The role of governance in the thriving devolved finance industry is nascent, and there are ongoing talks from key figures in the industry about its purpose and what governance will look like in the future.
Sam Bankman-Fried of FTX recently shared that his company’s participation in DeFi “will be driven by short-term profits and does not seek to have a long-term impact in governance protocols.” In doing so, he argued that he simply used DeFi protocols for the intended purposes.
This is not necessarily the case. Some mining programs are designed this way, and Bankman-Fried plays by the rules. If the project does not want participation of this kind, then the project should design its program accordingly.
Devolved governance is one of DeFi’s key missions
DeFi hopes to create an open financial system that anyone in the world can access. Governing tickets are usually designed to serve two purposes. First, projects use them to decentralize decision-making. The more people involved – as the logic goes – the less likely that a single party attack or abuse can occur.
To achieve the first goal, the tokens are usually designed to motivate occupants to participate and make beneficial decisions for the DeFi protocol. In this way, governing tokens can be compared to the traditional shareholding system in corporations, which is critical to capitalism’s success by incentivizing shareholders to borrow capital and govern a company out of pure self-interest.
Because one goal is to decentralize ticket holders, the concentration of governing tickets held by a few holders is said to be problematic. However, in the early stages of a project, it can be crucial.
Centralizing the decision-making process allows projects to move faster and leaner. For MakerDAO, for example, it was easier to vote on introducing new collateral assets when its stablecoin Housing moved too far from its beg.
But in the long run, when there is widespread community involvement in the progress of a project, it is better to have a decentralized symbolic distribution because whales could leverage governance in a way that benefits them, but not all stakeholders. In an extreme case, we would call it an attack, but even in MakerDAO governance, we can observe that large MKR holders are voting against other stakeholders. What’s more, even non-governmental tickets benefit more holders, as those are motivated to work for the benefit of the project only to get the symbolic increase in prices back. For governing tickets, this mechanism works even more so, because ticket holders can directly influence important product decisions on top of just writing blog posts and scaling on Twitter.
Many projects are aware of this and have taken a progressive devolution approach. Having a limited supply of governing tickets is good because it is more predictable for holders to get an idea of their voting power over time, and makes it more difficult for potential bad actors to be exploited.
Putting the product into product farming
Product farming, or liquidity mining, is a new way to win rewards with cryptocurrency holdings using unauthorized liquidity protocols as a concept – and has exploded in 2020 in the midst of DeFi’s boom.
Related: Product farming is a fad, but DeFi promises to change the way we interact with money
Many governing tickets are issued as the product in these product farming schemes. Devolved exchanges benefit from product farming by holding liquidity and even increasing project treasury for use towards a growth strategy. Consumers, on the other hand, earn a product in the form of the governance ticket.
The question is: How can this be sustainable? If consumers sell governing tickets, how can projects capture the liquidity and establish a broad base of governing ticket holders?
Looking at Uniswap, we see that the liquidity is somewhat drained with the end of issuing its governing ticket. However, this was less than expected and far from potentially harmful. An example is the distribution of UNiswap UNI government tickets to holders, who look decent enough to be ready for long-term governance.
Uniswap had no governance before releasing its UNI ticket a few months ago. At that time, changes to the protocol were decided solely by the Uniswap team.
Governance may mean more autonomy, but is this the best bet?
With many examples of founders selling their governing tickets and abandoning projects, there is growing concern that governing tokens are another investment pipeline, leaving project founders rich and consumers with empty pockets. As always, there are exceptions. After a long DeFi summer, though, we’ve seen decent projects and blueprints on how to successfully launch decentralized governance. Uniswap is one example, but even its delicious opponent SushiSwap seems to have found its niche.
So, as with most things, doing your research before getting involved, understanding the risk and taking it all in when considering your investment calculations is a good way to start. It’s similar to the reasons why some organizations understand that there are high risks of hacking, so they use risk-adjusted returns for their investment decisions.
Ultimately, decentralized governance works, as we have seen a lot of successful open source software, and we believe that a project can be successful by embracing collective wisdom.
At DeFi, governance tokens are arguably the best way to leverage collective wisdom and achieve devolved governance. There is still a lot for people to explore, and there are projects where governance is actually reputation based, which is also a promising approach.
The views, thoughts and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Lucas Huang is currently head of growth at TokenLon. Prior to joining TokenLon, he spent years working at Kyber Network and Deloitte Consulting. He studied computer science at the University of Chicago and accounting information systems at Michigan State University.