TLDR The problem with governance tokens is that there is no value accrual mechanism. In other words, increased network activity doesn’t directly benefit the token price. This doesn’t mean a governance token can’t be a good investment. Why? The token’s protocol and network activity can be great, and people simply want to own a piece of that.
Crypto investors understandably question the point of governance tokens. The sceptic’s argument goes: if there is no revenue to share, what is the point of governing the protocol? Isn’t it like owning shares in and governing a non-profit foundation? What’s the point?
But wait right there. It’s not the case that protocols with governance tokens don’t generate revenue. It’s just that the revenue doesn’t flow to the governance token holders. Take the most famous governance token of them all, UNI.
As you can look up on cryptofees.info, Uniswap generates more than a million dollars per day – on a slow day. That’s great, right? Well, indeed it’s great for… ETH holders. Because the fees Uniswap users have to cough up to swap coins are fees in Ether. If trading activity on Uniswap is on the rise, demand for ETH goes up.
This is a problem. Because we would like to see the price of our coin go up when the network it is part of, is successful.
So it’s a sensible question to ask: why is there even a UNI token? Fair point. See, the entire point of crypto is decentralization. So a protocol like Uniswap can’t govern through a board of directors. It has to hand over some power to users, who can propose and/or vote on decisions that affect the future of the protocol, such as what new protocol features should be implemented.
How does this governance work? The governance of blockchain protocols and dApps are generally managed through Decentralized Autonomous Organizations (DAOs). Uniswap has a DAO: a type of organization that is run through a set of agreed upon rules by the community called smart contracts.
A governance proposal vote might involve a decision on whether or not to burn some amount of a protocol’s native token from circulation. Should the governance token holders vote in favor of the proposal, a smart contract would be created to automatically and burn the tokens. It’s actually pretty simple: as a governance token holder, you head over to your DAO platform, connect your wallet, and vote. Not that a lot of holders do this, but hey. It’s real.
Comparison Between Governance Tokens and Other Types of Tokens
Governance Tokens: As discussed, the value of governance tokens is largely derived from the ability to influence the direction and operation of the protocol.
Gas Tokens: The original use case of native coins is gas. To use a blockchain, you pay with the coin of the network. As the coins power the network like a type of fuel, these tokens are sometimes called gas tokens. For transactions on Ethereum or apps that run on Ethereum, such as Uniswap, you pay in ETH (the technical term is gwei: one billionth of an Ether). The value of gas tokens is closely tied to the network’s activity level; more transactions generally mean higher demand for gas tokens.
Utility Tokens: Another type of token is a utility token. Used to access certain services or functionalities within a specific ecosystem. An example is Basic Attention Token (BAT),…
Erik started as a freelance writer around the time Satoshi was brewing on the whitepaper.
As a crypto investor, he is class of 2020. More of a holder than a trader, but never shy to experiment with new protocols.
