Valuing Governance Tokens

Governance tokens are critical assets to manage protocols, but currently get their value from second-order effects. The delegation framework is a first step, but just a stopgap to a larger problem.


  • Governance tokens are critical assets to manage protocols, but currently get their value from second-order effects
  • The delegation framework is a first step, but just a stopgap to a larger problem.
  • Governance token holders should be rewarded for contributing, with payment coming directly from protocol revenue.

What directly and inherently incentivizes someone to contribute to managing and steering an onchain protocol? The blunt, unfortunate answer, is nothing – incentives are generally intangible or indirect at best – and that is the reason for general governance apathy and protocol mismanagement.

Ether (ETH) is renowned for – and draws its value from – its versatility, especially its demand as a utility token to facilitate gas-based transactions. Essentially, the more economic activity onchain, the more demand for ETH. This utility fosters an intriguing parallel with the U.S. dollar’s role in the United States, which stands as the lone currency accepted for tax payments. It's a vital interaction; you can't use USDC for gas transactions just as you can’t pay US taxes in euros, highlighting ETH’s role as a pivotal form of money within the Ethereum ecosystem. With ETH being indispensable for transactions on the blockchain, its value is intrinsically tied to its utility.

Governance Tokens

Ethereum’s ecosystem continues to grow and create onchain value that is managed by governance tokens. These tokens empower users technologically to influence the trajectory of onchain projects. These tokens, however, aren’t expensed in utilization (unlike ETH) but still have substantial utility in directing onchain initiatives. Governance tokens permit users at a technological level to contribute to the management and direction of an onchain project. There are no legal rights attached to the token, or a mutual consensus to come together, just a built-in capability that allows holders to use their tokens to vote on proposals and specific outcomes.

There is no direct value attributed to governance tokens, and they are not a form of money.

If governance tokens had direct attributable value and shared in the protocol's revenue, the reason to hold a token would be two-fold. Such a dual function would create a split of intention between realizing value and governing.

Like any asset, governance token prices represent a speculative and intrinsic component. Like all assets, we can set aside the speculative component as it could be considered random in aggregate. The intrinsic portion, however, is much more interesting. This gives rise to the question - what is the intrinsic value of governance tokens? And, what is the source of that value?

Again, governance tokens are not like ETH; they are not expensed when utilized nor act like onchain money. Governance tokens are not used up in any way to perform their function, but still have utility in their capacity to steer onchain projects.

Incentivizing Good Governance should be the Source of Value

What incentivizes someone to contribute to managing and steering an onchain protocol? As mentioned, there is no direct incentive. Indirectly though, the reasons for holding tokens are the novelty of contributing through governance, participating in a community to become a paid contributor, and more importantly voting to integrate projects and functionality that are valuable to you.

Taking a deeper look:

  • Novelty, excitement, and network effects
  • New projects that show a lot of promise attract an excited community willing to contribute to share in the social capital and brand of the project.
  • Generally, community members do this with the hope that their participation in governance will lead, through Metcalfe’s Law, to an increase in value as the excitement turns into a network effect.
  • Participating in the community to become a paid contributor
  • Somewhere along the line, a workforce needs to emerge from the community, and the hope is that if one  participates long enough, especially in governance, or have the appropriate skills that governance recognizes, one may be selected to contribute and get paid to do so.
  • Integrate a project or functionality that is valuable to the token holder
  • Here, participants look to acquire a material number of governance tokens to propose, influence, and push through a valuable integration for another project or protocol functionality from which they derive a direct benefit. If the proposal succeeds, it could mean an increase in revenue that the participants directly enjoy or an increase in the token's price because of the shared network effects from integrating.

The takeaway is that governance tokens derive value from second-order effects. If one isn’t attracted by the above rationales, one probably won't get involved. Or, worse, a participant gets in for the novelty and stops participating when the novelty wears off, which unfortunately  encaptures many token holders. Consequently, governance struggles to work properly, and protocols are mismanaged or fail.

To solve this, we need to recognize that governance requires bandwidth from participants and should directly reward them for their contrbutions. Otherwise, there is no way for governance to economically determine the direct benefit of expending time and effort to contribute to the management and steering of a protocol. Considering there are many protocols, it becomes more difficult for a keen participant to know where to optimally apportion their time and effort.

From Stopgap to Real Solution

The delegation framework that has emerged as a solution to governance apathy is an excellent first step but still a stopgap because it still sits squarely in the novelty category. It emphasizes that governance is a full-time job, works against the network effect, and creates selection bias.

People who get involved with governance for the reasons specified are already high-quality contributors deep into the protocol or something adjacent, thus already in the network and don’t add to it, or they are folks who don’t have something else better to do thereby bringing a low-quality addition to the network effect.

The solution may be to create a structured payments program for participating voters - paying them for their contribution directly from the protocol revenue and not in governance tokens.

Governance tokens are utility tokens without built-in compensation. Rightly so, participants should not be rewarded for owning a governance token. They should be paid for using the governance token to contribute to the management of the protocol.

This ensures that tokens have an intrinsic value. Currently, Governance tokens’ source of value flows from price discovery on secondary markets without much, if any, intrinsic value tied to the use of the tokens, which means that the incentive to govern is determined purely by price speculation. Therefore, paying in Governance tokens re-enforces the randomness of speculative pricing behavior and detracts from rational price discovery. It thus detracts from optimal governance since there is no fundamental value to fall back on when a speculative market turns.

There are several ways to structure such a program, but ultimately it creates a defined benefit for those who actively govern - disincentivizing apathy. Only those who actively vote get paid this defined benefit. While there is an inverse relationship between the amount of voter participation and the size of reward, it is more valuable than typical staking; participants receive rewards with intrinsic value.

The net effect will be broad-based governance impacting protocol revenue, increasing the defined benefit when things go well and decreasing when it doesn’t - thereby aligning performance with decisions. Furthermore, it creates a disincentive for apathy, an incentive to govern based on the protocol's performance, and the ability of the participants to determine the intrinsic value of their contribution. Finally, it facilitates economically rational decisions as to which protocol, and to what extent, they will be able to contribute.