How does Governance work in DeFi?

Dec 17, 2021 2 min read
How does Governance work in DeFi?

Given the nature of the technology at play, the blockchain space holds the concept of decentralisation in high regard. The idea that power and responsibility should be spread as widely as possible is a key concept, and that extends to decision making in many DeFi platforms.

Democratising the “boardroom” decisions of a DAO has its positives and negatives, but even though it may not be a perfect system, governance is an important process in keeping decentralised finance decentralised.

A large number of teams are building in DeFi, and there is a wide range of ways in which different projects incorporate community feedback into project governance:

  • Smaller projects are often run by a core team whilst working on building their user base. The team may then choose to incorporate informal governance practices as they grow, for example by holding regular calls with the community to gain feedback and discuss strategy.
  • Other projects, however, are 100% governed by users voting on-chain, and no change to the protocol can be made without passing through the voting process. Any changes are then made either by the team or are automatically executed by smart contracts which update how the protocol functions.
  • Many DAOs also use a hybrid model, wherein smaller, day-to-day decisions are taken by the team, whereas on-chain voting is used to decide large-scale strategy, inflation schedules, etc.

The governance process usually begins with discussions of issues surrounding the project and potential changes, which take place via official channels such as a governance forum, Telegram or Discord. Once an idea has gained traction, any user can put forward what is generally referred to as an “Improvement Proposal” for an on-chain vote. These proposals are a formalised report of the planned changes and can come from within the team or directly from the community.

An on-chain vote can then be held on the proposal. Users are able to vote if they possess the project’s governance token, and the more tokens a user possesses, the more weight their vote carries. Most Improvement Proposals are accepted or rejected via a simple majority of tokens voting for or against, but proposals with multiple options are also common.

DeFi governance is a way of decentralising decision making power, allowing users to have a say in how projects are run. However, participation requirements and the fact that the holders of large quantities of tokens have such an inflated share of the votes, mean that some are sceptical over just how democratic the system really is in its current state. The current system may not be perfect right now, but new models are constantly emerging with the aim of further democratising project governance.

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