Today, the constant optimization of growth in the early stages of startups has become the norm to achieve development. They forget about profitability and focus entirely on gaining strong product-market fit. It’s a tried and true strategy that has helped build some of the world’s largest web2 companies. This is alpha. The same is true for DeFi protocols.
Today, DeFi protocols are focused on acquiring users, liquidity, and whatever else it needs. And because DeFi projects control their own “money,” they can rely on neat tricks like token releases to generate short-term traction.
But is this model sustainable?
Is this usage just masked by token incentives?
Are users really willing to pay for the services provided by the protocol?
Can DeFi protocols be profitable?
In this article, Bankless analyst Ben Giove answers that question by taking a deep dive into six major DeFi protocols (Uniswap, Aave, Compound, Maker, Lido, and Maple) and assessing their path to profitability.
Which DeFi protocols are profitable in this bear market?
By Ben Giove, Bankless Analyst
A defining theme of the 2022 bear market is the growing focus on fundamentals in all directions of crypto, especially DeFi.
As prices have fallen, wanton spending habits and the lack of sustainable business models have come into focus. While many blue-chip DeFi protocols are praised for their ability to generate revenue, less attention has been paid to whether they are actually profitable.
Let’s take a look at the profitability of six market-leading blue-chip DeFi protocols, Uniswap, Aave, Compound, Maker, Maple and Lido over the past six months and dive into the broader implications.
Before starting our analysis, it is important to define what it means to be profitable for a protocol, although there has been a lack of clear consensus on this definition.
While all DeFi protocols generate revenue to compensate participants (such as lenders or liquidity providers) for the risk they take, not all protocols capture a portion of that value for themselves.
Furthermore, the main costs of generating this revenue are often rarely discussed. Like many businesses, protocols “take money to make money.” They have payouts, the biggest and most common payout being token releases.
Tokens are a very powerful tool that can be used to incentivize all types of behavior, and are most commonly used in DeFi to incentivize adoption in the form of liquidity mining.
With these concepts in mind, in our analysis, we will use the profitability definition outlined in the Talking About Fight Club article Comparing DEX Profitability.
In that paper, the authors define profitability (net income) as:
Net Income = Protocol Income – Token Release
While the authors refer to protocol revenue in the context of fees charged to token holders, we will expand this definition to cover all DAO revenue, whether they are for token holders, accumulated to local vaults, or used for any other Purpose.
Token release refers to tokens distributed to participants in the protocol, such as through liquidity mining or referral programs. This definition does not include team or investor unlocks.
While it does not cover all operating expenses, such as compensation, it does give a good indication of the profitability of the protocol that a given DAO operates.
In addition to looking at net income, we’ll discuss profitability. Profitability is a valuable metric that allows us to understand how efficient each protocol is in capturing a portion of the total revenue it generates, and will allow for more nuanced comparisons of profitability.
The two ratios we will use are “Protocol Margin” and “Profit Margin”.
Protocol margin is a measure of the acquisition rate of the protocol, or what percentage of the total revenue generated should go to the DAO. It is calculated by dividing protocol revenue by total revenue.
Metrics from the past six months (January 27 – July 27)
Maker Protocol Revenue – Source: Token Terminal
Maker generates revenue by charging borrowers interest (called a stability fee) and cutting protocol liquidations.
During the six-month period, the protocol generated $28.61 million in total revenue, all of which was attributed to the DAO. Since Maker has no token release, its protocol and profit margin are both 100%. Nonetheless, it is worth mentioning that Maker is one of the DAOs that provides insight into its operating expenses, and the protocol has managed to remain profitable.
Aave Protocol Revenue – Source: Token Terminal
Aave generates revenue by taking a cut of the interest paid to lenders on the platform.
Over the past six months, Aave’s total revenue was $101.41 million, of which $90.48 million was paid to lenders (supplier-side revenue) and $10.92 million was paid to agreements. This puts their protocol margin at 10.8%.
However, Aave paid out $74.89 million in rewards as a token release during this period, leaving the protocol with a loss of $63.96 million.
Compound Protocol Revenue – Source: Token Terminal
Compound generates revenue by reducing the interest it pays to lenders (although this is currently used to buffer protocol reserves).
Compound generated $42.31 million in revenue, of which $4.8 million accrued to the protocol. This gives them a protocol margin of 11.3%, which is 0.5% higher than Aave’s main competitor.
Despite the higher margins, Compound still lost $21.36 million in six months (though smaller than Aave).
- Maple Finance
Maple Finance Protocol Revenue – Source: Token Terminal
Maple generates revenue from origination fees collected on loans issued by delegates, the entities that manage liquidity pools on the platform. Currently, the fee is 0.99%, of which 0.66% is accrued to the protocol (distributed between the DAO vault and xMPL stakers) and the remaining 0.33% is given to the pool representative.
Maple generated $2.15 million in protocol revenue over the past six months, while paying out $25.74 million in MPL incentives to encourage deposits to various pools, which cost them $23.58 million over the period.
- Lido Finance
Lido Protocol Revenue – Source: Token Terminal
Lido generates revenue by taking 10% of the staking rewards earned by validators on the beacon chain.
In this regard, Lido generated $15.64 million in protocol revenue, while generating $48.98 million in LDO through incentivizing liquidity on exchanges like Curve and Balancer, and through the Voitum bribe and protocol referral program.
This means that LDO lost $33.34 million during the period.
potentially profitable agreement
Uniswap Supply Side Income – Source: Token Terminal
Uniswap has generated $458.5 million in revenue for liquidity providers in the past six months. However, none of this counts towards the protocol as Uniswap has yet to turn on the “fee switch” in which the DAO can earn 10-25% of LP fees for the pools that turn it on.
It’s unclear what effect the fee switch will have on Uniswap’s liquidity, as cutting fees for liquidity providers could cause them to migrate to other platforms. This could potentially worsen trade execution, thereby reducing trading volume in the highly competitive DEX industry.
Uniswap’s goal is that it has paid $0 for token releases over the past six months, making it very likely that the protocol will be profitable if they choose to turn on the fee switch.
As we can see, by our definition, MakerDAO is the only profitable one of the six protocols.
On the one hand, this is understandable. The vast majority of early-stage startups—DeFi protocols certainly qualify—are unprofitable.
In fact, the protocols listed above, and many others, simply follow the Web2 model of operating at a loss for growth, a strategy that has proven very successful for a variety of different startups and companies.
Still, issuing tokens is of course an inherently unsustainable strategy. Money is not infinite, and liquidity mining schemes are highly reflexive, losing their potency and effectiveness the longer they persist due to the perpetual sell pressure they exert on tokens being issued. Additionally, selling pressure from token issuance often deprives the protocol of its ability to capitalize itself, as DAO vaults are often denominated in the protocol’s native token.
Perhaps more worrying than the lack of profitability of these blue-chip deals is their thin profit margins.
For example, lenders such as Aave, Compound, and Maple have negotiated profit margins of just 10.8%, 11.3%, and 6.7%, respectively, meaning they receive only a fraction of the total revenue their platforms generate. Lido has an 89.9% market share in the liquid staking space, and its protocol margin is only 10%.
Given the intense competitive dynamics within DeFi, these protocols are unlikely to increase their profits significantly, otherwise they would put themselves at risk of losing market share to competitors or being forked.
To make these protocols profitable, the real solution may be to think outside the box and create more profitable revenue streams.
While this is certainly challenging, we’ve seen the earliest signs of DAOs doing this, such as Aave launching their GHO stablecoin, which will have a similar business model to Maker (with higher profit margins and not having to rely on tokens) excitation).
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/analysis-of-the-profitability-of-the-bear-market-of-the-six-blue-chip-defi-protocols-only-one-has-achieved-profitability/
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