Governance Tokens vs Utility Tokens

Introduction

Tokens play an important role in allowing decentralized environments in the fast-growing blockchain and cryptocurrency world. This article dives deeply into a basic fundamental distinction within the token realm- the difference between governance and utility tokens.

Using this article, I want to shed some light on the key features that set governance tokens and utility tokens apart. We will be looking at their respective functionality, methods, and responsibilities in decentralized systems. By the end, readers will gain a complete understanding of the purposes behind these token categories in the blockchain space. Without any further delay, let's start our journey to uncover the amazing facts about the governance and utility tokens, along with the differences they provide.

What are Governance Tokens?

Governance tokens are a special type of blockchain token that grants its holders voting rights and decision-making capabilities in decentralized networks. These tokens enable community-driven governance, where stakeholders actively participate in shaping the future of the platform. If a user acquires some governance tokens, then they get access to the decision-making process, allowing them to put their opinions on the table and contribute to the platform's future development. You can read my previous article on Governance Tokens, "What are governance tokens and how do they work in DeFi?" to get in-depth of governance tokens.

Features and Characteristics

Governance tokens provide various features.

1. Voting and Decision-making Power: One of the most important features of governance tokens is their voting power. Each token represents a vote, and the more tokens a user possesses, the more power they have on the platform's decisions in the future.
2. Staking and Governance Participation: To participate in governance, many governance tokens involve staking, in which users lock their tokens for a set length of time. Staking ensures token holders' active participation and dedication, promoting a long-term interest in the platform's success.
3. Token Holder Benefits: Holding governance tokens many times comes with additional benefits for the token holder, such as receiving additional rewards such as more tokens or access to unique platform features. Such incentives encourage token holders to participate actively in governance matters.

How are Governance Tokens managed?

Governance tokens are governed and managed by smart contracts, which are self-executing pieces of code that guarantee voting and decision-making procedures are executed smoothly and openly. Smart contracts automate governance mechanisms, making them secure and tamper-resistant.

Compounds (COMP), Uniswap's (UNI), and MakerDAO's (MKR) are some famous examples of governance tokens. These tokens have helped to shape their respective protocols and communities.

How to create an on-chain Governance Tokens?

Creating an on-chain governance token involves a series of technical steps and considerations to ensure that the token functions as intended within the decentralized network. Some important aspects to consider when creating a governance token are as follows -

1. Choosing the Blockchain Platform: The first step is to select the appropriate blockchain platform where governance toke is to be created.
2. Smart Contract Development: Developers need to design the smart contract to include the governance mechanisms, voting, and decision-making processes.
3. Define Voting Mechanism: The voting mechanisms are the core of on-chain governance tokens. Token holders should be able to cast votes on proposed protocol upgrades, parameter adjustments, or other significant decisions. Different voting models, such as simple majority voting or quadratic voting, can be implemented based on the specific needs of the platform.
4. Token Distribution and Staking: Deciding how the governance tokens will be distributed among users is crucial.
5. Security and Auditing: Conducting thorough security audits and testing the smart contract for potential exploits is essential to safeguard the token and its users.
6. Community Engagement and Governance Reputation: Building a strong community around the governance token is vital for its success.
7. Governance Interface: A well-designed interface should allow users to view proposals, cast votes, and track the progress of ongoing governance processes.

It is important to consider these aspects during the creation of on-chain governance tokens.

Developing smart contracts for Governance Tokens

Creating smart contracts for Governance tokens is a crucial part of the process of governance token creation. One must follow correct token standards and practices when creating governance tokens. To create a governance token contract, you can use openZeppelin, which facilitates smart contract creation for tokens following various token standards on Ethereum and Ethereum similar chains like Polygon.

To create a governance token smart contract.

Visit the open zeppelin home page > contracts > select ERC20 token standard

Now provide a name and symbol for the token and check the boxes permit and votes.

Open the contract in Remix IDE and deploy it. After opening the contract in Remix IDE, it will contain the following code -

// SPDX-License-Identifier: MIT
pragma solidity ^0.8.9;

import "@openzeppelin/contracts/token/ERC20/ERC20.sol";
import "@openzeppelin/contracts/token/ERC20/extensions/ERC20Permit.sol";
import "@openzeppelin/contracts/token/ERC20/extensions/ERC20Votes.sol";

contract GovernanceToken is ERC20, ERC20Permit, ERC20Votes {
    constructor() ERC20("GovernanceToken", "GTK") ERC20Permit("GovernanceToken") {
        _mint(msg.sender, 100000000 * 10 ** decimals());
    }

    // The following functions are overrides required by Solidity.

    function _afterTokenTransfer(address from, address to, uint256 amount)
        internal
        override(ERC20, ERC20Votes)
    {
        super._afterTokenTransfer(from, to, amount);
    }

    function _mint(address to, uint256 amount)
        internal
        override(ERC20, ERC20Votes)
    {
        super._mint(to, amount);
    }

    function _burn(address account, uint256 amount)
        internal
        override(ERC20, ERC20Votes)
    {
        super._burn(account, amount);
    }
}

This contract will create an ERC 20 token with voting rights.

After deploying the ERC20 token contract, the next step is to deploy the Governor contract. In the same open Zeppelin contract page, now select Governor

Opening the contract in Remix will make the contract look something like this -

// SPDX-License-Identifier: MIT
pragma solidity ^0.8.9;

import "@openzeppelin/contracts/governance/Governor.sol";
import "@openzeppelin/contracts/governance/extensions/GovernorSettings.sol";
import "@openzeppelin/contracts/governance/extensions/GovernorCountingSimple.sol";
import "@openzeppelin/contracts/governance/extensions/GovernorVotes.sol";
import "@openzeppelin/contracts/governance/extensions/GovernorVotesQuorumFraction.sol";
import "@openzeppelin/contracts/governance/extensions/GovernorTimelockControl.sol";

contract MyGovernor is Governor, GovernorSettings, GovernorCountingSimple, GovernorVotes, GovernorVotesQuorumFraction, GovernorTimelockControl
{
    constructor(IVotes _token, TimelockController _timelock)
        Governor("MyGovernor")
        GovernorSettings(
            7200, /* 1 day */
            50400, /* 1 week */
            0
        )
        GovernorVotes(_token)
        GovernorVotesQuorumFraction(4)
        GovernorTimelockControl(_timelock)
    {}

    // The following functions are overrides required by Solidity.

    function votingDelay() public view override(IGovernor, GovernorSettings) returns (uint256)
    {
        return super.votingDelay();
    }

    function votingPeriod() public view override(IGovernor, GovernorSettings) returns (uint256)
    {
        return super.votingPeriod();
    }

    function quorum(uint256 blockNumber) public view override(IGovernor, GovernorVotesQuorumFraction) returns (uint256)
    {
        return super.quorum(blockNumber);
    }

    function state(uint256 proposalId) public view override(Governor, GovernorTimelockControl) returns (ProposalState)
    {
        return super.state(proposalId);
    }

    function propose(address[] memory targets, uint256[] memory values, bytes[] memory calldatas, string memory description) 
    public override(Governor, IGovernor) returns (uint256) {
        return super.propose(targets, values, calldatas, description);
    }

    function proposalThreshold() public view override(Governor, GovernorSettings) returns (uint256)
    {
        return super.proposalThreshold();
    }

    function _execute(uint256 proposalId, address[] memory targets, uint256[] memory values, bytes[] memory calldatas, bytes32 descriptionHash) 
    internal override(Governor, GovernorTimelockControl) {
        super._execute(proposalId, targets, values, calldatas, descriptionHash);
    }

    function _cancel(address[] memory targets, uint256[] memory values, bytes[] memory calldatas, bytes32 descriptionHash) 
    internal override(Governor, GovernorTimelockControl) returns (uint256) {
        return super._cancel(targets, values, calldatas, descriptionHash);
    }

    function _executor() internal view override(Governor, GovernorTimelockControl) returns (address)
    {
        return super._executor();
    }

    function supportsInterface(bytes4 interfaceId) public view override(Governor, GovernorTimelockControl) returns (bool)
    {
        return super.supportsInterface(interfaceId);
    }
}

Deploy this smart contract and, during the deployment, provide the token name and symbol on which the governance rights are present. Now you are ready with the smart contract for the governance token.

Difficulties while creating Governance Tokens

Governance tokens do come with a lot of features, including providing voting power, staking, and additional benefits to token holders. However, creating a governance token is not that easy. If you are thinking of creating a governance token, then you should know the difficulties that could come across when creating them. The difficulties faced when creating governance tokens are -

1. Regularity Considerations: Creating governance tokens requires careful consideration of regularity systems. Token issuers must manage legal complications in order to maintain accordance with developing rules, which may be difficult given the volatile nature of the blockchain industry.
2. Community Trust and Governance Reputation: Creating governance tokens also requires solid community trust and a robust governance reputation. To attract and keep active participants, token projects must support open communication, transparency, and a good track record of responsible decision-making.

What are Utility Tokens?

Utility tokens are a type of blockchain token that is used to perform specific tasks inside decentralized platforms or ecosystems. Utility tokens are also referred to as application tokens or user tokens. Unlike governance tokens, the primary functionality of utility tokens is to provide access to specific features or services of that particular blockchain platform. They may act as a payment medium or offer unique benefits and features to token holders. There can be a dApp where holding a specific amount of utility tokens allows its users to use the dApp services.

Features and Characteristics

Utility tokens have various features.

1. Token as Access Rights: Utility tokens are often used as access keys, providing users access to various features or services inside a decentralized application. These tokens allow for smooth interactions and encourage users to participate and engage with the platform.
2. Token as a Payment Medium: One of the most important features of utility tokens is their ability to be used as a method of payment inside the platform's ecosystem. Users may use these tokens to pay for products, services, or transactions, increasing the platform's usefulness and value.
3. Token for Platform Services and Products: Utility tokens can give special benefits or discounts for certain platform services or products. These rewards encourage token holders to utilize the platform and help it expand.

How are Utility Tokens managed?

Utility tokens use smart contracts to ensure their functionality. These smart contracts handle the token transfer, track ownership, and provide various platform interfaces, providing safe and secure transactions.

Some of the famous examples of utility tokens include the Ethereum gas token, which is used in the Ethereum network to pay for transaction fees, Binance Coin, which is used inside the Binance cryptocurrency exchange to pay for the trading fees and BAT (Basic Attention Token) which awards users for engaging with ads in the Brave browser.

How to create Utility tokens?

Developing a utility token involves technical expertise and considerations to ensure its seamless integration into a decentralized platform. The essential steps for creating an on-chain utility token are as follows -

1. Choose the Blockchain Platform: Select a suitable blockchain platform like Ethereum, Binance Smart Chain, or others that align with the specific requirements of the utility token. Consider factors like transaction speed, security, and existing user base on the platform.
2. Smart Contract Development: Like governance tokens, utility tokens are also implemented as smart contracts. Develop a smart contract that defines the utility token's functionalities.
3. Token Distribution and Supply: Decide on the total supply of utility tokens and how they will be distributed. Depending on the platform's needs, utility tokens can be distributed through token sales, initial coin offerings (ICOs), airdrops, or other distribution mechanisms.
4. Token Utility and Features: Clearly outline the specific utility of the token within the platform. For example, the utility token might act as a payment medium for services, grant access to exclusive features, or provide rewards for user engagement. Ensure that the utility token aligns with the platform's objectives.
5. Integration with Platform: Develop interfaces and integrate the utility token into the platform's ecosystem. This involves ensuring that users can seamlessly use the token for various functions within the decentralized application (dApp).
6. Security and Auditing: Conduct comprehensive security audits and testing to identify and fix vulnerabilities. Security loopholes can lead to potential token theft or unauthorized access to platform services.
7. Compliance and Legal Considerations: Address regulatory compliance to ensure the utility token's classification and functionality align with applicable laws and regulations in the target jurisdictions.
8. User Experience: Focus on creating a user-friendly experience for token holders.
9. Tokenomics and Economic Model: Develop a sound tokenomics model to ensure the utility token's stability and value proposition. Consider factors like token burning, inflation, and token utility in shaping the token's economic model.
10. Continuous Development and Community Engagement: Continuously improve the utility token based on user feedback and emerging trends. Engage with the community to ensure ongoing support and adoption.

Developing smart contracts for Utility Token

Developing smart contracts for utility tokens is one of the important steps involving utility token creation. To write a smart contract for utility tokens, we will be using openZeppelin as we used it during the time of governance token creation.

To write the smart contract for the Utility token for Ethereum and similar networks like Polygon, visit the openZeppelin home page > navigate to contracts > select ERC1155 standard

The utility token is based on the ERC1155 token standard. When we open this with Remix IDE, it will look something like this.

// SPDX-License-Identifier: MIT
pragma solidity ^0.8.9;

import "@openzeppelin/contracts/token/ERC1155/ERC1155.sol";
import "@openzeppelin/contracts/access/Ownable.sol";
import "@openzeppelin/contracts/token/ERC1155/extensions/ERC1155Burnable.sol";

contract UtilityToken is ERC1155, Ownable, ERC1155Burnable {
    constructor() ERC1155("") {}

    function setURI(string memory newuri) public onlyOwner {
        _setURI(newuri);
    }

    function mint(address account, uint256 id, uint256 amount, bytes memory data)
        public
        onlyOwner
    {
        _mint(account, id, amount, data);
    }

    function mintBatch(address to, uint256[] memory ids, uint256[] memory amounts, bytes memory data)
        public
        onlyOwner
    {
        _mintBatch(to, ids, amounts, data);
    }
}

Deploy this contract on the blockchain network, and now you are ready with your own utility token smart contract

Difficulties while creating Utility Tokens

Utility tokens have been recognized as advantageous tools for earning profits and gaining funding for new emerging projects. But as advantageous and recognizable as the utility tokens may be, there are still some difficulties when creating them. Difficulties that can come across during the creation of the utility tokens are as follows -

1. Compliance and Legal Framework: The creation of utility tokens requires careful consideration of regulatory compliance. Token issuers must navigate the legal framework in order to verify that the token's classification fits its intended purpose and agrees with applicable rules.
2. Development complexity and integration: Creating utility tokens involves technical complexities in designing smart contracts that govern token functionality effectively. To provide smooth interactions and user experiences, the integration of utility tokens into the platform's ecosystem requires solid planning.

Comparing Governance and Utility Tokens

Governance tokens enable community-driven governance by providing a stake in the network, while utility tokens are application tokens allowing users to use a specific feature of the network. Both Governance and Utility tokens are important for a network as they both influence the platform's growth that they are a part of. Considering both of them as blockchain tokens, both the governance and utility tokens share many similarities and differences. Let's discuss some important similarities that are shared by these tokens.

Similarities between Governance Tokens and Utility Tokens

1. Types of Blockchain tokens: Governance tokens and utility tokens are both built on blockchain technology and are types of blockchain tokens representing digital assets within decentralized ecosystems.
2. Decentralized Ecosystem: Both token types play integral roles within decentralized platforms, contributing to their governance, functionality, and overall ecosystem development.
3. Smart Contract Based: Both governance and utility tokens are governed and made by smart contracts.
4. Token Utility: Both tokens serve specific purposes and functions within their respective platforms. Governance tokens enable voting and decision-making, while utility tokens provide access to services, act as payment mediums, or offer rewards.
5. Influence Platform's Growth: Both the governance and utility tokens contribute to the growth and development of the decentralized platforms they are built.
6. Importance of Security: Security is extremely crucial for both governance as well as utility tokens, as vulnerabilities in smart contracts or attacks can impact token holders and the platform's integrity.

After finding out about the similarities both the tokens share, you must be wondering What are the differences between Governance and Utility Tokens? Well, both the governance as well as utility tokens share a lot of dissimilarities or differences among themselves. Some of the key differences between governance and utility tokens are as follows -

Governance Tokens vs. Utility Tokens
 

Criteria	Governance Token	Utility Token
Purpose and Use Cases	They enable voting and decision-making in DAOs and protocols.	Provide access to platform services and products, act as a payment medium, and offer rewards for user engagement.
Expecting Value	The value is closely tied to the platform's success, the effectiveness of decision-making, and the distribution of voting power.	Value depends on the demand for the platform's services, token supply, and the platform's overall utility.
Total Supply	Governance tokens often are scarce due to the distribution of voting power.	Total Supply varies depending on the use cases and platform's demand.
Token Distribution	Have different distribution mechanisms like token sales, airdrops, or liquidity mining.	Often distributed through token sales, initial coin offerings (ICOs), or a fair distribution model.
Benefits to Token Holders	Governance rewards, voting incentives, and token-based staking rewards.	Access to platform services, discounts, and loyalty rewards.
Security and Risk	Vulnerable to attacks on governance process and decision making.	Vulnerable to smart contract risks, token theft, and unauthorized access to platform services.
Examples	COMP(Compound), UNI (Uniswap's), MKR (MakersDAO's), etc.	ETH (Etherem's Ether), BAT (Basic Attention Token), LINK (Chainlink), etc.

Conclusion

In conclusion, governance tokens and utility tokens represent two essential pillars within the decentralized blockchain world, each serving its distinct purpose and functionality. Understanding the similarities and distinctions between governance and utility tokens is important to move forward in the blockchain space efficiently. As the blockchain world continues to evolve, these tokens will continue to play their crucial roles in influencing blockchain platforms and motivating users to participate in the network.

Overall, by grasping the unique features and roles of both token types, investors, developers, and enthusiasts can make educated judgments and contribute to the growing world of blockchain and cryptocurrency.

FAQ's

Q. What are governance tokens, and how do they work?

A. Governance tokens are a specialized type of blockchain token that grants voting rights and decision-making capabilities to token holders in decentralized networks. Holders of governance tokens can participate in shaping the platform's future by voting on protocol upgrades, parameter adjustments, and other key decisions. The more governance tokens a user holds, the more voting power they possess.

Q. How do utility tokens differ from governance tokens?

A. Utility tokens and governance tokens have distinct purposes within decentralized ecosystems. While governance tokens enable voting and decision-making, utility tokens provide access to platform services and act as a payment medium. Utility tokens are primarily used to interact with specific features or services of a blockchain platform, whereas governance tokens facilitate community-driven governance.

Q. What factors influence the value of governance tokens and utility tokens?

A. The value of governance tokens is influenced by the success of the platform, the effectiveness of decision-making, and the distribution of voting power among token holders. On the other hand, utility token value is driven by the demand for platform services, token supply, and the overall utility provided by the platform.

Q. Can you provide examples of popular governance tokens and utility tokens?

A. Examples of popular governance tokens include Compound's COMP, Uniswap's UNI, and MakerDAO's MKR. These tokens have played significant roles in shaping the governance and development of their respective platforms. For utility tokens, some well-known examples include Binance Coin (BNB), Ethereum's Ether (ETH), and BAT (Basic Attention Token), which are widely used for accessing services and making payments within their respective ecosystems.

Q. What are the main challenges in creating governance tokens and utility tokens?

A. Creating governance tokens requires careful consideration of regulatory compliance and building community trust. Token issuers must navigate the legal landscape to ensure compliance with evolving regulations, and they need a solid governance reputation to attract and retain active participants. Whereas developing utility tokens involves technical complexities in designing smart contracts to govern token functionality effectively. Integrating utility tokens into the platform's ecosystem requires meticulous planning to ensure seamless interactions and user experiences.