DeFi (decentralized finance) is currently the biggest thing in the history of finance.
The numbers show that the DeFi ecosystem is quite healthy as the number of unique DeFi addresses reached 4.3 million in January 2022.
Experts also predict 100x DeFi growth in the next 5 years.
The Governance Token Hype: What is a Governance Token?
Governance tokens have become the buzzword among crypto enthusiasts as DeFi continues to explode. In simple terms, governance tokens are cryptocurrencies that represent voting power on a blockchain project.
Major DeFi platforms such as Compound and Aave are creating and issuing more governance tokens.
But what are governance tokens and what’s the use?
A governance token is the main utility token of a DeFi protocol. These tokens allow for Decentralized Autonomous Organization (DAO) governance, where holders have the right to vote on governance issues in a DeFi protocol. It allows the token holders to help shape the future of the protocol by providing full control and right–something that is a basic tenet of the current crypto revolution.
With the Saddle Finance governance token (SDL), for instance, users can vote on proposals via the Snapshot platform.
Governance Tokens: The Pros and Cons
There’s more to governance tokens than voting. Tokens are also a type of investment that can generate returns, among other benefits.
But governance tokens are not all rosy.
Here’s a breakdown of the value of governance tokens and what to be wary of before buying.
Governance token: The good
- You get a share of protocol earnings
Some DeFi protocols distribute a share of the platform fees and earnings to token holders.
You earn your fee based on the number of tokens you hold.
- Staking earns you handsome profits, helps you get loans
Staking means locking up your crypto for a particular period of time.
Locking your crypto can earn you as much as at least 10% per year. The more you stake, the more your earnings and voting rights.
You can also use staked crypto as collateral for loans.
- Token valuations can go up fast
Governance tokens are very attractive to DeFi users as they hold the power to make important protocol decisions.
Increased demand for a particular token leads to a subsequent increase in its value.
YFI, the yearn.finance governance token, for instance, rose from $750 at launch in July 2020 to around $25,000 just after five months.
Governance tokens: The dark side
- Democracy in question
A huge amount of governance tokens is held by a small number of founders and team members.
The strength of your vote in a DeFi protocol depends on the number of governance tokens you hold. Most of the protocol decisions are not entirely democratic after all.
- A governance token can be overvalued at launch
Investors and owners lock up most of the governance tokens when launching, which inflates the token’s price.
The value of the governance token will later drop significantly if the few major holders liquidate at once.
Be keen on the total token supply and how much of it is locked up before investing in a governance token.
- Governance tokens could be treated as securities
U.S Securities Regulation suggests that a token issued before user-based governance is security.
Governance tokens are likely to be treated as securities for two reasons.
First, DAO owners are initial issuers of governance tokens. Secondly, tokens have high appreciation potential.
If regulators treat tokens as securities, you risk more regulations and scrutiny as a token holder which can undermine your user experience.
Governance Tokens are Valuable But Beware The Risks
Holding governance tokens is a way of getting your opinion heard on your favorite DeFi protocols.
You can also earn extra income from your staking.
Do your due diligence and buy tokens in platforms that have measures in place to protect you from unethical profit seekers.
Saddle Finance SDL token, for instance, is non-transferrable for the first 3 months to stop people who are out to make quick profits. Learn more about Saddle governance token.