The Importance Of Community Governance In DeFi

Decentralized Finance (“DeFi”) platforms have greatly grown in popularity in 2020 and 2021 year to date, having a significant impact on the financial technology sector. These platforms were created by combining blockchain technology with financial technology, providing financial services that billions of people use around the world, including lending, borrowing, savings, insurance, and investments.

This coming financial revolution was made possible by decentralized applications and the use of smart contracts, a computer program that automatically executes, controlsand/or documents legally relevant events and actions according to the terms of a contract or an agreement.

Decentralized apps aid in the elimination of "the middleman" in the traditional financial system, whereas smart contracts aid in the creation of trust when transacting on the blockchain. Unlike the traditional financial system, DeFi does not limit or discriminate against its users. DeFi is controlled by the users and is not governed by any central authority. Governance mechanisms are used by DeFi solutions to make critical business and development decisions such as adding new features/services, hiring new developers, and so on. Without a governance mechanism in place, a DeFi solution is not fully decentralized.

What are Governance Tokens?

Governance tokens are tokens that represent a user's voting power in DeFi projects. One of the first applications of a governance token was as an off-chain process by which stakeholders could determine the direction of a DeFi project. The disadvantage of the off-chain process is that it resulted in a situation in which miners and core developers wielded more power than users because most users lacked the resources to use the off-chain process.

The primary purpose of the governance token is to give users control over the platform. Any user who owns a governance token should be able to participate in platform decision-making. Another application for governance tokens is as on-chain processes.

The most popular type of governance token at the moment is on-chain governance, which allows users to vote on DeFi project changes directly from the blockchain. This form of governance was designed to give every user and individual on a DeFi project the ability to hold governance tokens. The governance mechanisms are stated in the smart contracts, and a decision is executed if the contract's stated number of votes is reached. Although the ‘popular' on-chain process is open to all users, the weight of a vote is determined by the number of governance tokens you possess. Today, governance tokens are most always based on the ERC-20 token standard and must be staked before a user can vote. Governance tokens are typically distributed to users as a thank you for using the platform. These incentives encourage users to use the project more frequently, resulting in increased liquidity for the DeFi project.

The demand for governance tokens is increasing as the DeFi sector grows. The presence of governance tokens in any DeFi project allows for a well-organized decision-making process. It also allows for the peaceful resolution of disputes.