Educational Byte: What are governance tokens and what can they do?

If ‘governance’ does sound similar to ‘government’, well, it’s because they’re in the same category, so to speak. Governance refers to how decisions are made about changes and improvements to any project. Since most cryptocurrencies and protocols are decentralized, governance, if there is anything to govern, is often decentralized too —which means important decisions fall into the same community instead of some centralized leaders.

In decentralized crypto protocols, governance involves rules, voting processes, and community involvement to ensure the project develops in a fair and transparent way. That’s exactly where governance tokens enter the picture. They’re a type of cryptocurrency that gives holders the right to participate in the decision-making process of a decentralized ecosystem or platform.

By holding these tokens, users can vote on proposals that affect the project’s future, such as changes to the protocol, allocation of funds, or new features. This system allows everyone interested to have a say in the venture’s development and ensures that decisions are made collectively, reflecting the interests of the broader user base. On the other hand, even if governance tokens were made for this especially, they usually can work as any other token, and be bought and sold.

How do governance tokens work?

Governance tokens are typically internal tokens in a chain, created for, well, governance purposes, but also as a sort of exclusive coin to offer further privileges. They often come during the initial launch of a crypto protocol or a decentralized application (Dapp), and can be distributed in various ways. It could be through an Initial Coin Offering (ICO), airdrops to early supporters, or by rewarding users who have been already contributing to the network, like by providing liquidity or staking other tokens. They can be bought and sold too, but that often comes after the initial distribution.

Once released, these tokens become a crucial part of the project’s ecosystem, enabling holders to influence its direction. They’re often tied to a voting system embedded in the project’s smart contracts. Holders of governance tokens can propose changes or vote on existing proposals related to the project’s rules, upgrades, and overall management. Each token generally represents one vote, meaning the more tokens a user holds, the greater their influence.

This decentralized approach ensures that decisions are made democratically rather than being controlled by a central authority. Besides, additional rewards or benefits could come with governance tokens. For instance, they can allow their holders to make loans or long-term staking, provide access to early features, or be an investment themselves by betting on their market price growth.

An example of governance

Several Dapps in Obyte have their own governance tokens, including the decentralized exchange Oswap.io, which has the OSWAP governance token. We can see how a governance token works by taking it as an example. This asset was released in 2023 on a bonding curve to ensure always-available liquidity, with the purpose of offering additional rewards to Oswap.io users.

Holders can stake their OSWAP tokens to earn long-term rewards and deposit their liquidity provider (LP) tokens to receive a share of OSWAP emissions. By locking OSWAP tokens for periods ranging from 14 days to 4 years, users are entitled to new OSWAP token emissions and can vote on important governance matters. The voting power increases with the number of tokens and length of the locking period, enabling more significant influence over the protocol decisions.

Through the governance interface on the OSWAP Token website, users can manage their staking and voting activities, such as selecting the amount to lock, distributing voting power among pools, and deciding the locking period. They can also vote on which pools should be eligible for rewards, adjust parameters like swap fees and inflation rate of OSWAP token, and propose changes to the system.

By participating in these governance activities, users help shape the development and direction of the OSWAP ecosystem, ensuring it evolves according to the community's collective input. That’s also the case with any other governance token: they’re there to let stakeholders have a say in a decentralized platform.

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