What is a governance token?
The beginner’s guide
A governance token is a type of cryptocurrency that seeks to democratize the management of decentralized applications (dApps) and other blockchain-based protocols.
For applications and platforms to be truly decentralized, founding teams and developers must hand over partial or complete control of their projects to their respective communities of globally distributed users.
Handing over control means allowing the community to propose and/or vote on key decisions that affect the future of the protocol, such as how treasury funds should be spent and what new protocol features should be implemented.
Governance tokens allow a community to have a direct impact on the strategic management of a cryptocurrency project.
To ensure only honest members of the community participate in the process, governance tokens provide voting powers to their holders. Typically, one governance token equals one vote – meaning those with a greater number of governance tokens have a greater ability to influence the future direction of a project than those with fewer tokens.
Why do governance tokens have value?
Many governance tokens have a limited supply. This fact makes them more valuable to existing and new users who want to have more influence in the governance process of a particular blockchain project.
Uniswap and MakerDAO's governance tokens (UNI and MKR respectively) for example, have both experienced strong price rallies in the past, as have a number of other prominent DAO-based tokens.
While some of these rallies may have been short-lived, they also may illustrate the perceived value of being able to cast a vote in the future strategic decision making of an emerging technology platform.
How do governance tokens work?
The governance of blockchain protocols and dApps are most often managed through the use of Decentralized Autonomous Organizations (DAOs).
A DAO is a type of organization that is run through a set of mutually agreed upon rules encoded as computer programs called smart contracts. The smart contracts allows these rules to be automatically enforced on a blockchain network. It is through smart contracts that DAOs are able to operate without a central authority or third-party intermediary.
The rules of the smart contract are validated and maintained by a computer algorithm referred to as a consensus mechanism. Consensus mechanisms help to maintain agreement between all participants. Consensus mechanisms achieve this in a decentralized way — without relying on a centralized intermediary to foster agreement across the network.
The goal of a DAO is to create an autonomous, self-sustaining organization that is able to make decisions and execute transactions without the need for a single intermediaries' intervention.
Smart contracts are also used in governance to ensure that votes are recorded correctly and the outcomes of each decision are enacted once votes have been submitted. All of this is accomplished thanks to the publicly available parameters of the blockchain network, rather than the private decisions of a single intermediary.
For example, a governance proposal vote might involve a decision on whether or not to burn (permanently remove) a set amount of a protocol’s native token from circulation. In this scenario, a smart contract would be created to automatically burn the tokens in the event a majority of governance token holders voted in favor of the proposal.
In this case, both the parameters of the vote, and the execution of the outcome of that vote, can be managed in a decentralized way as all information is transparently maintained on a blockchain.
How do you get governance tokens?
There are two main ways a person can acquire governance tokens:
- Purchase governance tokens.
- Earn governance tokens.
Purchase governance tokens
Many governance tokens can be purchased from platforms on the secondary market or during initial token offerings.
Initial token offerings are conceptually similar to initial public offerings in traditional finance, and involve the early sale or presale of governance tokens ahead of a protocol’s official launch.
Additionally, some protocols require users to purchase and stake native tokens in order to receive governance tokens.
For Curve, one of the largest decentralized finance (DeFi) protocols, users must first buy CRV tokens and lock them up in order to generate veCRV governance tokens in return.
Earn governance tokens
Another way of ensuring only honest, committed users participate in the governance of a protocol is by awarding tokens to users through airdrops for reaching certain usage milestones or completing certain activities within a protocol.
A well-known example of this was when Uniswap – a leading decentralized exchange – decided to airdrop over one billion dollars worth of its governance token, UNI, to anyone who had interacted with the platform prior to September 2020. 400 UNI tokens were freely distributed to each person, worth approximately $1,200 at the time.
Non-fungible token (NFT) marketplace Rarible also airdropped a sizable portion of its governance token, RARI, to anyone who had previously used its platform or purchased and owned an NFT.
How do you vote with governance tokens?
While the process varies slightly from platform to platform, there are three main parts to casting votes using governance tokens.
- Governance tokens: Prospective voters are required to purchase and hold an amount of native governance tokens.
- Governance forum: Each platform will have its own dashboard where active proposals are listed.
- Staking: To begin voting, governance tokens must be locked within a smart contract or delegated. Whilst locked away, tokens cannot be accessed for trading.
Once a number of governance tokens have been purchased, you’ll need to head over to your intended DAO platform and connect your digital crypto wallet. For leading governance-based projects like Uniswap, users will be prompted to connect their MetaMask or WalletConnect.
For this example, new proposals can also be submitted for the community to vote on by clicking the “Create Proposal” button.
MakerDAO governance follows a similar method. Users connect their wallet by visiting the project’s voting portal.
Some platforms offer users the chance to delegate their voting power to trusted individuals within the community. These can be personal connections or self-elected people listed on the platform that vote on their delegates' behalf.
Active proposals may have a minimum threshold of votes that must be cast before they can be settled, or after an allotted period of time has passed. These sorts of parameters aim to ensure that the community is able to collectively reach consensus, while still ensuring that a quorum is reached.
Examples of governance tokens
There are several governance tokens available to buy, trade, and sell on Kraken today. Learn more about how you can acquire these tokens and take part in their strategic decision making process by checking out the Kraken price pages below:
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