What are governance tokens and how do they work?

Governance tokens allow users to take a more active role in managing decentralized projects.

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Governance tokens are a type of cryptocurrency that allows token holders to vote on the direction of a blockchain project. The main purpose of governance tokens is to decentralize decision-making and give holders a say in project management.

Governance token holders are usually more invested in the success of the project as they stand to gain or lose more, depending on the outcome. Community members can use tokens to directly influence the direction and functionality of a blockchain protocol. Thus, it is possible to implement changes related to the user interface, to vote on fees and the distribution of rewards, or even to modify the underlying code of a project.

Although most decentralized finance (DeFi) tokens are governance tokens, voting is not their only defining feature. People with these governance tokens can use them to take out loans, stake them, and earn money through yield farming. Given all this, their primary function is still to distribute power.

Governance tokens are a relatively new invention, and there is still much debate about their effectiveness. Some believe they are the key to true decentralization, while others fear they will lead to the centralization of power within a small group of token holders.

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