What is a governance token: The correct evaluation method to distinguish by reliability and control power

Governance tokens are one of the most debated topics in the cryptocurrency market. Opinions range from viewing them as innovative to criticizing them as fundamentally unnecessary, with investors and developers divided in their views. However, properly structured governance tokens can potentially bring significant value to a project. This article proposes a practical framework to understand the essence of governance tokens and accurately assess their value.

Rethinking the Necessity of Governance Tokens

A governance token typically refers to a token that grants voting rights on project parameters. It enables token holders to participate in critical decisions shaping the project’s future, such as product updates, fee structures, and business development.

However, there are many doubts in the market. Some participants argue that “decentralized governance is unnecessary; protocols can function effectively without it, and in fact, efficiency may decrease.” There is also a strong critique that “many teams launch tokens solely to raise initial funds without any practical utility.”

Even respected industry figures like Ethereum co-founder Vitalik Buterin and flashbot strategy lead Huss have questioned the practical utility of governance tokens.

Classification Along Two Axes: The 4-Quadrant Evaluation Model

Previous evaluations of governance tokens have been vague. The 4-quadrant framework proposed by Outer Lands Capital measures the intrinsic value of governance tokens along two axes:

Y-axis: Reliability (Feasibility)

• How reliably the rights granted to token holders are executed
• Whether voting results are truly implemented by the team or protocol
• The extent of safeguards via smart contracts and legal protections

X-axis: Control (Economic Value)

• The magnitude of economic returns obtained by token holders
• Influence over key economic parameters of the protocol
• Actual benefits such as dividends, fee distributions, and incentive programs

By combining these two axes, governance tokens are categorized into four types: high reliability and control, high reliability but limited control, strong control but low reliability, and low in both.

Conditions for Success and Failure: Four Case Analyses

Both Reliability and Control: The Success of dYdX

dYdX (Token: DYDX) underwent a major upgrade to v4 in November 2023, transforming it into a decentralized derivatives exchange. Transitioning to its own Cosmos application chain significantly enhanced the value of its governance token.

DYDX’s control power is extremely strong. Validators and node operators contributing to network security through staking receive a direct share of trading fees. Even at current activity levels, this chain generates over $43 million annually for validators.

At the same time, reliability is also high. All voting results are executed on-chain, preventing arbitrary changes by the team. Key decisions—such as technology upgrades, new perpetual contract markets, and trading incentive programs—are made through voting by DYDX holders.

High Reliability but Limited Control: ENS as a Public Good

Ethereum Name Service (ENS) is a high-quality project generating $16.57 million annually. However, its strategic choices intentionally suppress the economic value of its governance token (ENS).

The ENS charter states that “fees are intended to prevent large domain hoarding and fund DAO operations; excess profits are not a priority.” The average renewal cost for domains is just $5 per year, less than half of what Web2 providers charge. Even if doubled, demand would remain minimal, and the DAO chooses not to raise fees.

In terms of trustworthiness, ENS’s structure is top-tier. Delegated voting, on-chain execution, multi-stage proposal processes, and legal entity functions via the Cayman Islands foundation set a standard for rights protection. However, due to its public good orientation, token owners cannot expect profits.

Strong Control but Lacking Reliability: The Collapse of Hector

Hector Network, an asset management project on Fantom, initially claimed a governance design with strong control. Investors could influence key parameters, including fund deployment decisions.

However, due to lack of execution and market downturns, the team failed to deliver on its roadmap over 18 months, paying out $52 million in rewards. When token holders demanded liquidation of the remaining pool, the team restricted voting rights and censored dissenting members from the project’s Discord.

Insufficient safeguards—unlike DYDX and ENS—meant there was no guarantee of reliability. During liquidation, the value of HEC tokens plummeted 99% from all-time highs.

Both Reliability and Control Lacking: The Legal Dispute of Aragon

Aragon (Token: ANT) provides infrastructure for DAOs, used by major projects like Lido, Decentraland, and API3. However, its governance token design had serious flaws.

ANT’s voting rights were ambiguous, with little control granted to owners. The team promised to transfer a $200 million fund pool to a DAO by November 2022, but the process was repeatedly delayed, finally happening in May 2023.

Activist investors like crypto hedge fund Arca bought large amounts of ANT to exert pressure. In response, the Aragon Association halted fund transfers, banned members from Discord, and accused them of attempting a 51% attack. Continued chaos led to the final decision to dissolve the project on November 2, 2023, but token holders were not granted voting rights, and legal battles are ongoing.

Designing to Maximize Governance Token Value

Developers and investors should focus on the following points:

Recommendations for Development Teams:

• Determine whether a governance token is necessary beforehand. Consider if certain decisions can be more effectively managed through decentralized mechanisms.
• If necessary, clarify and strengthen the rights of token holders. Giving ambiguous authority and later revoking it is worse than delaying decentralization.
• Incorporate strong commitment mechanisms such as legal protections and smart contracts. Refer to highly reliable designs like ENS.
• Clearly define the roadmap and outline a phased plan for gradual integration of decentralized governance.
• Set appropriate expectations for investors. If the project is non-profit, explicitly state that there is no investment return.

Checklist for Investors:

• Are voting results automatically executed via smart contracts? (Reliability check)
• Are there mechanisms for substantive returns, such as fee sharing or buybacks? (Control check)
• Are major constitutional amendments subject to higher voting thresholds (e.g., 2/3 majority, 10% quorum)?
• Is there a democratically elected and monitored emergency response committee?
• Are fund uses and key decisions subject to multi-stage, long-term deliberation?

Conclusion: Correct Understanding of Governance Tokens

Properly structured governance tokens are not merely investment products but essential mechanisms for protocol risk management and value distribution. The issue lies not with governance tokens themselves but with the reliability of their design and implementation.

The market is increasingly capable of assessing governance token value more efficiently. Failures like Hector are recognized as such, while robust designs like dYdX are highly valued. This trend reflects that development teams are becoming more conscious of balancing reliability and control, and investors are scrutinizing these aspects rigorously.

What matters most is that the value of governance tokens is not fixed at inception but can be improved through continuous refinement. Even ongoing projects can identify and fix flaws—it’s never too late. The industry’s history is still young, and by leveraging appropriate frameworks, it is entirely possible to transform weak projects into strong ones in a short period.