Hey DEFI WORLD community,
what’s the purpose of governance tokens?
They don’t produce any cash flow. They solely have the purpose to give holders the right to manage the protocol. But how do you value those tokens? And what is the true reason they exist?
This week, our good friend Jean-Pierre Buntinx wrote a guest piece about this exact problem.
You will enjoy this one!
Also, follow him on Twitter! @jdebunt
If you do not want to miss out any guest articles, token analysis and briefings, we encourage you to subscribe to our newsletter:
Decentralized Finance is an attractive industry because it bridges the gap between finance and cryptocurrencies. Innovative and rewarding programs exist to let users earn more cryptocurrencies. At the same time, there are a ton of governance tokens, which may not always serve a real purpose.
What Makes DeFi Appealing
At its core, Decentralized Finance (DeFi) is attractive because it doesn't involve middlemen. Anyone with cryptocurrency holdings can partake, although some projects may require conversion between tokens to unlock their full potential. Whether one wants to engage in lending, borrowing, yield farming, or providing liquidity, it can all be done in a few clicks of the mouse.
For most, this is a great way to earn passive revenue through existing cryptocurrency holdings. Others see it as a way to finally access specific services or products, without the need of banks and other institutions. DeFi has a little bit of everything for everyone, even though accessing this space is not always the most convenient. That is something developers can address once the industry has matured a bit more.
At the same time, there are some parts of DeFi that might not make sense. The issuance of platform-agnostic governance tokens, for example. Users can receive tokens tied to their favorite Decentralized Finance platform. An interesting touch, but will these tokens ever serve a purpose?
Figuring out DeFi Governance Tokens
Understanding a governance token is not overly complicated. These assets do not give a holder extra utility. Nor does it provide access to special features, services, or products. Instead, it can grant extra incentives to liquidity providers in different ways. That is, assuming there are people interested in buying a token that, by default, has nothing going for it other than speculative purposes.
Bringing usefulness to a governance token is a very tough balancing act. For some platforms, it is a reward given to participants on both sides of the spectrum (liquidity providers and liquidity takers). Other platforms simply offer it as a "yield farming option", yet it remains up to the users to give it an actual value. So far, these tokens seem to derive value from the total value locked - or TVL - by the platform issuing them.
What a governance token does provide is a right to vote on project proposals, improvements, and changes. Being part of the ecosystem is worth it to some, but not everyone sees it that way. Whenever value is attributed to a token with no real purpose, the speculative aspect kicks in. This turns governance tokens into a trading vehicle they were never intended to be.
Projects leaning heavily on their community will often see their governance tokens succeed, to a certain degree. This is primarily because there are active changes or improvements waiting to be voted on. Increasing pool liquidity, or supporting additional tokens for yield farming, is often decided upon through governance token voting. Reaching a big audience will always be a challenge, as most people just want profits quickly and conveniently.
Building the Right Token Economics
It is evident that governance tokens are somewhat flawed in their current form. Other than speculative for most, and somewhat crucial for some, they offer no real benefits. Building an economy for such tokens is not all that easy either.
Some DeFi projects explore the option of combining the governance token with a utility aspect. While holders can still vote on proposals, they also gain direct utility from holding it. More specifically, there are now platforms offering to share trading fees with holders of the governance token. An interesting concept, albeit not necessarily the ultimate solution either.
All of this raises two important questions. First; is there a way to make governance tokens more useful, but without adding an incentive to them like some platforms are doing now? Second: is there even a need for governance tokens in the DeFi space?
The answer to either of these questions will differ from person to person. Without governance tokens, DeFi yield farming becomes a lot less appealing. However, it may also help remove the bad actors and get-rich-quickly-schemers from the space altogether. Bringing more legitimacy to this industry should be possible without creating more tokens out of thin air.
In the end, very few people want to bear the responsibility of voting on DeFi-related changes or improvements. Decentralized Finance is currently seen as a passive revenue stream by crypto holders, yet its true purpose is to unbank the banked and remove the middlemen. So far, the industry is not achieving that goal, and the various governance tokens are not helping much either.
All information presented above is for educational purposes only and should not be taken as investment advice.