What is a Governance Token?
Governance tokens are a special utility token that can theoretically be used to help democratize decision making when it comes to the ongoing management of a public Distributed Ledger Technology (DLT), decentralized apps (dApp) and other decentralized protocols, or organizations that depend on them (e.g., a decentralized exchange, aka DEX or decentralized autonomous organization, aka DAO). In the spirit of the decentralized ethos behind public DLT, the idea behind governance tokens is to disintermediate single control points or autocratic decision makers who, throughout history, have made centralized decisions (sometimes malicious) based on their own self-interests as opposed to the best interests of all involved.
Similar to the way an individual’s unique identity affords him or her the right to cast one vote in a political election, each governance token (in a distributed ledger scenario) typically gives the holder a right to cast one vote in any decision-making process where the outcome is determined by the option that registers the most votes. Compared to political elections where each person is limited to a maximum of one vote, individuals who hold multiple governance tokens are usually granted the right to cast multiple votes; one for each governance token in their possession.
As a cornerstone of DAOs and decentralized finance (DeFi), governance tokens may also convey special rights to submit proposals — sometimes called “improvement proposals” — for platform modifications or updates (e.g., altering a user interface). Then, once the holders of governance tokens cast their votes to move forward with such a proposal (or not), the votes are usually binding (to different extents) for the team that’s responsible for implementation. Other uses for governance tokens include but are not limited to voting on developer funding, DeFi reward structures and fee schedules. An example is the MKR governance token, which bestows a voting right within the MakerDAO organization and for management decisions regarding the Maker Protocol software platform.
For enterprises and businesses looking into DLT as a platform for digital transformation, business innovation and industry disruption, governance tokens can support a variety of blockchain-related initiatives. For example, if multiple participants in a supply chain agree to leverage the public DLT benefit of multi-party transparency to track goods from the manufacturing origin to final customer delivery, the involved entities may choose to establish a DAO that collectively manages the smart contracts used to automate that tracking. Governance tokens would be issued to each of the DAO’s participating entities to democratize any decision making regarding the business logic and workflows represented in those smart contracts.
Regulatory Scrutiny Over Governance Tokens
At the time this glossary entry was published, it was unclear how global and domestic US lawmakers and regulators might act when it comes to the regulation of governance tokens (or any token for that matter). To the extent that governance tokens are considered by many to be a type of utility token, one possibility is that the forthcoming laws and regulations will be stratified according to major tokens (and therefore, what applies to utility tokens may apply to governance tokens). Another possibility is that governance tokens are special enough to be regulated differently from other classes of tokens. Still, a third possibility is that lawmakers and regulators decide to ignore the nuanced differences between token types and instead make one set of laws and regulations to rule all types.