DEX Governance Tokens Explained: What They Are and Why They Matter

Although much of the 2020 crypto trading landscape remains to be facilitated by centralized, third-party exchange platforms like Binance and Coinbase, the emergence and inevitable flourishing of DeFi companies promise a future of countless options and unbeatable flexibility to the average cryptocurrency user.

It goes without saying that DeFi is playing a vital role in the growth and reshaping of the financial sector. As an open and permissionless system, DeFi is available to pretty much everyone. The interoperability that it brings also makes it easier for DeFi companies to leverage other innovations in the industry and build upon each other’s successes.

How DeFi gave birth to governance tokens

Decentralized cryptocurrency exchanges have an attractive set of pros -- namely, more user control, better security, and lower fees, among others. However, one of the biggest advantages that centralized exchanges have over decentralized ones is liquidity. Issues related to availability and trade volume make users of the latter prone to low liquidity.

To solve this problem, DeFi has turned to liquidity pools. If you’re not familiar with the concept, liquidity pools are essentially pools of tokens that are used to facilitate trading between users. They provide users with enhanced liquidity at every price level. Because this quells one of the biggest concerns surrounding DEXes, more and more users are becoming comfortable turning to DeFi infrastructures.

But for a liquidity pool to work, it has to have an adequate supply of tokens. To address this need, DeFi projects have relied on handing out LP tokens to incentivize users to provide liquidity to the pool.

When you add liquidity to a DeFi project, you will be rewarded with LP tokens in proportion to the magnitude of liquidity you added to the pool. When a trade is facilitated in the pool, a small fee taken from the trade is distributed among all LP token holders, therefore earning them money with every trade.

LP tokens are a great way to leverage your assets to build a steady stream of income from liquidity pools. As such, they have been the sole driver behind the expansion of various DeFi projects in recent memory.

Some platforms, however, take it a notch further by offering governance tokens to incentivize certain actions among its users.

Governance tokens explained

As the name suggests, governance tokens give DEX users the power to make decisions that will impact the platform they belong to. Again, decentralized crypto exchange platforms operate without a third-party governing body. As such, governance is left to those who possess governance tokens.

Some DEXes champion decentralization even further by aggressively pushing for community-owned and run platforms. For example, there’s keykey.fi, which is a new DEX that is fully owned and governed by the people who power the trades.

KeyKey aims to give crypto users complete control and ownership of the crypto infrastructure tools they depend on. After all, DeFi is all about doing away with governing bodies and third parties that may, at one point or another, make decisions that aren’t aligned with the interests of its users.

That said, KeyKey has offered governance power and protocol ownership to liquidity providers through their LOCK tokens. The fact that LOCK is a non-dilutive token (meaning your stake will not be reduced by future token rewards) is what’s incentivizing early adopters to add liquidity to the pool ASAP (pre-mining is still ongoing, by the way).

Why governance tokens matter: A summary

Governance tokens play an important role in establishing the economic model and rules of DEXes. Those who possess such tokens have the power to take part in important decisions and consequently influence the developmental direction of the platforms they rely on. Some examples of aspects that can be changed or influenced by the community include:

• How the platform operates
• What assets are added to the platform
• What the incentive structure is

As the resources involved in a DeFi project grow, so does the power and value of its governance tokens.

Conclusion

Governance tokens have the potential to make a huge impact on how crypto infrastructures will evolve and succeed (or fail) in the long run.

This might be too early of a claim for some, but it looks like DeFi is definitely here to stay. Needless to say, taking advantage of governance tokens and what they have to offer is a great way for early adopters to protect and make the most out of their investments.