Probably, you have already heard more than once about the so-called management token, which is present in many cryptocurrency projects. The management token gives its owners the right to vote when making changes to smart contracts on emission protocols, which allows them to express their opinion when it comes to making changes to the operation of this protocol. According to the description of the projects, on Coinmarketrate.com Some management token holders also benefit from a share of protocol and trading fees and other rewards, especially those issued by DEX such as Uniswap, for depositing funds into their liquidity pools.
However, as issuers regularly state, management tokens have no intrinsic value: they are not useful tokens. In fact, they are very attractive to many DeFi users, which has led to a sharp increase in prices for many of these tokens. This also applies to YFI, the yearn.finance management token, which grew from $790 at launch in July 2020 to almost $25,000 in December 2020, which represented (at that time) a market capitalization of $740 million. True, 11 million of them were stolen, but that’s not what we’re talking about.
Important DeFi function
For many in the cryptocurrency world, the management token is a key function of the DeFi protocol that allows decentralization to work. A good example is Maker DAO, the issuer of the DAI stable coin, which completed the transition to full community management in March 2020.
After the start of the COVID-19 pandemic, the value of cryptocurrencies plummeted, causing a shock in the DeFi ecosystem, and the automatic liquidation of numerous accounts. For DAI, however, this became a particular problem, as a huge drop meant that its value fell below parity with the US dollar – the meaning of its existence.
Therefore, the Maker community called for the introduction of a voting process related to the MKR protocol token, which could allow changes to be made to the smart contract that manages it. This includes the required collateral levels, the stability fee when opening Maker repositories and, not so long ago, the debt ceiling for ETH. All these measures help to maintain the price and the overall supply of DAI at a stable level.
Democracy DeFi in Action
Although the above results could have been achieved without the participation of Maker DAO users, this approach corresponds to the decentralization of financing that the system hopes to achieve. As we have written more than once, the principles of DeFi are based on financial democracy: the opportunity for all users to have the right to vote in a monetary system that works in favor of the majority.
Along with Maker, other success stories include the Synthetix derivatives liquidity protocol with a market capitalization of $439.5 million, which, after being managed by general consensus (since its foundation in 2018), launched into three DAOs managing separate parts of the protocol. Although they are actually controlled by a group of leading developers, this indicates the direction of development of DeFi.
The Uniswap management token also allowed its users to vote on whether the liquidity mining on the platform will continue, and the majority of the Curve Finance token holders who voted voted for the distribution of almost $3 million of accumulated fees among themselves.
According to some, all this leads to the fact that in the future we may see organizations, perhaps not only in DeFi, managed solely on the basis of token ownership.
Where does the value come from?
During this year, the value of management tokens has increased dramatically. As of this date, the six largest DeFi management tokens (AAVE, YFI, UNI, COMP, SNX and MKR) have a combined market capitalization of 5.8 billion US dollars, which is not much less than Bitcoin Cash – 5.4 billion US dollars. Where does all this value come from?
Part of the answer lies in the interaction between liquidity extraction, lending and staking. Compound, for example, is considered a pioneer in the field of management, as it rewards COMP users, which encourages them to lend and borrow in order to earn more tokens and effectively insure themselves against non-repayment of the loan. Thus, COMP creates its own demand.
Then, of course, there are the good old speculations. As in traditional money markets and in the cryptocurrency space, interest in management tokens is driven by the hope that tokens and the protocols underlying them will become valuable. The decentralization of finance is the most important trend in cryptocurrencies at the moment, if not in the monetary world as a whole, and people are eager to be part of and potentially profit from the opportunity to influence how these projects are managed.
Isn’t management too centralized?
However, although the user management aspect of DeFi is one of the many attractive solutions that the cryptocurrency space offers compared to the closed world of traditional finance, it is not without its problems. Among them are the DeFi protocols, which have many pre-mined tokens, usually owned by the founders. For example, about 50% of COMP tokens were distributed among the founders, team and shareholders, which gave this group a huge impact on the protocol and its liquidity pools.
In such cases, when a significant part of the total token supply is held by one founder, management is actually centralized, which is not what DeFi intended. In addition, the functioning of the protocol can be jeopardized when the founders sell most of their tokens at once. For example, in September 2020, the creator of SushiSwap, Chef Nomi, sold SUSHI tokens worth about $ 13 million from the developer fund, which led to a sharp drop in the value of the token and a crisis of trust. Chief Nomi eventually returned the funds to the treasury, but caused significant damage to the image of SushiSwap.
With the passage of time and the growth of the managing ability of these DeFi tokens (as speculators hope), they may also become vulnerable to “hostile takeover” when an investor or investors buy a large number of tokens to influence the direction of development of projects. The effect of this is well known in traditional finance, where aggressive hedge funds often compete for a controlling stake in a company or fund and then pump up their operations before running out of profits and exiting the company.
Evolution of management
Some DeFi projects and platforms have responded to these problems, which are trying to find solutions to limit the negative consequences of the management token mechanism. For example, in the case of a large spending of tokens, the lender in DeFi Aave has implemented a “Security Module” in which users can lock their management tokens to receive a reward. It can also be accessed during “shortage events”.
In addition, as the DeFi protocols grow and require further development, it is likely that the founders will sell their shares to finance this work, gradually reducing their participation in these projects. Selling their shares in this way will eventually increase the value of the tokens and the protocol, which means that their interests completely coincide with the interests of all users and holders of management tokens.
The question of value is also important, as many are wondering how tokens like YFI can maintain such a high value in an ecosystem where these tokens have no intrinsic value. However, the same argument was once made about Bitcoin, and we all know how it turned out.