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Introduction
The blockchain and cryptocurrency space has undergone significant evolution since the advent of Bitcoin, the original digital token. The term "cryptocurrency" often implies that these tokens primarily serve as digital currencies. However, this designation can be misleading as these tokens' utility frequently transcends traditional currency's boundaries. A more apt term that encompasses the diverse functionalities of these digital assets is "token." These tokens not only act as mediums of exchange but also represent assets tokenized on a blockchain, serving various roles, from being a store of value to enabling access to specific ecosystems.
Bitcoin emerged as a pioneering token, introducing a peer-to-peer payment system that operates without the need for a trusted third party. Its success spawned a multitude of tokens, particularly between 2012 and 2017. During this period, the utility of these tokens was often limited, commonly used for transactional purposes such as paying for gas or as the exclusive payment method for specific products or services.
The landscape began to shift post-2018, marked by the bursting of the Initial Coin Offering (ICO) bubble. A significant development was the class action filed against Ripple in May 2018 for an unregistered token sale, leading to increased scrutiny in token sales. This period underscored the importance of tokens having a clearly differentiated utility value within their respective ecosystems.
Emergent Functionality: A Paradigm Shift in Token Design
The concept of emergent functionality represents a paradigm shift in the design and utility of tokens. Unlike traditional systems governed by a top-down authority, crypto systems are characterized by their emergent nature, operating via inductive, bottom-up mechanisms. The value in these systems arises from emergent trust, created by individual agents incentivized to collaborate and compete, converging on a consensus regarding the system's state. When a decentralized system functions effectively, its performance is emergent and cannot be reduced to the actions of any single agent. If such performance serves a specific intended outcome, it can be viewed as an emergent property of the system.
Gas Tokens like ETH
In the context of decentralized systems, a token's role extends beyond merely aligning the incentives. Ethereum's token, ETH, exemplifies this by being essential for executing operations on the blockchain. Understanding Ethereum’s fundamental operational concept, the “gas fee,” is essential for every trader or DeFi participant seeking to transact on the Ethereum base layer. Most straightforwardly, Ether is digital money on the Ethereum network. When a user interacts with the network, it is required to pay network fees in the form of “gas.”
Gas is the allocative internal pricing mechanism in Ethereum used in every transaction. Gas fees that users pay represent the cost of executing transactions, operating smart contracts, or performing any activity on the Ethereum blockchain. The idea to require gas to perform any action on Ethereum was designed to mitigate spam attacks on the network and efficiently allocate computational resources. Transactions on the network must have some cost. Otherwise, malicious actors could send millions of transactions a day for free, congesting the network.
Much like a car consuming fuel, each computational operation on the network consumes 'gas.' However, the capacity of the blockchain—the 'tank' in our analogy—is finite; each block can only hold so much data. Hence, users compete through bids to ensure their transactions or operations secure a spot in the upcoming block.
A critical point to note is that gas fees are dynamic and fluctuating based on the network's activity. Gas fees can reach exceptionally high price levels during periods of network congestion. Users can even prioritize their transactions by paying an additional fee, essentially enabling them to 'jump the queue.'
These operations are processed and validated across a decentralized network, facilitating a non-intermediated emergent consensus.
Governance Tokens: A Case Study in Decentralization
An illustrative example of emergent functionality is found in governance tokens. MakerDAO's MKR token, introduced in 2020, pioneered governance functionality by transferring control of the protocol to the community. This enabled token holders to steer the direction of the company, cementing MakerDAO's status as a decentralized entity. Governance tokens like MKR that effectively transfer control to the community epitomize emergent functionality. They diminish reliance on individual agents, distributing operational responsibilities across a broad spectrum of participants.
MKR holders stake MKR and govern the Maker Protocol, which sets standards for both MKR and Dai. This staking in the MakerDAO ecosystem allows holders to approve new assets as potential collateral as long as they adhere to the subject risk requirements, parameters, and safety measures of Dai (e.g., liquidation ratios, stability fees, savings rates, and debt ceilings). The decisions that the holders make affect what kind of assets can be locked into the Dai network. These measures enable the MakerDAO’s governance of the Dai credit system. The holders of MKR become stakeholders and are the decision-makers in its broader ecosystem, from fiat-collateralized stablecoins that are soft-pegged to the US dollar.
Furthermore, stakeholders have many other responsibilities, like reaching consensus on important community goals and evaluating views on executive voting proposals. Stakeholders ratify governance proposals originating from the MakerDAO forum signal threads, determine the values of system parameters that will be put to an executive vote, and ratify risk parameters for new collateral types as presented by risk teams.
MKR holders can cast votes, the results of which impact the overarching MakerDAO system. Votes are tallied on the amount of MKR that votes for a change, not the number of MKR holders. This implies that one individual or a small group of individuals who hold a substantial amount of MKR could have more weight when voting as compared to a large group of small stakeholders. While stakeholders are participating in a vote, their MKR is locked into a voting contract. Users can go to the official website to participate in and/or monitor current votes. Historical voting results and stats around voting participation can be found here.
Risks of Governance Tokens
The pursuit of decentralization within the blockchain ecosystem often inadvertently compromises security. This compromise, however, is not inherent to decentralization. Rather, it arises from a lack of understanding of fundamental economic designs and incentive structures. Entrusting the community with direct control over key elements such as the treasury, security parameters, or pivotal smart contracts in a bid for decentralization can invite catastrophe.
To explain this conundrum, consider this: if protocols allow community control, they inadvertently create opportunities for malevolent entities to seize control. From the perspective of a potential exploiter, one must consider the cost of acquiring enough governance tokens to manipulate a vote for transferring treasury assets. Beanstalk’s loss of $182 million provides a sobering illustration of this risk.
Consider a scenario where a low-value proposal is accepted. How and when is it implemented? What mechanisms are in place if it is neglected? The protocol's development team can potentially disregard community wishes, particularly if the token is merely a vote-only token. If the community discards the token, the impact might be negligible.
The common rebuttal that the team is compensated with the governance token and, therefore should care, does not necessarily hold. In such a scenario, management decisions might favor venture capitalists who fund their salaries over community holders. This could lead to venture capitalists proposing or voting on measures that benefit their investment strategies rather than the long-term health of the protocol.
Conclusion
Given these considerations, governance tokens should not be perceived as a shortcut around regulations, a means to offload team/investor allocations onto the public, or a magic wand to create “decentralization.” They are simply tools in the economic design of a protocol.
