Concept

A governance token is a type of crypto token that allows holders to take part, and play a role, in on-chain governance for a crypto project (a blockchain based or run project). These tokens are used to vote on certain proposals and decisions, and to influence or determine the future direction of a project in the ecosystem. The token is issued as an incentive, allowing the user (holder) an opportunity to become a partial owner (direct stakeholder) and decision-maker in a DeFi protocol. Governance tokens are linked to a specific DeFi protocol and purport to provide holders with certain rights and/ or with voting rights on future alternations to certain features of a protocol.

However, the tokens do not allow the holders to gain control over the protocol at the enterprise level. Normally, a governance token entitles the holder to a single vote, and votes can also be delegated (through proxy) by respective holders who do not wish to take part in the voting process. Given that the amount of tokens can dictate the proportion of voting power in the hands of owners, governance voting systems characteristically encourage plutocratic decision-making and concentrates power in the hands of the wealthy.

Broader category

Crypto tokens are digital assets that are created on top of an existing blockchain (using smart contracts) and can carry out a wide range of functions, including representing a physical asset to granting access to platform-specific services and privileges. Tokens provide for certain other functions, including utility (utility tokens), security (security tokens), and governance (governance tokens). Examples are tokens such as Cronos (CRO); Very, Very Simple Finance (VVS); and Uniswap (UNI).

Example

A prime example of a governance token is a DAO token. To be able to sell these tokens on respective platforms, users must accumulate a fixed minimum number of DAO tokens. As a native utility token, a DAO token is used to fund allocations automatically amongst users- allocation is extended to a winning user in the form of a participation slot. DAO tokens can also be staked to earn a yield via a DAO vault. Given the embedded voting mechanism, DAO tokens functions as a governance token, allowing holders to cast their votes for governance of the DAO ecosystem. In addition to the above, the token gives users access to certain exclusive features on the network such as discounts and rewards associated with certain transactions or events.