also exciting breakthroughs in the legal space for DAO – check this link for one example.

Generally, as you can see, the Web3 governance space is really vibrant and always seeking to find and test new governance models. Be aware that the chain is the strong as its weakest part. Governance tokens and Decentralized Autonomous Organizations are no exception to this rule.

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