Governance Rights for Tokenholders: A Crucial Question
Builders are currently grappling with the decision of whether to allocate governance rights to tokenholders and, if so, when this should occur. Concurrently, regulators are keen to dissect the intricacies of crypto governance. Specifically concerning network tokens, they seek to ascertain whether the blockchain systems in question are under the control of a particular individual or a collective group acting in concert. This discussion aims to clarify the essential role of governance in the crypto landscape while delineating which types of tokens should possess governance capabilities and which should not. The insights provided here are intended to assist both developers and regulators in navigating the complexities of governance, decentralization, and authority.
The Importance of Governance
Governance refers to the framework through which a community or organization establishes its rules and makes decisions. Effective governance is vital as it fosters trust among key stakeholders, paving the way for increased investment, collaboration, innovation, and overall growth. It supports decentralization, thereby preventing the excessive concentration of power. Furthermore, good governance enhances decision-making by harnessing collective intelligence, leaving the community feeling more engaged with the decision-making process—even when they may not fully agree with the outcomes. Governance outlines who is responsible for making specific decisions and the methods through which these decisions are made. In the digital realm, governance can encompass aspects such as the formulation and enforcement of community standards, fee adjustment protocols, and the workings of ranking algorithms, among others.
Tokens and Their Governance Rights
Governance is a significant concern in the crypto realm, paralleling its importance in conventional institutions like corporations and non-profit organizations. However, the crypto space introduces unique dynamics. Tokens grant authentic digital ownership and may also bestow governance rights, enabling certain tokenholders to directly influence protocol operations. While some decisions are encoded in smart contracts or the blockchain’s foundational protocol, others may be made by the founding team, developers, validators, or through a democratic process involving tokenholders. The scope of decisions that tokenholders can influence is embedded in the blockchain’s architecture from the outset.
This leads to the pivotal question of when and why a token should grant governance rights. Two key motivations drive projects to adopt token voting: to uphold decentralization and to ensure that community-informed decisions are binding.
Maintaining Decentralization in Network Tokens
The primary reason for incorporating token governance is to safeguard network decentralization, particularly when future decisions cannot be foreseen or coded into the system. This is particularly pertinent for network tokens, which are essential for the operation and security of a blockchain network, covering aspects such as transaction fees and voting mechanisms. Centralized control is antithetical to the fundamental purpose of blockchains and is a critical legal consideration in determining whether a token falls under securities regulations. The more a network token operates based on predetermined smart contracts or protocols, the less room there is for human intervention, promoting a decentralized ecosystem.
In some scenarios, this programmability can render a token entirely decentralized, free from any individual or group’s control. However, as new challenges and opportunities arise, unforeseen decisions may need to be made, necessitating a decentralized governance structure. This ensures that decisions are made collectively by tokenholders, rather than a select few individuals, thereby satisfying regulatory requirements and fostering a mature project status.
Voting Mechanisms for Network Tokens
For core network tokens such as AAVE or UNI, the motivation for decentralization is paramount. Decisions related to protocol fees, upgrades, and other strategic aspects must adapt to evolving circumstances, including the emergence of new tokens and technologies. Token voting serves as a mechanism to involve human perspectives without reverting control to the founding team, thus justifying governance rights for network tokens that require ongoing decision-making beyond initial programming.
These tokens often serve as the backbone of ecosystems populated with diverse builders and users. By distributing proposal and voting powers among these stakeholders, protocols can maintain credibility and mitigate fears of exploitation, encouraging greater investment and participation.
Governance Beyond Token Voting
Onchain token voting isn’t the sole method for achieving decentralized governance. Take Ethereum, for instance: the ETH token doesn’t offer voting rights, yet the network remains decentralized due to its democratic decision-making process, striving for a “rough consensus.” Similarly, Solana’s validators engage in token-based voting for non-binding recommendations, akin to informal checks found in other decentralized autonomous organizations (DAOs).
Consequently, while network tokens can extend voting rights, it is not a necessity. The decision hinges on the importance of explicit governance processes, the community’s ability to reach consensus, concerns regarding potential governance attacks, and other relevant factors. Achieving decentralized governance is critical, but it is only one aspect of a broader decentralization strategy.
Crowdsourced Engagement Through Governance
Another driving force behind token governance applies to various token types: fostering community-informed decisions and enhancing ownership and engagement. Granting governance rights can lead to more informed decisions, even if decentralization is not the primary goal. Historical insights, like those from the French philosopher Condorcet, suggest that majority voting can yield better outcomes than expert opinions under certain conditions.
Numerous DeFi protocols, such as Aave and MakerDAO, utilize community voting to determine critical parameters, while projects like Arbitrum and Optimism leverage collective input for grant distributions, hoping that the community can identify deserving initiatives.
Even in cases where voting does not necessarily lead to informed decisions, it can still cultivate a sense of community and engagement. Outside the crypto sphere, fan voting for competitions or awards serves as a common strategy. In the crypto space, innovative examples include NounsDAO, which allows NFT owners to vote on future actions, and other DAOs engaging their communities in whimsical yet meaningful decisions.
Tokens across various categories can facilitate voting, whether for governance in network tokens or for community-driven decisions in other contexts, such as games or creative projects.
Conclusion
As the landscape of crypto tokens continues to evolve, so too does the regulatory and policy framework governing them. Understanding the dual motivations for governance—maintaining decentralization where programmability is limited and fostering community engagement—can provide valuable guidance in determining governance rights for different types of tokens. This framework serves as a foundational tool for both developers and policymakers navigating the complexities of governance in the crypto ecosystem.
