Thread by @awrigh01

Why are governance tokens interesting and important? A short thread below 👇

There is often no IP protection with many blockchain-based protocols and assets move fast on a blockchain. Teams are using governance tokens to build a community, which ideally helps generate integrations with other blockchain-based projects.

These two strategies (community/integrations) appear to be the cornerstone of the blockchain-based network effect.

One way to think about governance tokens is this: these tokens serve as a shelling point in the coordination game that a smart contract-based protocol is trying to solve.

They channel a community to organize its activity, and if the community becomes large enough, it protects the protocol from competitors who can copy the underlying smart contract code (e.g., what we're seeing with Uniswap and Sushi), thus solving for low IP protection.

However, governance tokens may serve other functions too (overtime, especially if the market for these assets mature). Some governance tokens trade freely and a few now have a high implied total market caps.

Many projects are exploring this direction and we'll likely see a whole class of these assets being launched over the next several years, including protocols that serve the same basic function (stablecoins, marketplaces, lending, options, etc.).

Some of these competitors will be direct forks and others will be novel implementations to provide similar functionalities.

Over time, the value of a governance token should serve an important signal for consumers and users exploring competing smart contract-based protocols. In other words, the value of governance tokens is a rough proxy for the trustworthiness of the underlying smart contracts.

Think about it, how can users know whether a smart contract-based protocol is reliable, safe, and trustworthy, especially if they aren't technical? The market cap of these governance tokens is not a bad (albiet imperfect) proxy.

I'd argue that a high price would tend to signal that there is a community backing / using the project.

Are market prices a perfect signal? Of course not. Markets are notoriously inefficient. And the current value of governance tokens may be inflated.

But, with blockchain tech operating with a high degree of transparency, and with delegated voting, etc., we should get decent directional pricing over time (especially if we see opportunities to short these assets).

Governance tokens are also interesting because they often enable the community to upgrade the smart contract protocol. This is really important too.

As many know, smart contracts are difficult to change once deployed and sometimes this software can operate autonomously. What happens if there is a bug, error, change of parameter in the smart contract that is needed to reflect moving market conditions?

Interested members of the community can weigh in and hopefully solve the problem or change the relevant parameter.

Now that may be scary to some: a random group of people supporting an important financial product? Run.

But as we've seen with other large user-run ecosystems, this hive approach can work well, if the ecosystem is well-governed and entry is open and permissionless

(A good example here is Wikipedia and how it has largely avoided the fake news problem, through community-run curation, and beat out more traditional encyclopedias in scope and accuracy)

In addition, if the protocol becomes large enough--and important enough--it gives the community the ability to address regulatory concerns (if they should arise). That's a win for projects aiming to impact the real world and not just the crypto world.

I'm not fully pulling the above out of the air. The above benefits have been recognized by legal scholars.

Smart contract-based protocols are provided on a "take it or leave it basis." There is no room for negotiation if you want to use a smart contract-based protocol, which often performs a financial and quasi-legal function.

You either deploy your capital into them, execute a transaction with them, or you don't.

Scholars like Frank Easterbrook and Daniel Fischel have argued that the market can price corporate governance (for traditional organizations) in these types of "take it or leave it" scenarios in the legacy world.

We now have a way to test some of these theories and that's pretty cool. I think many folks are dismissing governance tokens, but I think the above characteristics make them worthy of careful consideration.

I hope that regulators don't jump the gun and just assume that there is no value to these tokens, simply because several of them are trading for a comparatively high valuation.