What Are Governance Tokens?

In the world of DeFi (decentralized finance) and DAOs (decentralized autonomous organizations), governance tokens play a hugely important role in ensuring projects and protocols remain decentralized and the will of the community is upheld.

As more people enter DeFi and NFTs, the demand and need for governance tokens have grown. In this article, you’ll discover the benefits and risks of adding governance tokens to your crypto portfolio.

Governance Tokens Explained & How Do Governance Tokens Work

A governance token is a crypto token unique to one project, product, or protocol. Holders of governance tokens are essentially shareholders of that particular project. They have a financial interest in the success of the project and are providing funds to support its goals. In return, these investors and community members are given voting powers and rewards.

Usually, DAOs distribute governance tokens because, unlike traditional organizations, they don’t have a centralized individual or board members who have the final say on decisions.

Instead, all governance token holders are given voting powers proportionate to the number of tokens they hold. This ensures a DAO isn’t controlled by a single entity. Rather, all people with a financial interest in the project are able to vote on important issues.

Pros of Holding Governance Tokens

Decision-Making Power

Holding governance tokens gives you voting rights and decision-making power within that particular DAO. Whether you have a personal or financial connection to the project, having voting rights means you can contribute to ensuring the project achieves its goals. Furthermore, it helps keep the community aligned on the values and overall mission of the project.

Together, token holders will decide the project roadmap, how funds are allocated, team member elections, and much more.

Community Engagement & Influence

The reason most DAOs are successful is the quality of the community. Governance tokens are designed to encourage engagement by incentivizing community members to actively participate in the governance of the project. When the community readily engages, the voting process becomes easier, and the project is able to remain aligned with the people who want it to succeed the most.

Financial Rewards

Are governance tokens a good investment? Yes, particularly if you’re looking for financial rewards.

When you invest in governance tokens, you’ll be eligible for airdrops, dividends, and staking rewards, making them a good option for generating passive income.

Early Access & Insider Information

Many projects offer insider information and early access to project updates to all governance token holders. For example, if a project is launching a new digital asset or NFT, you, as a governance token holder, may be able to purchase this in a private pre-sale before the general public gets access.

Cons of Holding Governance Tokens

Volatility and Risk

DeFi governance tokens are known to be quite volatile, with prices fluctuating rapidly. While the more established DAOs and projects have found some stability, many tokens still suffer from volatility, which can make them riskier investments than other tokens.

Lack of Regulation & Oversight

Governance tokens don’t have their own regulatory framework, meaning they are often targets of scams and fraudulent projects. Sometimes, people create projects purely to increase the value of the token. Then, they sell all of their tokens for a huge profit. This leaves community members holding coins that retain no value.

To avoid scams like this, conduct thorough research on the founding members and team behind the project to ensure they’re legitimate.

Decision-Making Challenges

Sometimes, decentralized decision-making can be an incredibly slow and inefficient process. When you have a large volume of governance token holders, getting them all to conduct a fair vote in a timely manner can be challenging.

Furthermore, project voting can be easily manipulated if a small group of individuals retains the majority of the voting power.

Limited Utility

Governance tokens only have utility within a specific ecosystem, meaning they can be difficult to sell or trade. Some governance tokens may appear to be a valuable investment, but if you can’t sell or swap them, they will never live up to their perceived value.

Additional Tips for Investing in Governance Tokens

do Your Research

Before investing in any governance token, take the time to research the project, learn the history of the team members, and dive deep into the whitepaper. You need to know the project is legitimate before investing.

Diversify Your Portfolio

Don’t put all your eggs in one basket. A governance token can be a risky investment, so be sure to invest in different asset classes, such as stablecoins. Doing this will help reduce the overall risk of your portfolio.

Be Patient

It can take time for governance tokens to appreciate in value. Remember, they’re reliant on an engaged community—this takes time to develop. Don’t look at governance tokens as a get-rich-quick investment.

Conclusion

Overall, governance tokens can be an incredibly beneficial investment. However, you shouldn’t focus your entire crypto portfolio on this asset class. Instead, spread your risk across multiple asset classes.

Before investing, take your time to research projects thoroughly, and invest only what you can afford to lose.
To protect yourself while investing and for a place to safely store all your governance tokens, check out Escrypto’s institutional-grade digital wallets.