A cryptocurrency used by a protocol’s community to vote on the direction of future development.
As a cryptocurrency used by a protocol’s community to vote on the direction of future development, governance tokens play a central role in decentralized autonomous organizations. DAOs enable innovative new forms of human organization without reliance on a central company or foundation to make decisions. They are an example of what is known as on-chain governance.
Governance tokens are featured in layer-one protocols, like Tezos and Polkadot, and in decentralized applications, like MakerDAO. In the former examples, introducing a governance token is intended to reduce the likelihood of contentious hard forks splitting a project’s community.
When used in DApps, governance tokens put users at the heart of the decision-making process. Many DApps have development funds, and community voting determines the allocation of resources. A prominent example of such is the popular decentralized exchange platform Uniswap. The Uniswap Grants Program allows community members to introduce proposals, and the community uses the UNI governance token to vote on which ideas to allocate the pooled funds.
Many governance tokens serve multiple purposes. In addition to extending voting rights to users, governance tokens like UNI create an incentive to provide liquidity to their respective platforms. Others serve as utility tokens, enabling their holders to interact with a DApp’s various functions.
Governance tokens can strengthen a DApp’s claims of decentralization. Without such on-chain governance mechanisms, all future development would need to be enforced in a traditional top-down fashion, creating a central point of failure.