How DeFi Uses Decentralized Governance and DAOs
Just as DeFi is an emerging industry, so is decentralized governance an emerging concept. Therefore, not all DeFi protocols can be said to embrace fully decentralized governance. While full decentralization should be any protocol’s ultimate goal, individual DeFi protocols have adopted their own approach for various reasons.
Founder Control: The least decentralized projects have a similar governance structure to private companies, with founders guiding the project strategy, controlling the execution of the technical roadmap, and ‘DeFining’ the project’s future.
Some projects will claim that they lean towards this form of governance temporarily because they are at an early stage, and the mechanics required for the project to function correctly are not launched yet. This can be a reasonable position, but unfortunately some projects fail to prove they are moving towards decentralization by making the necessary code changes in the protocol. For example, they will not design steps to transfer governance to or share governance with users, so we flag this lack of open governance to the community.
Council Model: This approach is sometimes used by immature projects. It involves selecting a group of experts to help make decisions about the product, roadmap, and any issues that must be resolved. Councils are usually made up of core developers and established crypto founders such as Andre Cronje or Stani Kulechov. This partnership style approach is usually in high demand because of the industry influence these individuals wield.
Representative Democracy: Users are able to elect individuals to represent them, and this group of representatives is assigned to making decisions concerning project development on the users’ behalf.
Full Decentralization: This is what open governance looks like, and it is something we have never seen before in traditional finance. This approach is enabled by governance tokens, with projects distributing governance tokens to users so they are put in direct control of a project’s future. A project may choose to use a Decentralized Autonomous Organization (DAO) platform such as Aragon to manage this process.
The primary goal of governance tokens within DeFi is to give project users the right to influence strategic decisions about how the project develops and how to solve any issues. Governance token holders are able to influence the direction of the project by:
● Proposing a change and initiating a vote to decide whether it goes ahead
● Voting for or against a change that they or another user has proposed
The growing demand for governance tokens indicates how crypto market participants want to take control of how DeFi projects use their assets. Furthermore, as the weight of a user’s vote is directly correlated with the amount of governance tokens they hold or stake, many people believe this is a good reason to acquire as many governance tokens as they can.
This innovative approach to governance has definitely raised the standards of how all crypto projects are designed and run.
When governance tokens don’t work: It’s worth noting that governance tokens are not a panacea for all issues related to governance, and they can lead to undesirable consequences.
For example, if governance rights are tokenized but no vesting period is put in place for the tokens, a malicious founder could dump their tokens onto the open market, causing a supply shock that undermines the price of the token as well as the project’s credibility.
Another potential issue might arise if an already well-established project uses its position to acquire a significant portion of a new project’s governance token, resulting in parts of the DeFi ecosystem becoming centralized in the hands of the larger project’s token holders.