Which DeFi protocols have achieved profitability in this bear market?

Optimizing growth in the early stages of startups is now the norm for achieving growth.

They forget about profitability and focus entirely on achieving strong product market fit.

It's a tried and tested strategy that has helped build some of the largest web2 companies in the world.

This is alpha. The same is true for DeFi protocols.

Today, a DeFi protocol is focused on acquiring users, liquidity, and whatever else it needs. And because DeFi projects control their own "money," they can rely on clever tricks like token releases to generate short-term appeal.

But is this model sustainable?

Is this usage just overshadowed by token incentives?

Are users really willing to pay for the services provided by the protocol?

Can the DeFi protocol be profitable?

In this post, Bankless analyst Ben Giove answers that question by taking a deep dive into six of the top DeFi protocols (Uniswap, Aave, Compound, Maker, Lido, and Maple) and assessing their path to profitability.

Which DeFi protocols have achieved profitability in this bear market?

introduce

A defining theme of the 2022 bear market is the growing focus on fundamentals in all directions of crypto, especially DeFi.

Reckless spending habits and a lack of sustainable business models have come into focus as prices have fallen. While many blue-chip DeFi protocols have been lauded 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 wider implications.

Define Profitability

Before starting our analysis, it is important to define what it means for a protocol to be profitable, but 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 some of that value for themselves.

Furthermore, the main costs of generating such revenue are often seldom discussed. Like many businesses, the protocol "costs money to make money". They have payouts, the largest 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 the Profitability of DEXs".

In the article, the authors define profitability (net income) as:

Net income = Protocol income - Token release

While the authors refer to protocol revenues where fees are charged to token holders, we will expand this definition to cover all DAO revenues, whether they are directed at token holders, accrued to local vaults, or used for any other purpose.

Token release refers to tokens allocated to participants in the protocol, such as through liquidity mining or referral programs. This definition does not include team or investor unlocks.

While it doesn't cover all operating expenses, such as compensation, it does provide a good indication of the profitability of the protocol given the DAO's operations.

Profitability

In addition to looking at net income, we'll also discuss profitability. Profitability is a valuable metric that allows us to understand how efficiently each protocol captures a portion of the total revenue it generates, and will allow for more nuanced comparisons of profitability.

The two ratios we will use are the "Margin of Agreement" and the "Margin of Profit".

The protocol bond is a measure of the protocol’s take rate, or what percentage of the total revenue generated should go to the DAO. It is calculated by dividing agreement revenue by total revenue.

result table

Metrics are from the past six months (January 27th - July 27th)

A Profitable Agreement

Maker

Maker Protocol Revenue - Source: Token Terminal

Maker generates income by charging borrowers interest (called a stability fee) and by cutting protocol liquidations.

During the six-month period, the protocol generated $28.61 million in gross revenue, all of which went to the DAO. Since Maker has no Token release, its agreement and profit rate are both 100%. Nonetheless, it’s worth mentioning that Maker is one of the DAOs that provides insight into its operating expenses, and the protocol has managed to remain profitable.

unprofitable agreement

Aave

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 (supply-side revenue) and $10.92 million was paid to protocols. This puts their agreement margin at 10.8%.

However, Aave paid out $74.89 million in rewards for token release during this period, making the protocol a loss of $63.96 million.

compound

Compound Protocol Revenue - Source: Token Terminal

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Compound generates income by reducing interest payments to lenders (although this is currently used to buffer protocol reserves).

Compound generated $42.31 million in revenue, of which $4.8 million was accrued to the protocol. This gives them a protocol margin of 11.3%, 0.5% higher than Aave's main competitor.

Despite higher margins, Compound still posted a loss of $21.36 million over six months (though smaller than Aave).

Maple Finance

Maple Finance Protocol Income - Source: Token Terminal‌

Maple generates revenue from origination fees collected on loans made by pool delegates, the entities that manage liquidity pools on the platform. Currently, the fee is 0.99%, with 0.66% accruing to the protocol (distributed between the DAO treasury and xMPL stakers), and the remaining 0.33% going to pool representatives.

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 into various pools, which cost them $23.58 million over the period.

Lido Finance

Lido Protocol Revenue - Source: Token Terminal

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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 incentivized liquidity on trading platforms such as Curve and Balancer, and through the Voitum bribery and protocol referral program.

This means that LDO lost $33.34 million during the period.

potentially profitable agreement

Uniswap

Uniswap Supply Side Income - Source: Token Terminal

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Uniswap generated $458.5 million in revenue for liquidity providers in the past six months. However, none of this is factored into the protocol, as Uniswap has yet to turn on the "fee switch" in which the DAO can earn 10-25% LP fees for the pools that open it.

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 worsen trade execution, reducing trading volume in the highly competitive DEX industry.

Uniswap's goal is that it paid $0 for token releases in the past six months, making it very likely that the protocol would be profitable if they chose to flip the fee switch.

Summarize

As we can see, MakerDAO is the only one of the six protocols that is profitable by our definition.

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 to fuel growth, a strategy that has proven to be very successful for a variety of different startups and corporations.

Nonetheless, issuing tokens is of course an inherently unsustainable strategy. Money is not infinite, and yield mining schemes are highly reflexive, losing their potency and validity the longer they last due to the perpetual sell pressure they exert on the tokens being issued. Additionally, selling pressure from token issuance often deprives the protocol of its ability to capitalize itself, as DAO treasuries are typically denominated in the protocol's native token.

Perhaps more worrisome 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 protocol margins of just 10.8%, 11.3%, and 6.7%, respectively, meaning they only receive a fraction of the total revenue generated by their platforms. 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 significantly increase their profits, or they would expose themselves to the 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 higher-margin revenue streams.

While this is certainly challenging, we have 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 token incentives) .