Governance Token

The primary function is to grant voting power on governance proposals. Token weight typically determines voting influence. Proposals can cover:

• Parameter changes (e.g., fee adjustments, interest rates)
• Treasury management (funding grants, investments)
• Protocol upgrades (smart contract modifications)
• Working group elections (e.g., Uniswap's Grants Committee) Examples: Compound's COMP for adjusting collateral factors; Maker's MKR for setting stability fees.

To reduce voter apathy and enable expert governance, many systems allow token delegation. Holders can delegate their voting power to other addresses (often experts or representatives) without transferring ownership. Staking mechanisms are also common, requiring users to lock tokens to participate in governance, which can align long-term incentives and prevent sybil attacks. For instance, Curve's veCRV model locks CRV to boost voting power and protocol rewards.

Beyond governance, tokens often embed economic utility to drive demand and security. This can include:

• Fee capture or revenue sharing: A portion of protocol fees is distributed to stakers (e.g., SushiSwap's xSUSHI).
• Collateral: Used as collateral in lending protocols (e.g., AAVE).
• Access rights: Gating access to premium features or pools. This dual nature—governance + utility—creates a more robust value accrual model than governance alone.

A critical governance function is controlling the protocol treasury, a pool of assets (often native tokens and stablecoins) funded by fees or token reserves. Token holders vote on treasury allocations for:

• Development grants and bug bounties
• Liquidity incentives and partnerships
• Strategic acquisitions
• Buybacks and burns to manage token supply Examples: ENS DAO's multi-million dollar treasury governed by ENS token holders.

Governance systems face unique security and economic challenges:

• Voter apathy: Low participation can lead to centralization.
• Whale dominance: Large holders can sway votes for personal gain.
• Governance attacks: Attempts to exploit proposal logic or tokenomics (e.g., a "governance takeover").
• Vote buying & bribery: External incentives to influence outcomes.
• Implementation risk: Bugs in governance contracts can be catastrophic. Mitigations include vote delegation, quorum requirements, and timelocks.

Governance tokens enable on-chain voting, where token weight determines voting power. Proposals can include:

• Parameter changes (e.g., sequencer fees, gas parameters)
• Treasury allocations for grants and ecosystem development
• Protocol upgrades and smart contract modifications Votes are executed via smart contracts, ensuring transparency and immutability. Examples include Optimism's OP token votes on grant funding and Arbitrum's AIP process for technical upgrades.

Token holders can delegate their voting power to representatives or stake tokens to participate in security or consensus mechanisms. This creates a representative system and can align incentives.

• Delegation: Allows less active participants to contribute voting power to knowledgeable delegates.
• Staking for Security: Some L2s use staked governance tokens as a cryptoeconomic security layer, where malicious behavior can lead to slashing. This model is common in optimistic rollups with fraud proofs.

A protocol treasury, often funded by transaction fees or token reserves, is controlled by governance token holders. They vote on:

• Grant programs to fund ecosystem projects and developers
• Liquidity incentives and retroactive funding
• Budget allocations for core development and marketing This decentralized control over capital is a key function, turning the token into a tool for directing the ecosystem's growth. The Optimism Collective's RetroPGF rounds are a prime example.

In some Layer 2 architectures, governance tokens can influence the sequencer (which orders transactions) and proposer (which submits data to L1). Governance may decide:

• Sequencer whitelisting or permissioning
• Revenue distribution from sequencer fees
• Fallback mechanisms and decentralization roadmaps This is critical for transitioning from an initial centralized operator to a decentralized sequencer set, a key goal for networks like Arbitrum and Optimism.

Governance tokens can be integral to the fee tokenomics of an L2. Holders may vote on:

• Fee structures and how revenue is generated (e.g., base fee, priority fee)
• Token burn mechanisms or buyback-and-distribute models using protocol revenue
• Inflation schedules for staking rewards or ecosystem funding These decisions directly impact the token's utility, scarcity, and the long-term economic sustainability of the network.

For Layer 2s that are part of a broader ecosystem (e.g., an L2 within a larger L1 ecosystem), governance can involve cross-chain messaging. Token holders on the L2 may vote to send instructions or state updates to the parent chain. This requires secure message bridges and can involve managing:

• Bridge parameters and security councils
• Upgrades to the underlying L1 smart contracts
• Settlement layer dependencies It adds complexity but is essential for the L2's autonomy and security.

The influence a token holder has in a governance system, typically proportional to their token holdings. This can be measured in several ways:

• One-token-one-vote: The simplest model where each token equals one vote.
• Quadratic Voting: Voting power increases with the square root of tokens committed, designed to reduce whale dominance.
• Delegated Voting: Token holders can delegate their voting power to a representative or a Delegator.
• Time-weighted Voting: Power is boosted based on how long tokens have been locked (e.g., veToken models).

A formal, on-chain or off-chain submission that suggests a change to a protocol's parameters, treasury, or code. The lifecycle typically involves:

• Temperature Check: An informal, off-chain poll to gauge community sentiment.
• Formal Submission: A structured on-chain proposal requiring a deposit.
• Voting Period: A defined window where token holders cast votes.
• Execution: If the vote passes, the proposed changes are automatically implemented via a Timelock or multisig transaction.

A pool of assets (often native tokens and stablecoins) controlled by the protocol's governance. It is the financial engine for decentralized autonomous organizations (DAOs). Governance token holders vote on:

• Funding allocations for grants, development, and marketing.
• Capital deployment strategies, such as yield farming or liquidity provision.
• Token buybacks and burns to manage supply. Examples include Uniswap's community treasury, which holds billions in UNI tokens and USDC.

An entity (individual or organization) to whom token holders delegate their voting power. This creates a representative democracy model to reduce voter apathy and increase expertise in decision-making. Key aspects:

• Passive Delegation: Token holders assign votes without actively participating.
• Delegation Platforms: Services like Tally or Boardroom help users discover and delegate to credible delegates.
• Incentives: Some protocols offer token rewards or a share of fees to active, effective delegates.

A smart contract that enforces a mandatory delay between when a governance vote passes and when the approved action is executed. This is a critical security mechanism.

• Purpose: Provides a final review period, allowing users to react to malicious or risky proposals (e.g., by exiting liquidity).
• Process: Once a proposal passes, it is queued in the timelock contract. After the delay (e.g., 48 hours), any address can trigger the execution.
• Security: Acts as a safeguard against governance attacks by preventing immediate, irreversible changes.