The recent airdrop of the UNI token shows the growing popularity of DeFi governance tokens. In the past, it seemed like DeFi was an "advanced" level crypto topic, but the sudden expansion of DeFi protocols and governance tokens means that even novice crypto users may interact with DeFi, so its important to know the basics of how DeFi governance tokens work. In this article, I'd like to describe the dual nature of governance tokens as both an investment/asset and an actual voting/governance mechanism.
A Token is a Token
First off, it is true that governance tokens are in fact tokens. Therefore, they can be sold, traded, exchanged, and staked (depending on token) just like other cryptocurrency tokens. Since they are a tradeable asset, they will naturally have some form of a monetary value that depends on supply and demand in the market. However, I want to point out that although governance tokens DO have a monetary value, their primary purpose is providing governance and structure for decentralized financial protocols.
In the general sense, governance and rules are important because they set boundaries, promote stability, and provide an ordered framework in which action can take place. Although governance in itself is important, traditional governance is usually carried out by a strong centralized leader, or group of leaders and the laws/rules are rarely decided by the people themselves. Even in Democratic societies, the vast majority of our laws are made by elected representatives, and thus the power to decide the laws for hundreds of millions of people is still centralized in the hands of a few hundred people. The key point here is that governance tokens provide a much more direct form of democracy in which anyone that holds the token can vote on the proposals.
The centralization of power also applies to cryptocurrency platforms. Before the launch of governance tokens, the key decisions about the future of the protocol were made by the development team. This doesn't mean that the team acted malevolently or abused users. It simply means that there was no viable method to enable decentralized governance of the protocol, so the founding team had to act as a “benevolent dictator” so to speak. As governance tokens have come into their own, many decentralized financial development teams are handing over control of the protocols to the users through the use of the governance tokens. Users who hold governance tokens are able to vote on new proposals/upgrades to the protocol, and their vote is weighted in proportion to the number of governance tokens the hold.
Governance tokens are one way of providing governance and boundaries while also democratizing and decentralizing the governance process to empower individuals. It's important to state that different decentralized financial protocols issue tokens in different ways, and different tokens will have different values and slightly different benefits. In general, however, holding governance tokens gives holders the ability to vote and propose (depending on the number of tokens held) changes to the way the protocol operates. The proposals can range from anything to adjusting interest rates for a specific asset to changing the governance structure of the protocol itself. For a more in-depth look at specific governance tokens and their capabilities, I found this article to be helpful.
Some of these changes can be relatively minor, such as adjusting the interest rate that is paid for lending a certain asset. On the other hand, governance tokens also give users the ability to make significant changes to the protocol, and holders of the COMP token recently passed a proposal that changes the emission rate of the comp token itself. In other words, a governance token was used to update the governance structure itself.
In summary, governance tokens are a way that many decentralized protocols fulfill the needed function of governance while also upholding the principle of decentralization which is fundamental to the cryptocurrency ethos. Although governance tokens certainly do have value and can be traded and exchanged, they also fulfill the role of allowing the community to propose, vote on, and approve changes to the way the protocol operates.
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