Who writes the rules for a blockchain?
What is the value of the right to vote on the rules that govern a cryptocurrency? With a focus on the price of cryptocurrencies, another asset – governance tokens – offers investors more than the mere possibility of monetary returns: it helps them write the rules for a particular blockchain. In the absence of a central governing body, decisions about blockchains are left to their users. But not just any user. Early adopters using a new DeFi service can purchase (or earn) governance tokens, which give the holder the right to vote on how the blockchain is maintained, upgraded, and managed. One token, one voice. These tokens often have monetary value, but the ability to shape the future of a blockchain as these systems become more integrated into day-to-day operations is its own substantial asset.
Dogecoin, the joke currency that millionaires struck overnight. CryptoKitties, the cartoon cat digital trading cards that have sold for over a hundred thousand dollars. A Pringles “Flavor” which exists only as a non-fungible token, and sells for, well, a lot more than the chips you can actually eat. At first glance, these blockchain-based projects may seem absurd – baffling to the general public and mocking to the financial establishment. These are parodies and pranks that sometimes make money. But if you can look past the jokes, jargon, and goofy names, you’ll see that there is serious work going on in crypto. A community of developers and investors are building a strong and sustainable infrastructure that will underpin a whole new kind of economy: a decentralized economy. Part of the decentralized economy is building an open and decentralized financial system (DeFi).
DeFi is young and growing productively (although at times confusing). There is too much live experimentation to reliably predict what might happen next. However, a growing market suggests that fundamental blockchain innovations – and the crypto and software innovations that made it possible – are here to stay.
While much of the focus on cryptocurrencies has been on price speculation, the bigger game is still unfolding. The decentralization and automation that cryptocurrencies allow is transformational as it enables new ways to create and transfer value. When artificial intelligence (AI), the Internet of Things (IoT), robotics and cryptocurrency converge, the innovation cluster creates the possibility of something new: autonomous operations or business processes that evolve. ‘perform themselves. The rules for this new system are being written right now, often by users who hold “governance tokens”, which allow them to have a say in the direction in which these systems evolve. For forward-looking businesses and individuals who work with crypto, these oft-overlooked tokens hold special value: a say in what comes next.
The value of a vote
There are two important concepts in the architecture of the crypto ecosystem: decentralization and on-chain governance. Let’s start with decentralization. Blockchain is a stand-alone peer-to-peer ledger technology for managing and recording transactions. Designed for accuracy, transparency and autonomy, blockchains eliminate the need for third parties or paying intermediaries – verification is built into the software. Users do not have to deal with gatekeepers or fees and do not need to request permission to use this public infrastructure. Unauthorized access to public blockchains is fundamentally transforming the architecture of how we think about financial transactions and the infrastructure of the financial system. Because blockchains are immutable, that is, you cannot edit or modify a recording, it means that the trust of a third party is no longer required. And this innovation alone reduces costs and friction.
Then there is on-chain governance, which determines how the rules that govern activity on a particular blockchain are defined and revised. This could be used to build a Decentralized Autonomous Organization (DAO) or DeFi system. Our current financial system depends on trusted intermediaries, like mortgage brokers or bank presidents – they set protocols and rules that protect the institution itself and the consumer. In a decentralized blockchain-based financial system, this rule-writing process is often done through the use of on-chain governance. Early adopters using a new DeFi service can purchase (or earn) governance tokens, which give the holder the right to vote on how the blockchain is maintained, upgraded, and managed. One token, one voice.
These tokens tend to come into play after a crypto-network is established. Most blockchain projects start with something called ‘off-chain governance’, which can mean anything from developers exchanging emails about how to change the code to founders passing notes passed in. GitHub, the primary software source code repository used for open source software projects. The people who build the currency write a foundational set of rules. Once that is defined, many establish chain governance and use governance tokens.
Once that switch is flipped, governance tokens can become extremely valuable. It happened for Compound funding, a notable first DeFi project where users earned governance tokens and the value of that token increased significantly when the system went live on their mainnet. On-chain governance is more formal and democratic than off-chain, and it allows each governance token holder the right to vote on the decisions and choices that will guide the particular blockchain ecosystem. Some ecosystems can vote on the features to be published. This could be the setting of monetary policy or the reserve requirement for a loan. Or, it could be the type of consensus mechanism used by the blockchain that affects the performance, resource usage, and security of that blockchain. The on-chain governance structure is designed to maintain transparency, as anyone can see the proposals and see the calculation of a vote’s results – and avoid making any behind-the-scenes human-led deals.
While the primary focus of crypto investors so far has been speculation about appreciation, governance tokens are likely to become more important – and valuable – as crypto investing matures. The reason is quite simple: As the value of a crypto-network increases, so does the value of the right to rule it. Since token holders must own the crypto asset to continue voting for the benefit of this particular ecosystem, investors will want to get and hold more tokens so that they can continue to participate in governance. As long as the ecosystem makes good decisions and provides good, competitive service, the token will likely gain in value over time.
We have something analogous in the traditional financial system. While traditional equity confers a right or claim to cash flow after all business expenses have been paid, governance tokens are somewhat analogous to equity in that they confer the right to control the direction of the business. ‘a cryptographic network and its treasury.
A token with rights
If you have a cell phone, you are an investor or a potential crypto user. But it’s not as easy as opening a Coinbase account: A savvy investor will ignore the fancy products in the news and take the time to educate themselves on the fundamentals of crypto. Because they have the right to help shape the future of cryptocurrencies, governance tokens are likely to become more important as crypto investing becomes more sophisticated.
We are entering a new world where more and more is done with less and less. This is partly possible thanks to technology, because innovation is at the heart of the economy. The world is becoming more and more automated. And as this trend continues, we will need mechanisms that manage the boundary between man and machine. In DeFi, on-chain governance systems and the use of governance tokens look quite promising. Crypto is still in its teens. Coins should be taken for what they are – a joke. But let’s not confuse nonsense with real innovation. The only crypto asset that gives its holder an explicit right is a governance token. Let us not just participate in speculating. Governance tokens give investors not only a stake, but also a say. As we have seen throughout history, the right to vote is a powerful thing.