Governance Token

The primary function, allowing token holders to cast binding votes directly on the blockchain to decide on protocol parameters, treasury allocations, and upgrade proposals. Voting power is typically proportional to the number of tokens staked or delegated.

• Example: Uniswap (UNI) holders vote on fee structure changes.
• Mechanism: Proposals are executed automatically via smart contracts if they pass.

Token holders can delegate their voting power to experts or representatives without transferring custody, enabling efficient governance. Staking tokens often grants voting rights and may provide staking rewards or fee-sharing.

• Delegation: Used in Compound (COMP) and Maker (MKR) governance.
• Staking-for-Governance: Protocols like Curve (CRV) require locking tokens as veCRV to gain voting power and boost rewards.

Governance tokens often incorporate mechanisms to align holder incentives with protocol health, creating potential value accrual. This can include revenue sharing, buyback-and-burn programs, or liquidity mining rewards.

• Fee Sharing: SushiSwap (SUSHI) distributes a portion of swap fees to xSUSHI stakers.
• Tokenomics: Designed to incentivize long-term alignment, often through vesting schedules or lock-ups.

Beyond voting, tokens can grant exclusive access to protocol features, early product launches, or specialized pools. They act as a membership key to the ecosystem.

• Example: Holding Aave's stkAAVE provides safety module incentives and governance rights.
• Privileges: Some DAOs use tokens for gated access to community channels, airdrops, or beta testing.

A critical feature is the ability to create formal governance proposals, which usually requires holding a minimum token threshold. Prior to on-chain votes, temperature checks and discussion forums (like Snapshot for gasless voting) are used to gauge community sentiment.

• Proposal Threshold: MakerDAO requires 80,000 MKR to submit an executive vote.
• Signaling: Snapshot votes are off-chain but critical for consensus-building.

A key legal and functional distinction. A utility token primarily provides access to a product/service (like a governance right). A security token represents an investment contract with an expectation of profit from others' efforts. Most governance tokens walk a fine line, with their classification depending on design and marketing.

• Howey Test: The U.S. SEC uses this to determine if an asset is a security.
• Design Implications: Protocols carefully design token functions to emphasize utility.

These are the most common participants, often token holders who delegate their voting power to trusted experts or representatives. They engage by:

• Delegating votes to active community members or development teams.
• Participating in temperature checks and signaling votes on major proposals.
• Their primary incentive is to ensure the protocol's long-term health and utility, which supports the value of their holdings.

The builders and maintainers of the protocol are deeply invested in its governance. They use tokens to:

• Propose and ratify technical upgrades, parameter changes, and treasury allocations.
• Steer the protocol's roadmap and strategic direction.
• Their usage is driven by the need to implement changes necessary for development, security, and competitive adaptation.

Dedicated groups or multi-signature wallets that manage the protocol's communal funds. Their governance token usage focuses on:

• Approving grant proposals to fund ecosystem development, marketing, and research.
• Managing treasury diversification and investment strategies.
• Allocating funds for bug bounties and security audits.
• Their role is fiduciary, aiming to use capital to generate sustainable growth.

Formalized legal or social structures that use governance tokens as membership shares. Prominent examples include MakerDAO and Uniswap DAO. They employ tokens for:

• On-chain voting on executable proposals that directly modify the protocol.
• Electing working group members or stewards.
• Ratifying legal agreements and real-world asset investments.
• This represents the most advanced form of decentralized corporate governance.

Participants who have staked tokens or provided liquidity, often receiving additional governance rights as a reward. They use tokens to:

• Vote on fee structures and reward distributions that affect their yields.
• Influence decisions about supported assets or pools within DeFi protocols.
• Their engagement is economically motivated, focused on optimizing their return on invested capital.

Professional entities that offer voting as a service or conduct deep research. Examples include Gauntlet, Chaos Labs, and BlockTower. They utilize governance tokens to:

• Vote algorithmically based on economic modeling and risk analysis.
• Provide transparent voting rationale and reports to the community.
• Their involvement professionalizes governance, introducing data-driven decision-making to mitigate risks and optimize parameters.

A critical risk where a majority of token holders do not vote, leading to governance decisions made by a small, potentially unrepresentative group. This can result in:

• Low quorum requirements being exploited.
• Proposal fatigue from excessive or complex votes.
• Centralization of power among a few active whales or core teams, undermining decentralization.

The 'one-token, one-vote' model often leads to a plutocracy, where voting power is proportional to wealth. This creates risks such as:

• Whale manipulation: Large holders can single-handedly pass or veto proposals.
• Vote buying: The potential for tokens to be borrowed or pooled to swing votes.
• Misaligned incentives: Decisions may favor short-term token price over long-term protocol health.

Governance tokens often control access to a protocol's treasury, a pool of assets that can be allocated via vote. Key risks include:

• Malicious proposals to drain the treasury.
• Inefficient capital allocation due to poor voter judgment.
• Lack of professional oversight compared to traditional corporate governance, increasing the potential for financial mismanagement.

The governance mechanism itself is implemented in smart contracts, which are vulnerable to exploits. This includes:

• Bugs in voting logic or token distribution.
• Governance attacks where an attacker gains temporary voting power (e.g., via a flash loan) to pass a malicious proposal.
• Upgrade risks: Proposals to upgrade core contracts can introduce new vulnerabilities if not properly audited.

The classification of governance tokens remains ambiguous in many jurisdictions, creating compliance risks:

• Securities regulation: Tokens conferring profit rights or resembling investment contracts may be deemed securities (e.g., SEC vs. Ripple, Howey Test).
• Liability for decisions: Potential for token holders to be held liable for protocol actions, especially in decentralized autonomous organizations (DAOs).
• Evolving frameworks: Regulations like the EU's MiCA are creating new compliance burdens.

Delegating votes to representatives or governance aggregators introduces principal-agent problems:

• Misaligned delegates: Delegates may vote in their own interest, not their constituents'.
• Centralization of influence: Power consolidates with a few well-known delegates.
• Lazy delegation: Token holders delegate without due diligence, reducing overall governance quality. Platforms like Snapshot facilitate delegation but don't solve the underlying incentive misalignment.