The Bullish Case for Governance Tokens

Anthony Sassano makes his bullish case for governance tokens and why a handful of these will go on to one day be worth trillions of dollars!

This article is a part of a new series of opinion articles written by independent researchers that will be published in DeFi Pulse Farmer. The articles will first be shared with the Alpha Tractor subscribers, and will later be made accessible for free subscribers.


The Bullish Case for Governance Tokens

Opinion article by Anthony Sassano.

You’ve probably seen the infamous meme floating around on Twitter about “valueless governance tokens” and how a token giving its holders governance rights over a project isn’t enough to make the token valuable. This meme came about for 2 reasons:

  1. Usually, project teams will state that their new token “has no value” as a legal and regulatory shield.

  2. Most of these tokens actually don’t have much fundamental value and often get very overheated in price based on pure speculation.

Personally, I agree with these 2 points to an extent but I also believe that they miss the forest for the trees. This is because what these governance tokens actually do is allow a global and distributed set of people to coordinate and affect any kind of change they want over a protocol - this is incredibly powerful.

What these governance tokens actually do is allow a global and distributed set of people to coordinate and affect any kind of change they want over a protocol - this is incredibly powerful.

If we take a step back and take a first-principles view of governance tokens we can see that they are essentially social coordination tools. Think about it - Ethereum doesn’t have on-chain governance (for a number of good reasons) and ETH is not considered a “governance token” but ETH holders are still socially coordinated to grow and steward the protocol in the best way that they can. This is because they have a direct financial incentive to do so since the logic follows that ETH would fall in price if the Ethereum protocol was not managed correctly. ETH as an asset also acts as a “Schelling point” for the entire Ethereum ecosystem to build around - we see this playing out in numerous ways on Ethereum (such as ETH being supported by every single project on Ethereum).

There is around 8.7 million ETH ($18.7 billion) locked in Ethereum-based DeFi protocols

Community-governed protocols

I believe that this same Schelling point principle applies to all of the apps/protocols that are managed directly by token holders. In saying that, most protocols will fail to gain any sort of adoption which means their tokens will have nothing of value to govern over and it follows that the tokens value would trend to 0. This is why I believe that a project should, at the very least, find product/market fit and build out a community before issuing a governance token as I think this greatly enhances the chances of long-term success.

What changes can token holders actually bring to a protocol?

Well, in theory, basically anything can be altered whether that’s changing a protocol parameter such as the loan-to-value ratio of an asset on a money market, directing treasury funds to certain initiatives (like what the Uniswap Grants Program does), or even allocating a portion of protocol revenue to token holders (such as xSUSHI).

Whatever changes are implemented by token holders has direct consequences on the project itself in both positive and negative ways. For example, if the token holders of a money market protocol decide to add a toxic asset as a form of collateral, then this could expose the system to unnecessary risk and in the worst case, the system could be exploited and the protocol/users could lose money.

This would, of course, naturally lead to a drop in the tokens price which means the governors of a protocol are directly incentivized to think carefully about what changes they bring into effect.

Not all token holder governance is created equal, and it mainly comes in 2 different flavors: off-chain “soft” governance and on-chain “hard” governance.

  • Soft governance: it refers to token holders having the ability to signal their preference for a specific governance proposal (usually via a tool like Snapshot) and then the outcome of this proposal is executed by a group of multi-sig holders (usually the core development team).

  • Hard governance: it refers to what is currently implemented by Maker, Compound, and a few other projects - that is, token holders can vote for or against proposals directly on-chain and, if a specific proposal passes, it is then activated in-protocol without the need for a multi-sig to execute it.

From what I can tell, the projects that currently use soft governance do so only because they are young and want to be able to move quickly and build up a dedicated token holder base over time. Then, when the time comes, these projects will integrate hard governance and remove the multi-sig part of the process.

Governance tools

There are many different tools that projects utilize as part of their governance toolkit.

Typically these tools include:

  • An off-chain signaling mechanism (such as Snapshot).

  • A delegation system (Compound’s smart contracts are a favorite here).

  • A governance forum (Discourse).

  • A messaging platform (Discord, Telegram).

  • A public debate arena such as Twitter.

By utilizing these tools, token holders (or really anyone who wants to participate in governance) can come together and hash out the relevant social, economical, and mechanical politics associated with various proposals. These tools also act as a way to document the governance process and work to set precedents for future discussions and debates.

The MakerDAO Governance Forum

Something that all protocols will suffer from over the long run is voter apathy because most of these governance tokens are either held by speculators or people who don’t really care to participate in governance. There are various ways to keep token holders engaged but the most popular one that I’ve seen is for protocols to integrate native delegation into their governance systems.

There are various ways to keep token holders engaged but the most popular one that I’ve seen is for protocols to integrate native delegation into their governance systems.

The way this works is that token holders are able to “delegate” their voting power to a more involved member of the community (sometimes referred to as a “protocol politician” or “steward”). Compound Finance has been the main pioneer in this area with many other projects such as Uniswap and Gitcoin following in their footsteps. 

Compound Finance Governance Leaderboard

Now, there are arguments that state that delegation just further increases voter apathy because users who delegate their tokens will most likely not be paying any attention to what’s actually happening with the project and will essentially trust that whoever they delegated their tokens to will act in the best interests of the project. This is a valid concern though I still believe token holders being able to delegate their voting power to the more engaged community members to be a net positive over these tokens just sitting in cold storage doing nothing.

I am personally long-term bullish on governance tokens that are able to adequately capture the value generated by the protocol that they are tied to. Unfortunately, many governance tokens are simply either issued too early in a project’s life cycle (before the project has achieved product/market fit) or their distributions are skewed towards insiders (such as early investors) which deters members of the public from getting involved. In saying that, the projects that are able to cultivate a dedicated community, achieve a healthy token distribution, and harness the power of an effective governance process will go on to one day be worth trillions of dollars.

Follow Anthony Sassano on Twitter: @sassal0x 🔥🔥🔥 !


This article reflects the opinion of its author, who has received no compensation for it (other than from DeFi Pulse). All info in this newsletter is purely educational and should only be used as research. DeFi Pulse is not offering investment advice, endorsement of any project or approach, or promising any outcome. This post is prepared using public information and does not account for specific goals or financial situations. Be careful and keep up the honest work!