Detailed Instructions

Begin by analyzing the tokenomics and value accrual mechanisms of the governance token. This involves understanding its supply schedule, inflation/deflation dynamics, and the specific ways it captures value from the underlying protocol's success.

• Sub-step 1: Analyze Supply Metrics: Use on-chain explorers to examine the total supply, circulating supply, and vesting schedules for team and investor tokens. For example, check the token contract 0x1f9840a85d5aF5bf1D1762F925BDADdC4201F984 (UNI) on Etherscan.
• Sub-step 2: Model Value Accrual: Determine if value is captured via fee sharing, buybacks and burns, or staking rewards. Calculate the protocol-owned liquidity percentage and its impact on token scarcity.
• Sub-step 3: Benchmark Against Peers: Compare metrics like Market Cap/Fully Diluted Valuation (FDV) ratio and Price-to-Sales ratios with similar governance tokens in the sector.

Tip: Use tools like Token Terminal or Dune Analytics to create custom dashboards tracking these metrics over time. A sudden change in vesting unlocks can significantly impact price.

Detailed Instructions

This step quantifies the real utility of the token beyond speculation. Focus on the tangible governance rights, the proposal process, and the decentralization of decision-making power.

• Sub-step 1: Map Governance Rights: Catalog specific powers, such as voting on treasury expenditures, parameter changes (e.g., fee rates), or protocol upgrades. For instance, a proposal on Compound might look like Proposal 123: Adjust COMP distribution for USDC market.
• Sub-step 2: Analyze Voter Turnout & Concentration: Use governance platform data (e.g., Tally, Snapshot) to calculate historical voter turnout and the Gini Coefficient of token holdings among voters. A high concentration indicates risk of centralization.
• Sub-step 3: Evaluate Proposal Barriers: Determine the minimum token threshold to create a proposal and the quorum required for passage. A very high barrier can stifle community participation.

codeCopy
// Example query to find top voters for a Snapshot space
query {
  votes(
    first: 10,
    where: { space: "ens.eth" },
    orderBy: "vp",
    orderDirection: desc
  ) {
    voter
    vp
  }
}

Tip: A token with high utility but low voter turnout may be undervalued, or it may signal apathy due to ineffective governance.

Detailed Instructions

Governance tokens carry unique risks that must be stress-tested. This step involves creating models for worst-case scenarios and assessing the regulatory classification of the asset.

• Sub-step 1: Regulatory Risk Scoring: Assess the likelihood of the token being classified as a security by regulators like the SEC. Review project communications, decentralization claims, and reliance on managerial efforts.
• Sub-step 2: Smart Contract & Governance Attack Vectors: Audit the governance contract for vulnerabilities like flash loan attacks to manipulate voting. Use tools like Slither or Mythril for basic static analysis.
• Sub-step 3: Model Financial Scenarios: Create a Monte Carlo simulation to model portfolio impact under different conditions: a 50% drop in protocol revenue, a 75% drop in voter turnout, or a successful governance attack leading to treasury drain.

Tip: Always model a "rug pull" or exit scam scenario, even for established projects, by assuming a total loss of capital. This defines your absolute downside risk.

Detailed Instructions

The final step translates analysis into actionable portfolio strategy. Determine position size as a percentage of the portfolio and establish clear rules for active participation or passive holding.

• Sub-step 1: Determine Strategic Allocation: Based on the prior steps, assign a score (e.g., 1-10) and allocate capital accordingly. A core holding might be 2-5% of the portfolio, while a speculative one might be 0.5-1%. Use the Kelly Criterion for dynamic sizing: f* = (bp - q) / b, where p is win probability, q is loss probability, and b is win/loss ratio.
• Sub-step 2: Establish Hedging Mechanisms: If holding a large position, hedge using options (if available), shorting correlated assets, or holding stablecoin liquidity pools that include the token.
• Sub-step 3: Plan Governance Participation: Decide on a voting strategy (e.g., delegate to a known expert, use a voting service, or self-vote on all proposals). Automate vote tracking with alerts using a service like Boardroom.

codeCopy
# Example Python snippet for basic Kelly Criterion calculation
p = 0.55  # Probability of token price increasing
q = 1 - p
b = 2.0   # Win/Loss ratio (if win, gain 2x; if lose, lose 1x)
f_star = (b * p - q) / b
print(f"Optimal fraction of portfolio to allocate: {f_star:.2%}")

Tip: Treat governance participation as a source of potential alpha (e.g., earning airdrops, influencing profitable decisions) and factor the time cost into your investment thesis.

Detailed Instructions

Begin by conducting a deep dive into the governance token's utility. Determine if its value is derived from fee-sharing, staking rewards, or purely from voting power. A token with fee-sharing mechanisms often has a stronger fundamental value proposition than one with only governance rights. Evaluate the tokenomics model, including emission schedules, vesting periods for team/VC allocations, and inflation rates.

• Sub-step 1: Review the protocol's documentation and smart contracts to map all utility functions. For example, check if the token contract includes a distributeFees function.
• Sub-step 2: Calculate key metrics like the percentage of protocol fees directed to token holders and the annual inflation rate from new emissions.
• Sub-step 3: Analyze on-chain data for staking participation rates and voting turnout to gauge community engagement and token lock-up.

Tip: Use blockchain explorers like Etherscan to verify contract functions. For a token like UNI, you would examine the Governor Bravo contract at 0xc0da01a04c3f3e0be433606045bb7017a7323e38 to understand proposal mechanics.

Detailed Instructions

This step focuses on the technical risk inherent in the governance smart contracts and the procedural risk of the governance process itself. A vulnerability in the governor contract or a poorly designed voting system can lead to fund loss or protocol capture.

• Sub-step 1: Examine audit reports from reputable firms like OpenZeppelin or Trail of Bits. Check if findings are resolved and if the code has been verified on-chain.
• Sub-step 2: Review the governance process parameters. Identify critical values such as the proposal threshold, quorum requirement, voting delay, and voting period. For instance, a very low quorum (e.g., 2%) makes the protocol vulnerable to low-cost attacks.
• Sub-step 3: Test interaction with the contracts using a forked mainnet environment. Simulate creating a proposal to understand the flow and cost.

javascriptCopy
// Example: Checking a proposal's state on-chain using ethers.js
const governor = new ethers.Contract(GOVERNOR_ADDRESS, governorABI, provider);
const proposalState = await governor.state(proposalId);
console.log(`Proposal State: ${proposalState}`); // 0=Pending, 1=Active, etc.

Tip: Always cross-reference the live contract code on Etherscan with the audited source code to ensure no unauthorized changes have been deployed.

Detailed Instructions

Concentration risk occurs when a portfolio is overly exposed to a single governance token or a cluster of protocols sharing the same underlying technology or economic dependencies. Correlated risk arises when multiple holdings are susceptible to the same market or systemic event.

• Sub-step 1: Quantify portfolio allocation to the governance token and related liquidity positions (e.g., LP tokens in associated farms). Use a portfolio tracker like DeBank or Zapper.
• Sub-step 2: Analyze ecosystem dependencies. If the token governs a lending protocol, assess the risk of its collateral assets. A crash in a major collateral like ETH would impact the protocol's TVL and token value.
• Sub-step 3: Stress-test for black swan events. Model scenarios such as a governance attack passing a malicious proposal to drain the treasury, or a flash loan attack manipulating a vote.

Tip: Set hard limits for exposure to any single governance token (e.g., no more than 5% of the portfolio's DeFi allocation) and regularly rebalance.

Detailed Instructions

Passive holding of governance tokens is risky. Implement active monitoring of governance forums (e.g., Commonwealth, Snapshot) and on-chain voting. Simultaneously, use financial hedging to protect against price depreciation unrelated to the protocol's fundamental health.

• Sub-step 1: Set up alerts for new governance proposals, large token movements by whales or team wallets, and changes in key contract parameters. Tools like Tenderly or EigenPhi can be configured for this.
• Sub-step 2: Hedge price exposure using derivatives. For tokens on centralized exchanges, use futures or options. For DeFi-native hedging, consider using put options on platforms like Lyra or Dopex, or creating a delta-neutral position.
• Sub-step 3: Participate in governance to protect your investment. Vote on proposals that affect treasury management, fee changes, or security upgrades. Delegate voting power responsibly if you cannot vote on every proposal.

bashCopy
# Example: Using The Graph to query recent proposals for a protocol
graph query --node https://api.thegraph.com/subgraphs/name/[subgraph-name] \
'{
  proposals(first: 5, orderBy: startBlock, orderDirection: desc) {
    id
    title
    startBlock
  }
}'

Tip: Allocate a small portion of the token's value (1-2%) annually to purchasing out-of-the-money put options as an insurance policy against catastrophic failure.