Around the block, key issues in the encryption space are revealed. In this version, Justin Mart and Ryan Yi analyzed the potential value drivers in the Ethereum ecosystem and the risks of governance tokens.
Potential value drivers and risks
In the past 12 months, DeFi has achieved tremendous growth. All indicators (value lock-in, users, transactions, valuation, etc.) are rising sharply. However, while some of these indicators are easy to track and digest, others are more vague.A challenging indicator is Appraisal.
In traditional stocks, valuation is tied to the equity itself or the direct partial ownership of the company.This equality equals actual control And grant certain benefits to equity holders, such as the proportional distribution of profits (dividends).
So what is a governance token?
In a decentralized protocol, the code is the law, so Actual control It boils down to the content of the code description. In this sense, each DeFi application will have a different sense of ownership, because each agreement will organize a set of rules that define different content. ownership method. Some protocols are coded as having no concept of external ownership-they will only operate according to their original internal rules and will never change! However, most of the teams that created these agreements recognized the need for adaptations, upgrades, and changes, and therefore coded in the concept of ownership so that the selected parameters could be adjusted and changed.
Enter “Management Token”. In short, these are ERC-20 tokens related to specific projects in which a quorum of token holders is required to adjust or change selected parameters. Therefore, these tokens “manage” the protocol.
But it is important to note:
- Governance token will not result in Unilateral control. Governance tokens can only affect selected parameters that have been coded into the project at the beginning.
- Every project will have one Different definitions of ownership and governance, And will decide which parameters can be changed and how to approve the changes.
Obviously there are many nuances here. In this release, we will quickly understand the reasons that make governance tokens valuable, as well as some reasons for careful use.
Reasons why governance tokens can be valuable
Why is the control and influence of decentralized protocols valuable? In short, governance tokens pass certain privileges, including:
Cash flow rights: The agreement may charge its users a fee. Collecting these fees, governance votes can decide to allocate part of the fees to token holders, similar to stock dividends.
Right to change the agreement: As mentioned earlier, the token grants its owner the right to vote on the future of the agreement.For example, most projects allow token holders to vote in two ways Smart contract Code change with Money management.
The code changes represent the direct business logic of the application. In some cases, these decisions can be very important, similar to a board of directors voting on the company’s strategic direction. The control and influence of these decisions is very important, and some political parties are willing to pay a considerable price for this.
Fund management usually focuses on the percentage of tokens that are usually allocated to “community activities,” which is a budget used to fund beneficial projects and feature development. The impact on these decisions is another extension of control over the future direction of the agreement.
The right to distribute tokens in the future: Some projects usually mint new tokens to protocol users in the following ways: High-yield agriculture. The idea is to distribute governance proportionally to the users of the agreement, leading to deeper retention and participation. The governance token is usually used to set these parameters.
Here are some examples of existing DeFi projects in these dimensions:
Finally, the governance token is the closest job that a decentralized project must complete ownership, And usually have a certain degree of influence on the future direction of these projects. Most projects also charge users a certain fee, for which part of the value may eventually go to the token holders.
Reasons to be cautious when investing in governance tokens
Although governance tokens can provide compelling benefits, please be aware of some key challenges and risks:
The utility of the token cap table: The total supply of tokens usually includes a large distribution of founders/team members and investors, thus granting control to a relatively small group of people. As a result, the agreement is actually richer than the democratic system. As a result, some projects completely avoided the distribution of the team and investors, but chose to “fair start”, that is, completely distribute the governance tokens to platform users. However, in reality, as the whales gain oversized positions, this may still lead to position concentration.
St. Louis Fed’s DeFi paper Noticed “In many cases, most governance tokens are held by a small group of people… Even if people think the issuance is relatively “fair,” the actual distribution is often still highly concentrated.”
Attribution cliffs for upcoming investors and teams: Most of the team’s and investor’s tokens are usually not immediately liquid, but are kept locked on a prescribed vesting schedule. The cumulative effect is that when tokens are first launched and started trading, most token supply is illiquid.Reduced float may make the project Fully diluted value It seems that the numbers are too high.
The potential challenges are more complicated. Usually a part of the team and investor tokens will immediately become liquidity (barriers to ownership), leading to supply shocks, which will affect governance voting and may affect market prices. When participating in governance tokens, please pay attention to the total supply of tokens and any locking cliffs.
Regulatory pending: U.S. Securities and Exchange Commission has issued guide The greater the degree of decentralization of the project, the less likely the underlying token is to be considered a security. It is not clear how to define decentralization in practice, but the US Securities and Exchange Commission stated that BTC and ETH have reached this title before. Despite this, the threat of being considered a security still hangs over projects with governance tokens, because it is not clear how the SEC will view some of these projects in the future.
Looking sideways, governance tokens are similar to traditional equity: they can control the future of the agreement, and can control cash flow and/or receive dividends.However, the main difference is that the scope of governance tokens is limited (only a small part of the parameters can be voted), and it is usually provided for free to the users of the agreement, and strictly Is not Fairness in the legal sense.
It is also helpful to be aware of potential negative effects. Each project will implement governance tokens in a different way, carrying a unique token cap table, which may contain a cumbersome vesting schedule, so that the initial float is low, and its compliance will be independently assessed by the regulator.
There are reasons to be excited about the new paradigm introduced by governance tokens, but this is also an early stage in its evolutionary history. These are new concepts, the design space is large and will continue to evolve, so be sure to conduct your own research and proceed accordingly.
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