- Governance tokens are a kind of shares in the context of blockchain ecosystems. They give the right to vote on key issues in the development of decentralized protocols.
- Governance tokens are not only instruments of direct democracy. They can be used in many other use cases.
- Utility tokens serve as a means of interacting with services or to gain access to certain functions, as well as special privileges in ecosystems. Such assets cannot be used for voting within the DAO.
What is a governance token?
A governance token (or governance token) is a digital asset whose holders can vote on key issues in the development of a blockchain project as part of the work of a decentralized autonomous organization.
The latter can make decisions regarding:
- determining the value of various protocol fees and their distribution among ecosystem participants;
- user interface changes;
- creation and filling of the project development fund;
- grants to developers, etc.
Many crypto assets in the DeFi ecosystem are governance tokens. The use cases of the latter are not limited to voting. Such coins can usually be used in staking, lending protocols and profitable farming.
There are ratings of governance tokens, where they are sorted in descending order of market capitalization.
What is a utility token?
Utility tokens are crypto assets designed for specific use cases in specific ecosystems. They are also called native or utility tokens.
Such assets also replicate the mechanics of gas on the Ethereum network. For example, the MATIC utility token of the Polygon ecosystem is used to pay transaction fees.
Basic Attention Token (BAT) allows you to reward Brave browser users for their attention to advertising materials, as well as act as a form of payment for advertisers.
In some cases, a utility token is required to access the platform, but more often it is used optionally to use certain functions or privileges.
For example, BNB holders receive a discount on trading fees when interacting with the Binance centralized exchange, as well as the opportunity to support new projects on the Launchpad platform.
The same asset is a key element of the BNB Chain. In addition, it is used to pay transaction fees for operations in the DeFi ecosystem.
LINK, the native token of Chainlink, is used primarily to pay for the work of node operators, on the basis of which the oracles of the decentralized network operate.
What are the main differences between governance tokens and utility tokens?
Governance tokens are in many ways similar to ordinary shares in traditional finance, allowing voting on key issues of public companies.
The holders of such blockchain assets submit, accept or reject proposals within the DAO.
Thus, governance tokens are a key element of decentralized systems, an instrument of direct democracy.
In turn, utility tokens do not give voting rights – only the ability to use them in certain use cases. Most of these assets are something like a stripped-down version of governance tokens.
What are the advantages and disadvantages of governance and utility tokens?
We list the main advantages of governance tokens:
- Decentralization. Only when using such assets can DeFi applications be called decentralized. Without governance tokens, platforms would be faceless sets of smart contracts controlled only by developers and founders.
- Opportunities for cooperation. Voting sets the stage for constructive discussions about the future of projects. Discussions, in turn, create incentives for cooperation among ecosystem participants.
- Involvement. Governance tokens are leverage on the future of blockchain projects that motivate holders to participate in voting.
There are also pitfalls:
- The elements of direct democracy do not guarantee that the project will certainly develop in the right direction. There are always members of the DAO who are guided primarily by selfish interests. Among such players there may be large holders of tokens that can significantly influence the results of voting.
- If the decision taken by the community turns out to be suboptimal and ultimately harms the project, the majority will be to blame. This means that none of the participants in the DAO will be held liable.
- Every decentralized autonomous organization has a large number of governance token holders. They are able to single-handedly create proposals and achieve acceptable results for themselves. The latter may be contrary to the interests of other members of the community. Therefore, the mechanism for allocating governance tokens should be well thought out.
- Due to legal uncertainty, many projects and, accordingly, assets can attract the attention of regulators.
Holding utility tokens can also be associated with significant risks. For example, during the “ICO fever” of 2017-2018, many “dummies” were created that did not have fundamental value and prospects. Such assets were often issued by scammers in order to get the funds of novice crypto investors.
There are exceptions – it was in those years that the tokensales of the now largest centralized exchange Binance and the leading non-custodial platform Uniswap took place.
The cost and prospects of utility tokens depend on the quality of the respective project and the relevance of the use case in which they are involved. If the platform is not in demand, the asset will steadily fall in price.
Utility tokens do little to contribute to the mainstream adoption of cryptocurrencies, as their actual use is mostly limited to individual platforms and use cases. Therefore, only a few of these assets retained their value over long periods of time.
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