The error correction capabilities of the DeFi protocol are generally overestimated, and governance tokens may open the door to re-centralization, leading to more serious centralization.
Written by: Mohamed Fouda, partner of Volt Capital, a cryptocurrency investment institution, member of the TokenDaily research team
The core of DeFi’s explosive growth lies in DeFi’s governance tokens.
COMP, LEND, etc. are all governance tokens. The process of distributing these tokens to DeFi liquidity providers (LP) is called Yield Farming, and recent agreements that provide income farming have attracted unprecedented liquidity. The most typical example is the phenomenon-level soaring of YFI’s value.
YFI is a governance token released by the DeFi protocol yearn.finance on July 17th. The project party claimed that the token was “no value”, but the price of the governance token soared to more than $1,000 in 72 hours, with less than two releases. Weekly rise to more than 4400 US dollars.
Price chart of YFI token since its release
The great power of voting
Someone may easily label the rise in the value of governance tokens as “speculation and speculation” and “liquidity mining stimulation results”. However, something very worthy of attention has happened beneath the surface. For example, the heavyweight venture capital fund a16z holds a large number of MakerDAO and Compound governance tokens, and they are unlikely to make quick money by selling tokens.
DeFi governance tokens provide a unique opportunity to influence the direction of open protocols, otherwise it is almost impossible to control the protocol. These tokens authorize token holders to vote to change the parameters of the underlying protocol. If they have enough voting rights, governance token holders can basically change the smart contract or launch a newer version of the agreement. The power allocated to these governance token holders is very similar to the power allocated to shareholders.
Compared with traditional stocks/shares, governance tokens have several advantages. In traditional startups/enterprises, stocks allow owners to vote for CEOs or other C-level executives that are beneficial to them, and governance tokens eliminate the need for proxy voting.
Specifically, when funds and large investors have enough votes, they can openly and quickly propose changes, put the reform plan to a vote, adopt a large-scale expansion plan that is beneficial to them, and force their wishes. In other words, the system that utilizes governance tokens actually creates a traditional/centralized finance (CeFi) version, but just pretends to be DeFi. We at Volt Capital internally call it ReFi, or recentralized finance.
Since the development of the DeFi protocol is still in its infancy, we don’t expect to see this happening for the time being. However, once these agreements grow to the size of Chase, Bank of America BoA or Wells Fargo, their incentives will change.
Support and opposition to governance tokens
Will governance tokens become stock 2.0? What are the support and opposition? Let’s look at the most representative statement:
- Governance token distribution is fairer than equity distribution
- These decentralized protocols cannot be regulated
- If there is a large number of disputes, the agreement may fork
The above arguments largely overestimate the error correction capability of the agreement. Let’s examine one by one:
Token distribution
The founders and developers of the DeFi protocol tried to widely distribute tokens and distribute tokens to liquidity providers to try to achieve this goal, but the actual situation often fails to meet expectations. Taking the phenomenon of income farming as an example, funds and wealthy investors (also known as whales) use recursive liquidity provisions to maximize the income/share of governance tokens. As a result, these tokens are concentrated in the hands of a few investment institutions/farmers.
In addition, investors in these DeFi projects currently control a disproportionately large number of votes. For example, over 13% of the voting power of Compound is controlled by the first 10 addresses. Of course this ownership structure is better than today’s JPMorgan Chase Bank or Bank of America, but how much better? The following figure shows that the difference is actually very small:
Equity distribution of traditional financial institutions, source: CNN Money
Anti-regulatory
A common misunderstanding in the cryptocurrency field is that DeFi can operate on a large scale without supervision. If you create a smart contract and burn the control keys to ensure that there is no practical way to edit or change the contract, this idea may be realized. However, the existence of governance tokens makes this task impossible. Some projects have achieved small-scale success so far, but on the basis of large-scale operations, possession of governance tokens may lead to corresponding responsibilities for product use, leading to increased supervision.
Major governance token holders may eventually be held accountable by justice for illegally using their financial control agreements, such as money laundering. If most of the owners of these tokens are held accountable by justice, a small share of token holders will inevitably follow the changes to the agreement and limit the use of the “DeFi” agreement to users who are “unwanted”.
Bifurcation
It is generally believed that if users think that the protocol has changed, it can be easily forked. But it is very difficult to fork in practice. The agreement relies heavily on development momentum, and forking away from the existing governance structure means an agreement to reverse the development momentum against the wishes of its leadership. A certain degree of brand stickiness will reduce the impact of forks. Ethereum Classic or Bitcoin Cash are typical examples. The vast majority of users generally think that the forked protocol is not so trustworthy.
There are two other factors that make forks almost impossible.
First, the current successful DeFi protocol builds a moat by investing in and supporting other DeFi protocols, integrating them and serving as their community. This creates a marshallable fortress that cannot be easily copied into the fork protocol.
Second, the main investors and supporters of the popular DeFi protocol are basically the same group of investment institutions. Comparing it with the previously mentioned list of top ten shareholders of JPMorgan Chase and Bank of America, you will quickly find that the rules of the game are not much different.
Governance tokens can open the door to recentralization, and many people originally thought that the door had been closed. Ironically, plans designed to decentralize control tend to lead to more serious centralization.
Thanks to Magdalena Gronowska, David Vorick, and Leigh Cuen for their helpful feedback on this article.
Source link: www.tokendaily.co
