Today, we’re diving into the valuation models and revenue analysis of decentralized finance (DeFi) protocols on Ethereum.
For this week’s New Frontiers section, CoinDesk Research’s Teddy Oosterbaan presents his findings on the most profitable types of DeFi applications in terms of return for liquidity providers, token holders and protocol treasuries.
This article originally appeared in Valid Points, CoinDesk's weekly newsletter breaking down Ethereum 2.0 and its sweeping impact on crypto markets. Subscribe to Valid Points here.
Pulse check
We’re excited to introduce new and improved graphics for our weekly pulse check on the Ethereum 2.0 Beacon Chain and CoinDesk’s Eth 2.0 validator. Moving forward, two graphics will replace our usual stream-of-consciousness writing in this section and give you a quick overview of activity on Eth 2.0 over the past week.
The first graphic above illustrates the overall health of the Eth 2.0 blockchain through four metrics, including network participation rate, number of validators, total ETH deposited and share of total ETH supply deposited. Generally, the higher these numbers are, the greater the overall security and value of the Eth 2.0 Beacon Chain.
The second graphic above illustrates the overall health of the CoinDesk Eth 2.0 validator dubbed “Zelda.”
Zelda has been an active participant of the network since Feb. 17. She has submitted 34,525 attestations, which are votes confirming the validity of data on the blockchain, and proposed four blocks. Rewards from attestations make up the bulk of Zelda’s daily income as a validator. However, during the rare days when Zelda is tasked with the responsibility of a block proposal, daily income can increase by up to 67% from the norm.
In the weeks to come, the daily income chart featured in our second graphic will illustrate fluctuations in Zelda’s earnings as a result of her on-chain activity.
Disclaimer: All profits made from CoinDesk’s Eth 2.0 staking venture will be donated to a charity of the company’s choosing once transfers are enabled on the network.
New frontiers: Profitability of DEXs and DeFi applications
Among DeFi applications, decentralized exchanges (DEXs) are the most profitable in terms of return for liquidity providers, token holders and protocol treasuries.
The DeFi landscape can be broken down into three broad categories – lending, trading and asset management. These finance-focused applications generate revenue in a similar way to their traditional counterparts, like commercial banks, exchanges and hedge funds. However, by automating financial services with smart contracts and removing the large amount of human capital traditional firms require, DeFi applications can return a greater portion of their revenue to their users.
As of July 18, the market capitalization of DeFi tokens was about $60 billion. Some of the top DeFi protocols by market capitalization, such as Compound, Uniswap and Aave, have generated a combined annual core business revenue of over $1.3 billion in the last year. According to DeFi Llama, these three projects are responsible for around 20% of “Total Value Locked” (TVL) in DeFi. TVL is a metric that captures the idle capital locked in a DeFi protocol, which can be used to borrow or to trade against, or to do both.
Using blockchain data for DeFi revenue analysis
The transparency of blockchains allows for the auditing of every on-chain transaction. Token Terminal uses blockchain data to better understand exactly what each DeFi protocol is doing with the assets they manage and how profitable their strategies are.
Revenue data from Token Terminal is limited to the core business revenue stream of each DeFi protocol and doesn’t capture revenue from other business streams. Marc Zeller, the integrations lead at Aave, told CoinDesk in an interview that beyond revenue generated from Aave’s core business of crypto lending, the protocol has generated roughly roughly $105,000 in fees from flash loans, $234,000 from liquidations and $5.2 million in Aave and Matic liquidity mining incentives since Tuesday, July 13.
For the purposes of revenue analysis in this article, we’ll also limit data to the core business stream of each DeFi protocol. By comparing the core business revenue of DeFi protocols, we can compare the performance of DeFi categories as a whole and see how these decentralized applications match up to their competitors. This type of comparable analysis can also help investors decide which DeFi assets are overvalued and which are undervalued, relative to the market.
Here is a list of definitions and assumptions we used in our revenue analysis:
- Revenue is the total monetary value returned to token holders, liquidity providers and the protocol treasury from *only* the core business revenue (i.e. trading fees for decentralized exchanges, borrow interest for decentralized lending protocols).
- Earnings is strictly the share of revenue that goes to token holders and the protocol treasury.
- Total Value Locked (TVL) is the difference between the total amount deposited and the total amount borrowed from the protocol.
- Adjusted Total Value Locked (aTVL) is the total amount deposited into a protocol.
Data for these metrics were aggregated from Token Terminal, DeFi Llama, DeFi Pulse and various other DeFi protocol dashboards such as Compound and Aave.
DEXs versus decentralized lending platforms
The most direct multiples for measuring asset efficiency are Revenue / Adjusted Total Value Locked and Earnings / Adjusted Total Value Locked. The first metric measures the return on assets for all parties, including liquidity providers, token holders and the protocol treasury. The second metric shows cash flow to the protocol alone, which is dependent on the DeFi protocol’s fee structure.
Using Revenue / aTVL to measure return on assets (ROA), Uniswap and SushiSwap, both popular DEXs on Ethereum, are sitting at 29% and 20%, respectively. Aave and Compound fall below, coming in at 2% and 2.7% at the time of writing.
Similar to traditional finance, ROA differs significantly between industries and does not fully encompass a protocol’s success. Furthermore, because the ROA calculated in our model uses revenue only from the core business of each protocol, the resulting figure could vary if other revenue streams were added.
Even so, ROA metrics within DeFi help visualize the return all stakeholders in the platform have historically received. Using data from the past 180 days annualized, we can see that DEXs are generally the most productive with the assets they have under management and that lending platforms require more capital to generate the same amount of revenue.
Speaking to these results, Henri Hyvärinen, CEO of Token Terminal, noted that dividend distribution models for DEXs and other DeFi protocols are still in their early stages of development.
“The dividend distributions in the [DeFi] crypto market are a bit premature. Most of the protocols are still akin to early stage startups, where the focus should be on reinvesting the money into growth,” Hyvärinen said in an email to CoinDesk.
Validated takes
- Anthony Di Iorio, one of the eight co-founders of Ethereum, plans to sell his blockchain software company Decentral Inc. and focus on other business ventures not related to cryptocurrencies. BACKGROUND: Di Iorio is looking to leave the crypto industry over concerns for his personal safety. He also mentioned that he wanted to focus on “larger problems,” stating that cryptocurrencies and blockchain technology are only “a small percentage of what the world needs.” (Article, Bloomberg)
- After months of parabolic growth, the supply of dollar-backed stablecoin tether (USDT) has suddenly stopped climbing. BACKGROUND: Since the end of May, the market capitalization of USDT has stayed constant at just over $63 billion, while tether’s largest competitor, USDC, has shown modest supply growth from $22 billion to $26 billion over the same time period. One possible reason for the lack of supply growth in USDT is mounting user mistrust over the token’s reserve composition. (Article, CoinDesk)
- Long-standing cryptocurrency management platform Shapeshift is executing a radical plan to fully decentralize its operations. BACKGROUND: In efforts to convert the company into a decentralized autonomous organization (DAO) run by token holders, Shapeshift is airdropping 340 million FOX governance tokens to past ShapeShift users and several well-known decentralized finance protocols, including Uniswap and Yearn. (Article, CoinDesk)
- The Maker Foundation responsible for guiding the development of the original Ethereum DeFi application. MakerDAO has announced it too will soon shut down in efforts to fully decentralize its operations. BACKGROUND: Rune Christensen, the founder of MakerDAO, said in a blog post that the foundation will dissolve “within the next few months” as part of a plan to put more power back in the hands of MakerDAO token holders. (Article, CoinDesk)
- Ethereum is gearing up for a backward-incompatible upgrade, also called a hard fork, in early August. BACKGROUND: Recently published community resources to help prepare users and dapps for the hard fork, dubbed London, include a countdown clock and an informative data visualization. (Blog post, Ethereum Foundation)
- Ethereum Classic, a version of Ethereum created in 2016, is preparing for a hard fork this Friday. BACKGROUND: The hard fork, code named Magneto, is aimed at enabling greater compatibility with the Ethereum network by mimicking some of the code changes rolled out on Ethereum back in April. (Blog post, Etherplan)
Factoid of the week
Open comms
Valid Points incorporates information and data from CoinDesk’s own Eth 2.0 validator in weekly analysis. All profits made from this staking venture will be donated to a charity of our choosing once transfers are enabled on the network. For a full overview of the project, check out our announcement post.
You can verify the activity of the CoinDesk Eth 2.0 validator in real time through our public validator key, which is:
0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.
Search for it on any Eth 2.0 block explorer site!
New episodes of “Mapping Out Eth 2.0.” with Christine Kim and Consensys’ Ben Edgington air every Thursday. Listen and subscribe through the CoinDesk podcast feed on Apple Podcasts, Spotify, Pocketcasts, Google Podcasts, Castbox, Stitcher, RadioPublica, IHeartRadio or RSS.