Governance Tokens in DeFi Projects

4 min readJun 6, 2022


The Function of governance tokens

The tokens of blockchain projects each have their own purpose. Some are stores of value, such as Bitcoin, which can be used to store value and circulate value.

In addition to Bitcoin, some tokens can pay transaction fees, and ETH is used to pay gas fees; some are used as work rights, and only a certain amount of tokens can be pledged to participate in the block generation of the network, such as various PoS tokens (such as EOS, Harmony, etc.); some can capture transaction fees, such as kyber to capture value by destroying tokens; some tokens are governance-based, such as MKR, 0x and other tokens. Of course, most tokens have more than one purpose. There are tokens that can both capture fees and also be used for governance, such as MKR and Kyber.

The premium of DeFi governance tokens mainly stems from the scale of assets locked in the project itself, which is also related to security. As the scale of locked assets increases, so does the gaming demand for governance.

MakerDAO VS. Compound

MakerDAO’s governance token is MKR. MKR is a voting right. Similar to EOS, the head project of DPOS, holding EOS can participate in the election of 21 super nodes, and supernodes initiate proposals and votes on behalf of the community. MKR has similar functions. MKR holders vote to determine risk parameters in the system, such as collateral selection, liquidation ratio, stability fee, etc. After a little thought, you can see that the voting rights of retail investors are basically useless, and the big players have the right to decide.

MKR enjoys the project bonus. When users redeem their mortgage assets, they need to pay interest with MKR, and this MKR will be destroyed. If the MakerDAO project works well, the destruction speed of MKR will help increase the unit price of MKR.

The “3.12” black swan event caused MakerDAO to generate about $5 million in system bad debts and caused the price of MKR to drop to $200 at one point. For this reason, it was necessary to auction more platform currency MKR to make up for the loss of the platform. These MKRs are sold for DAI, which is destroyed until the bad debt is dealt with by the system. Bidders bid for a fixed amount of DAI and buy less and less MKR until the highest bidder wins and the system’s debt is paid off.

Suppose the influence of the black swan continues and the bad debts of the system continue to increase, then the decline of MKR will continue.In addition, in terms of liquidity, the market is very short of DAI to participate in the MKR auction, so Maker quickly opened the USDC over-collateralization channel to make up for the lack of liquidity of DAI in the market.

Compound’s governance token

The total amount of COMP tokens is 10 million,Daily rewards to protocol users of 4.23 million COMP tokens (42.3% of the total) will be placed in a “Reservoir” smart contract, and 0.5 COMP will be transferred out for each Ethereum block (about 2880 COMP per day, which is means that 4.23 million COMP will take 4 years to distribute), waiting for the agreement to distribute.

Half of each day’s COMP is distributed to asset providers and the other half to borrowers. The most active assets also receive the most COMP per day, so allocations change as the market moves.

Any community member can propose changes to the Compound protocol. Changes may include adding new assets, changing the model used to set interest rates on a given asset, or canceling assets.

Are governance tokens worth investing in?

Since most DeFi projects allow token holders to share some of the benefits generated by the agreement, whether by participating in governance, becoming a liquidity provider, or simply holding tokens, the tokens have the economic right to share the benefits of the agreement. so we can use the price-earnings ratio valuation model (Price-to-Earning Ratio for short PE) in the traditional financial market to value the tokens of various DeFi protocols.

The formula for PE is “price per share (P) divided by earnings per share (EPS)”, which is one of the most widely used indicators in the current securities market. It reflects the company’s value by the ratio of stock price and earnings per share, reflecting the company’s future profitability. An asset with a high price-to-earnings ratio generally means that the asset is either overvalued or that the market has high growth expectations for it. Vice versa, if an asset has a low P/E ratio, it means that the asset is either undervalued or has low expectations for its future growth.

The calculations show that among all DeFi projects with tokens attached, there are two clear outliers: Augur (REP) and 0x (ZRX), with ratios of 16,761 and 6,935, respectively. this phenomenon may indicate that investors have large growth expectations for both liquidity and derivatives protocols.

In traditional financial markets, a P/E ratio between 50 and 100 is normal for many high-growth tech stocks: Netflix, for example, currently trades at around 86. Therefore, those DeFi protocols with a P/E ratio of less than 100 mean that the current token price is relatively fair in terms of current earnings.

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