Governance Tokens and Value Capture

Over the past year in DeFi there’s been a renewed interest among the community in value accrual mechanisms for tokens.

This is for a good reason. Due to a combination of opportunism and naivete, the 2017 ICO era was flush with utility tokens that attempted to jam useless tokens into new projects. It was only during 2018 as the ICO bubble burst that the community came to understand the velocity problem inherent in utility tokens and many went back to the drawing board to figure how tokens may actually be designed to accrue value within a protocol.

The industry has evolved significantly since then. Not only are protocols working and thriving as opposed to the mere whitepapers and vaporware in 2017, but they also have tokens that have legitimate use. In DeFi we’ve seen tokens used to backstop protocols, govern protocols, secure protocols, and a range of other functions. In return for these functions many tokens receive value flows whether they be in the form of dividends or buybacks. The idea that tokens have value now is no longer controversial, it's apparent to anyone that has spent a sufficient amount of time in DeFi.

However, at a certain point over the past few months it became evident that many projects may have overcorrected towards building-in value accrual mechanisms to their tokens. The industry’s lessons from the ICO era evolved into a new obsession with fee extraction and dividends. On the surface this sounds desirable and like a sound path to real economics for tokens. But the problem is that this philosophy doesn’t consider protocol maturity. In exchange for ensuring a path to value capture, protocols dismissed a key of building early stage technology organizations: growth.

Uniswap and Silicon Valley

The point was solidified for me recently as Uniswap (UNI) rocketed to the top of the DeFi market cap leaderboards. For some time many in the DeFi community espoused that governance tokens without fee capture were useless and would lag tokens that implemented direct fee capture. UNI’s rise to the top signaled the biggest invalidation of this thesis that fee capture today actually matters. And that makes a ton of sense. So long as DeFi protocols have 100x+ growth ahead of them they should be prioritizing growth over fee capture. By not extracting fees from liquidity providers, Uniswap implicitly subsidizes growth over fee capture.

This philosophy of growth over profits is not new. It’s been the Silicon Valley mantra over the past two decades that's created many of the world’s most successful companies in history. One only needs to look to the Amazons of the world who haven’t paid owners a dime, but whose stocks have still been rewarded incredibly to see this truth. It’s all about future cash flows, not a single digit yield you may receive over the next 6-12 months from fee capture.