Governance Token

Token holders vote on the core economic and risk parameters of a protocol. This is a fundamental governance right.

• Examples: Setting collateral factors, loan-to-value (LTV) ratios, interest rate models, and liquidation penalties on lending platforms like Aave and Compound.
• Impact: These votes directly affect the protocol's risk profile, capital efficiency, and user experience.

Governance tokens grant authority over the protocol's treasury, which often holds significant reserves from fees and token allocations.

• Budget Allocation: Deciding how treasury funds are spent on grants, development, marketing, or security audits.
• Asset Management: Voting on investment strategies, such as converting fees into other assets or funding insurance pools.
• Example: Uniswap governance votes on the use of its multi-billion dollar treasury.

Token holders decide on smart contract upgrades and the introduction of new features, ensuring the protocol evolves in a decentralized manner.

• Smart Contract Upgrades: Authorizing migrations to new, audited contract versions.
• New Integrations: Voting to add support for new collateral assets, blockchain networks, or product features.
• Process: Proposals are typically submitted, discussed, and then put to a formal on-chain vote, as seen with Curve's gauge weight votes.

Governance determines how protocol-generated revenue (fees) is distributed and how liquidity incentives are allocated.

• Fee Switch: Voting to activate a mechanism that diverts a portion of trading or lending fees to token holders or the treasury.

• Liquidity Mining: Deciding on the allocation of token emissions to different liquidity pools or lending markets to direct capital and usage.

• Example: SushiSwap governance votes on how SUSHI emissions are distributed across its Automated Market Maker (AMM) pools.

Governance power can be delegated to experts or other protocols, creating layered governance systems.

• Vote Delegation: Token holders can delegate their voting power to other addresses (e.g., experts, DAOs) without transferring ownership.
• Meta-Governance: Protocols use their treasury-held governance tokens (e.g., AAVE, UNI) to vote in other protocols' governance, influencing a broader ecosystem. This is a key strategy for Decentralized Autonomous Organizations (DAOs).

Beyond voting, governance tokens can grant exclusive access to protocol features or early information.

• Priority Access: Gaining early or exclusive access to new product launches, token sales, or airdrops.
• Staking for Privileges: Locking tokens (e.g., ve-token models) to receive boosted rewards, fee shares, or increased voting power.
• Example: Curve's veCRV model gives locked token holders the right to direct CRV emissions and earn a share of trading fees.

A critical risk where a small minority of token holders control governance outcomes due to widespread disengagement. This undermines the decentralized ideal and can lead to decisions that don't reflect the broader community's interests.

• Low turnout makes protocols vulnerable to capture by a small, coordinated group.
• Vote delegation to experts can help but creates new centralization risks.
• Real-world example: Many major DAOs see voter participation rates below 10% of circulating supply.

The risk that governance power is concentrated among a few large holders (whales), early investors, or the founding team. This can lead to centralized control masquerading as decentralization.

• Large holders can single-handedly pass or veto proposals.
• Sybil resistance mechanisms (like token-weighted voting) inherently favor capital over individuals.
• Mitigations include quadratic voting or conviction voting, but these are not widely adopted.

Governance tokens often control access to a protocol's treasury, a pool of assets that can be worth billions. Poor treasury management or malicious proposals pose existential financial risks.

• Proposals can authorize large, irreversible fund transfers.
• Rage-quitting mechanisms allow dissenting members to exit with funds, but are complex.
• Security depends on the integrity of the multisig wallets or smart contracts holding the assets.

The practice of accumulating tokens temporarily to influence a specific vote, separate from a long-term stake in the protocol. This exploits the decoupling of voting power from economic interest.

• Attackers can borrow tokens (flash loans) to gain massive, short-term voting power.
• Bribery markets can emerge where voters are paid to vote a certain way.
• Defenses include vote escrow models (like veTokens) that lock tokens for longer-term alignment.

The underlying voting smart contracts are complex code subject to bugs, exploits, or upgrade mechanisms controlled by governance. A governance attack can itself be a vector to exploit the core protocol.

• A bug in the governance contract can lead to illegitimate proposal execution.
• Timelocks are critical to delay execution, allowing review of malicious proposals.
• The governance module is often a privileged, upgradeable contract with admin keys, creating a central point of failure.

Governance tokens exist in a regulatory gray area. They may be classified as securities by regulators (e.g., the Howey Test), exposing holders and founders to legal risk. This uncertainty can stifle development and adoption.

• Active participation in governance can strengthen a security classification.
• Decentralization is a key defense, but proving sufficient decentralization to regulators is challenging.
• Legal actions against one protocol can set precedents affecting the entire sector.

The structured process for creating and executing governance decisions. A typical lifecycle includes:

• Temperature Check: An informal poll to gauge community sentiment.
• Formal Proposal: A detailed, on-chain proposal specifying executable code or a directive.
• Voting Period: A defined window where token holders cast votes.
• Timelock & Execution: A mandatory delay after a vote passes for security review, followed by automated execution of the proposal's code.

A DAO Treasury is a pool of assets (crypto, stablecoins, NFTs) controlled by the protocol's governance. Token holders vote on treasury allocation for:

• Grants & Funding: Financing development, marketing, or community initiatives.
• Protocol-Owned Liquidity (POL): Providing liquidity for the protocol's own tokens.
• Buybacks & Burns: Using protocol revenue to reduce token supply.

A protocol fork is the ultimate governance mechanism, where a dissenting community can copy the protocol's code and start a new chain with different parameters or leadership. This acts as a credible exit threat, incentivizing fair governance. Notable examples include the forks that created Uniswap (from SushiSwap's vampire attack) and Compound Finance forks like Iron Bank.

Vulnerabilities unique to on-chain governance include:

• Vote Buying: Accumulating tokens temporarily to pass a malicious proposal.
• 51% Attacks: Controlling a majority of voting power.
• Proposal Spam: Flooding the system with proposals to cause voter fatigue. Safeguards include quorums (minimum vote threshold), timelocks, multisig guardians for emergency pauses, and vote delegation to non-transferable 'soulbound' badges.

While often combined, these represent distinct functions. A Utility Token provides access to a protocol's core service (e.g., paying fees, staking for security). A Governance Token confers voting rights over the protocol's future. Many tokens, like UNI (Uniswap) or AAVE, are hybrids, offering both utility within the protocol and governance rights over its parameters and treasury.