Governance tokens belong to the category of utility tokens because owning them gives you a certain right. Governance tokens give owners the right to vote on issues that determine the strategy, tokenomics, operations and further development of a blockchain project.
In many cases, such governance tokens are used in the context of decentralized autonomous organizations (DAOs), but they are also commonly used in DeFi and dApp projects to delegate decision-making, or voting powers to a community. Such (international) networks, or DAOs, explore new and innovative ways of organizational development and collaboration, without the traditional hierarchical structures, using blockchain technology and governance tokens.
However, this construct also leads to novel coordination challenges arising from a decentralized, autonomous organizational structure. Governance tokens are being used to address these specific challenges. Governance tokens are used to make decisions across time, space, and language. They thus provide an efficient way for protocols, DAOs, or other blockchain projects of any kind to delegate decision-making authority to communities, thus decentralizing governance. This decentralized governance model aims to align the interests of token holders with those of the project. The specific mechanisms and processes through which these rights are exercised vary by project and organization. There are different voting models, and in each case it is necessary to define which model to use before launching a decentralized organization. Of course, each model brings its own peculiarities, advantages as well as disadvantages, or risks.
An important note about governance tokens is that these types of tokens have been abused in various ways and therefore it is always important to do a thorough analysis before buying a crypto project's governance tokens. What we observed many times is that the tokens served purely as a monetary incentive rather than being a true representation of voting rights.This is very tricky as it turns them into a trading object (in this case also a regulatory issue if the token is used like a “security token”), which can be dangerous and does not correspond to the basic idea of governance tokens. A well-known example of what can happen is Sushiswap's so called “exit scam”.
Another risk is a non-proportional distribution of the tokens. You can think for yourself what can happen if a participant (or two collaboration partners) have more than 50% of all voting rights because more than half of all governance tokens are in the same hands. If this is the case, this person (or collaboration partners) can then make suggestions for the project, which can be decided on their own, so to speak, for their own advantage rather than for the sake of the whole community.
Another risk is related to governance communication. In order for a decentralized organization and governance to work at all, it is imperative that all token holders participate so that a decision can be reached at all. In some cases, the number of proposals is very large or the topic is very technical, which can lead to under-participation. This can have fatal consequences, as it means that important decisions cannot be made in a timely manner.
Last but not least there is the potential regulatory risk if the initially defined features and usage of a governance token change over time and suddenly become subject to more (financial) regulations. Also, it is possible that national or even supranational laws can be put into force that have an impact on the use cases and management of governance tokens.