Tokens Governing DeFi DAOs
A look at how co-creation is paving the way for building the Internet-native, remote-first organizational structures that will be the future of work.
Written by Conflux Network’s Strategy Manager Karan Ambwani
One of the core premises that makes capitalism successful is aligning the incentives of an individual to that of the broader socio-economic system. An individual can have selfish intentions of making money by starting a business. However, this money is made by serving the customers with the products or services that will benefit them in general. With the scale and distribution of internet business, the balance is not always easy to maintain and the new data-driven incentive structures are not easy to keep up with as an individual.
In the internet era, from the early cypherpunk movement to the recent mass-awareness of data-centralization and limited privacy, majority digital users understand how the transformational powers of technology are concentrated in the hands of few. This includes a lot of platforms we interact with and get our information from in the present day world. Today, companies like Facebook and Twitter, as an example, capitalize on user data not just for advertising but to the extent that they manipulate how we perceive reality. The digital power and control is easily and globally scalable.
Web3 makes the promise of redesigning some of these incentive structures and coming up with new ways of aligning the interactions between the users and technology platforms. The term Web3 itself means the next phase of the internet era. In this phase, the power is decentralized and the control is in the hands of the community who are the early adopters, believers and investors.
The Web3 infrastructure is built on permissionless, distributed networks and the applications on top are creating unique mechanisms to make the decision-making and governance majorly token-driven.
To keep this philosophy of decentralization intact we are building applications that are for the direct benefit of the users. This empowers the users to decide themselves how to run the products and operations. We can see a lot of innovation happening in the DeFi industry, but soon this will trickle into every kind of digital application that we use today and in the near future.
The most interesting development with the sprouting of DeFi protocols last summer is the aspect of governance tokens. Most of these DeFi protocols are established as DAOs, that are internet-native businesses collectively owned and managed by the community. That is, many people are given a chance to hold a governance token and those holders collectively control the protocol’s codebase and its treasury.
The governance infrastructure is a layered structure with the top layer interacting directly with the community members using forums and tools like Discord, Telegram, Tally. The second layer contains voting mechanisms involving governance tokens on platforms like Snapshot, Boardroom, Stampers and others. The third layer involves managing the treasury and funds of the DAO. Products like Llama, Gnosis Safe are good tools for getting insights into protocol treasuries and managing multisig wallets for fund disbursements.
Along with allowing participation in voting on decisions of the DAO, Governance tokens serve as rewards for early adopters of protocols and can be traded in secondary markets. The tokens gain value for the holders and platforms by:
- Facilitating early growth and liquidity
- Aligning incentives between users and the protocol
- Creating network effects and community support
There are usually two mechanisms for transferring value to holders: token buyback or revenue distribution. With token buybacks, the protocols use treasury to reduce supply of tokens in the market, thus increasing the price like in the case of MakerDAO. Revenue distribution through tokens is done by the protocol to the token holders for example in Ren.
Utility of Governance Tokens
It is important to distinguish between utility and governance tokens when we are trying to understand how governance tokens are used. Utility tokens are usually for a specific purpose and do not have an aspect of decentralized governance. To take an example, for any data request to the Chainlink oracle, the fees are charged in LINK. On the other hand, governance tokens provide the users with the voting power to, for example, participate in protocol improvement proposals, and thus modifying the structural and functional aspects of a platform.
There are some clear advantages of a community using voting to make decisions for a protocol they actively use. For example, in case of a DEX, the users themselves can list or delist a market pair simply based on their conviction, utility, or market interest and without any influence from external forces.
Some of the popular use cases of governance tokens are:
- Delegating voting rights
- Making protocol improvement proposals
- Tracking historical voting weight
- Managing community treasury
- Allocating protocol fees & discounts
- Owning a decentralized domain like .cfx
- Decentralizing decisions on pair listings
New protocols are even coming up with interesting governance token models to drive more user adoption and usage. MoonSwap, which is one of the most popular DEXs on Conflux Network, the community can participate in defining the product and new market proposals by using the cMOON tokens which are counted towards the votings in a weighted mechanism called MOONPOWAH. MOONPOWAH is counted by participating in staking and yield farming with cMOON. Thus, powering users of the platform have more voting powah!
Limitation and the Future
DeFi DAOs function best when the tokens are evenly distributed. This is not usually the case with venture funded projects and this is leading to more fair-launches in the wild and improved voting mechanisms like Quadratic & Conviction Voting.
Governance tokens provide a way to coordinate community efforts required in running multibillion-dollar DAOs. Web3 users understand the capabilities of these new token innovations and are building more and more robust mechanisms for DApps that will go beyond the crypto-verse and will touch our everyday life — like how some of the social apps on our screen impact our daily routines.
Conflux Network is actively building and partnering with projects in the ecosystem to create a DAO services stack that will provide these robust tools and infrastructure components. This will allow the creation of the protocols of tomorrow to be driven by tokenomic governance on our highly scalable PoW network.
This article is not financial advice and is intended only for educational and awareness purposes. We do not endorse any of the products mentioned in the article. Please do your own research before interacting with any of the products mentioned in the post and always read the security audit reports to understand the security risks associated with investing in decentralized financial instruments.