Author: @Kairos_Res
Translation: Blockchain in Vernacular
The following report aims to explore some of the most influential DeFi protocols from a financial perspective, including a brief technical overview of each protocol, as well as an in-depth analysis of its revenue, expenditure, and token economics . Since we do not have access to audited financial statements, we use on-chain data, open source reports, governance forums, and conversations with project teams to estimate the full-year financial reports of Aave, Maker (Sky), Lido, and ether.fi.
The table below presents the most important findings from our research, providing readers with a high-level overview of each protocol’s current status. While revenue multiples are a common way to judge overvaluation and undervaluation, key considerations around dilution, new product pipelines, and future revenue potential tell a more complete story.
The DAI savings rate is factored into the cost of revenue, but the Aave security module is not.
Token incentives from ether.fi are not included as they are in the form of airdrops.
This is a very rough estimate using growth rates, interest rates, Ethereum price increases and profit margin estimates for new products (GHO, Cash, etc.) and should not be considered investment advice.
Aave is currently considering redesigning the token economics to include AAVE buybacks and distributions.
Through our analysis, we conclude that multiple protocols are undergoing a transition to sustainable profitability, a process that is ongoing after years of liquidity bootstrapping and barrier building. Aave appears to have reached an inflection point, achieving profitability for the first time and rapidly launching a new high-profit lending product in GHO. ether.fi is still in its early stages, but its TVL has exceeded $6 billion, placing it among the top five protocols. The liquidity re-pledge leader has also learned some of Lido’s shortcomings and launched a series of other high-profit ancillary products to maximize the use of their billions in deposits. Read the full report to better understand our calculations, estimates, and the efforts of various communities to drive the value of their protocols.
1. Problem Statement and Definition
Since the rise of DeFi in 2020 , on-chain data and analytics have continued to improve, and platforms such as Dune, Nansen, DefiLlama, TokenTerminal, and Steakhouse Financial have played a key role in creating real-time dashboards for crypto protocols. At Kairos Research, we believe that driving standardization within the industry is an important part of increasing credibility so that financial performance, health, and sustainability can be demonstrated. Profitability is often overlooked in the crypto space, but value creation is the only way to sustainably align the various participants in a protocol (users, developers, governance, and community).
Below are some definitions that we will use in our research and financial statements to standardize similar costs across agreements.
Gross Revenue/Expenses: This includes all revenue generated by the protocol, belonging to the users of the protocol and the protocol itself.
Take Rate: The percentage of fees the protocol charges its users. Net Profit : The revenue left for the protocol after paying protocol users and taking into account revenue costs. Operating Expenses : A broad range of protocol expenses, including payroll, contractors, legal and accounting, audits, gas costs, grants, and potentially token incentives. Net Operating Income: The bottom-line dollar figure after deducting all costs incurred by the protocol and token holders, including token incentives related to protocol operations. Adjusted Earnings : One-time expenses are added to earnings to more accurately project future earnings, minus known future costs that are not currently represented through earnings.
2. Protocol Introduction
In this report, we will provide a high-level analysis of the core products of each of the focused protocols, which are selected from the most influential protocols in various crypto sub-sectors.
1) Aave
In short, Aave is a “decentralized, non-custodial liquidity protocol where users can participate as suppliers, borrowers, or liquidators. ” Suppliers deposit crypto assets to earn a lending yield and increase their borrowing power so they can leverage or hedge their deposited positions. Borrowers can be overcollateralized users seeking leverage and hedging, or arbitrage traders leveraging atomic flash loan. In order to borrow against crypto collateral, Aave users must pay a fixed or floating interest rate on a specific asset . Aave’s protocol fee is the total interest paid on open (unrealized), closed, or liquidated positions, which is then split between lenders/suppliers (90%) and the Aave DAO Treasury (10%). Additionally, when a position exceeds its specified loan-to-value maximum, Aave will allow “liquidators” to close the position by assuming collateral risk and paying off the remaining debt.
Each asset has its own liquidation penalty, which is also split between liquidators (90%) and the Aave DAO Treasury (10%). A new product offered by Aave is an overcollateralized crypto-backed stablecoin called GHO. The introduction of GHO enables Aave to provide loans without the need for a stablecoin provider on the other side of the transaction, giving them more flexibility in interest rates while being able to cut out intermediaries and earn 100% of the borrowing interest on any outstanding GHO loans.
Aave transparently displays all of the DAO ’s revenue, expenses, and current operational data via the TokenLogic dashboard. We were able to extract the “Treasury Income” data from August 1st to September 12th and apply a multiplier to annualize it, resulting in a net income of $89.4 million. To calculate the total revenue, or gross revenue, we relied on TokenTerminal’s income statement data to estimate profit margins, as Aave’s revenue structure is no longer a simple 90%/10% but is more complex due to the allocation between the traditional lending market, liquidations, and GHO lending. Our 2025 forecast is based primarily on a few assumptions, including a relative upward trend in crypto asset prices, which will increase borrowing capacity. In addition, Aave’s net profit margin in our model is also improved due to the expected shift in borrowing to GHO rather than third-party stablecoins and improvements to the protocol’s security module, which will be further explained later.
Crypto’s leading lending market is expected to see its first profitable year in 2024 as supplier incentives have been reduced while active lending continues to grow, with active borrowing now exceeding $6 billion. Aave is clearly a significant beneficiary of the liquid staking and re-staking market, where users deposit Liquid Stamp Tokens (LST)/Liquid Stamp Receipts (LRT), borrow Ethereum, and then convert Ethereum to Liquid Stamp Tokens, and repeat the process. This is called a round-robin operation, and it allows Aave users to generate a net interest spread (the annualized yield on Liquid Stamp Token/LRT deposits minus Aave’s borrowing interest) without taking on significant price risk.
As of September 12, 2024, Ethereum is Aave's largest outstanding borrowing asset, with over $2.7 billion in active loans across chains. We believe this trend is due to the concept of proof of stake + re-staking, which has changed the landscape of the on-chain lending market, allowing protocols like Aave to significantly increase utilization in a relatively sustainable manner. Before the popularity of circular operations, these lending markets were dominated by users seeking leverage on crypto assets, so they tended to only borrow stablecoins because their investments tended to be heavily long.
The introduction of GHO creates a new high-margin lending product for Aave. It is a synthetic stablecoin where borrowing fees do not need to be paid to the supplier. This also enables the DAO to provide loans at slightly below market rates, driving lending demand in an otherwise difficult environment. From a financial perspective, GHO is undoubtedly one of the most important parts to monitor Aave in the future, as this product has:
High upfront costs (technology, risk, and liquidity)
Audits, development work, and liquidity incentives will continue to slowly dissipate over the next few years
Large relative upside
The outstanding GHO supply is $141M, which is only 2.35% of the total outstanding loan balance on Aave and 2.7% of the outstanding DAI supply
Nearly $3B of non-GHO stablecoins (USDC, USDT, DAI) are currently borrowed on Aave
A lending market with higher profit margins than Aave
While there are other costs to consider when issuing a stablecoin, it should be cheaper than having to pay suppliers
Maker DAO’s net revenue margin is 57%, while Aave’s net revenue margin is 16.31%
The protocol’s native token, AAVE, trades at a fully diluted valuation (FDV) of $2.7 billion, with estimated annual revenue of $26.4 million, or a P/E ratio of about 103x. However, we believe this multiple could effectively compress in the coming months. As discussed earlier, favorable market conditions should boost borrowing capacity, spark new demand for leverage, and potentially be accompanied by liquidation revenues, which were relatively small in 2024. Finally, even if GHO’s market share growth is simply the erosion of Aave’s traditional lending market by stablecoins, it should have an immediate positive impact on margins.
2) MakerDAO
Maker Protocol is a decentralized organization that issues the stablecoin DAI, supports a variety of crypto and real-world collateral, enables users to leverage their assets, and provides a "decentralized" stable value store for the crypto economy. Maker's protocol fees consist of a "stability fee" paid by borrowers and the yield generated by the protocol's allocation of yield-generating assets. These protocol fees are distributed between MakerDAO and depositors who deposit DAI into the DAI Savings Rate (DSR) contract, with the specific proportion depending on the DAO. Similar to Aave, MakerDAO also charges a liquidation fee. When a user's position falls below the necessary collateral value, the loan is closed through an auction process, and the protocol extracts a portion of the remaining position value to suppress liquidation and protocol pressure.
MakerDAO has thrived over the past few years, benefiting from liquidations during the speculative volatility of 2021, while also creating a more sustainable, less risky business line as global interest rates rise. The introduction of new collateral assets, such as US Treasuries and USDC, has enabled Maker to make its assets yield-producing, earning returns beyond the standard DAI borrowing rate. When analyzing the DAO’s spending, several things are apparent:
DAI is deeply ingrained throughout the crypto ecosystem (CEX, DeFi), allowing Maker to avoid issuing millions of dollars in liquidity incentives. DAOs do an impressive job of prioritizing sustainability
In 2024, Maker is expected to generate approximately $88.4 million in net protocol revenue. Considering MKR is valued at $1.6 billion, it trades at a multiple of 18x net protocol revenue. In 2023, the DAO voted to reshape the protocol’s token economics to return a portion of the proceeds to MKR holders. As DAI continues to accumulate through ongoing borrowing rates (stability fees), Maker builds a system surplus with a target of approximately $50 million. Maker’s smart burn engine uses this surplus to buy back and destroy MKR through surplus auctions. According to Maker Burn’s data and Steakhouse’s visualization, 11% of the MKR supply has been bought back and used for destruction, protocol-owned liquidity, or treasury construction.
3) Lido
Lido is the largest provider of liquid staking on Ethereum, connecting ETH holders with a decentralized network of validators willing to stake their assets. When users stake ETH through Lido, they receive a "liquid staking token", an alternative representation of their underlying staking balance, thereby avoiding the opportunity cost of unstaking queues and not being able to use the staked ETH in DeFi . Lido's protocol fee is the ETH revenue used to verify the network, which is distributed between stakers (90%), node operators (5%), and the Lido DAO Treasury (5%).
Lido is an interesting case study in DeFi protocols. As of September 10, 2024, they have 9.67M ETH staked in the protocol, which is about 8% of the entire ETH supply, and they have over 19% of the staking market share. At $22B in total locked value, there are few other protocols that can control the market as effectively as Lido. However, as shown above, they are still not profitable. So, how can we ensure that Lido can achieve cash flow in the short term?
Several variations can be considered:
Adjusting the protocol fee structure : By increasing the share of revenue distributed to stakers or reducing the share of node operators, Lido may attract more stakers and thus increase total revenue.
Increase product diversity : Launch new financial products or services, such as staking lending, which allows users to borrow liquidity while staking ETH, thereby expanding the user base and revenue sources.
Optimize operating costs : Analyze current operating and technology costs and seek opportunities to reduce costs to improve overall profitability.
Expand market share : Actively promote the advantages of liquid staking, especially in new DeFi projects, to expand market influence and attract more users.
Introducing additional revenue streams : For example, participating in revenue sharing on DeFi protocols or collaborating with other projects to increase non-traditional revenue.
With these changes, Lido could strengthen its financial position and become profitable in the near term.
Over the past two years, The DAO has made tremendous progress in reducing costs . Liquidity incentives are critical in driving the use of stETH, as core users will naturally gravitate toward liquid staking tokens that have the highest liquidity in the ecosystem. We believe that as stETH demonstrates a strong moat, The DAO will be able to further reduce this expense. If Lido completely eliminated liquidity incentives like Maker, we estimate that they could already be profitable in 2024. Despite the cost cuts, $7 million in profits may not be enough to justify LDO's fully diluted valuation of over $1 billion.
In the coming years, Lido must seek to expand or cut costs to justify its valuation. We see several potential growth paths for Lido, either an increase in the Ethereum network’s staking rate from 28.3% or Lido’s efforts to expand outside of the Ethereum ecosystem. We believe the former is fairly likely over the longer time horizon. For comparison, Solana’s staking rate is 65.5%, Sui’s is 79.5%, Avalanche’s is 49.2%, and Cosmos Hub is around 61%. If Lido can double the amount of ETH staked and maintain market share, they would be able to generate over $50 million in net revenue to offset costs. This assumption is also an oversimplification and does not take into account the compression of ETH issuance as the staking rate rises. While increasing current market share is also possible, we see Ethereum’s community consensus becoming very skeptical of Lido’s dominance in 2023, marking the peak of its meteoric growth.
4) ether.fi
Like Lido, ether.fi is a decentralized, non-custodial staking and re-staking platform that issues liquid receipt tokens for users' deposits. ether.fi's protocol fees include ETH staking income and active verification service income earned by providing economic security through the Eigenlayer ecosystem. These fees are divided into ETH staking income, which is distributed at 90% (stakers), 5% (node operators), and 5% (ether.fi DAO); and Eigenlayer/re staking rewards, which are distributed at 80% (stakers), 10% (node operators), and 10% (ether.fi DAO).
ether.fi has several other ancillary products that generate significant revenue, including “Liquid,” a vault of re- collateralized and DeFi strategies designed to maximize returns for depositors. Liquid charges a 1-2% management fee on all deposits, which accrues back to the ether.fi protocol. Additionally, ether.fi recently launched Cash, a debit/credit card product that allows users to spend their re-collateralized ETH or use it as collateral for real-life purchases. Cash enables users to earn cashback and avoid crypto withdrawal and gas fees, provided that fees are paid annually in ETH.
As of September 2024, ether.fi is the undisputed market leader in liquid restaking, with a total value locked (TVL) of $6.5 billion across its restaking and yield products. We have attempted to model the potential protocol revenue for each product in the above financial statements, using the following assumptions:
ether.fi Stake’s 2024 average TVL will be ~$4B, assuming current stakes remain constant for the rest of the year
The average ETH staking yield will drop by about 3.75% this year
EIGEN's pre-market FDV is approximately $5.5B, and the restaker incentive emission plan is 1.66% in 2024 and 2.34% in 2025, which means
ether.fi should be directed to ~$38.6M in 2024 and ~$54.4M in 2025 EIGEN revenue
By looking at EigenDA, Omni, and other AVS rewards programs, we estimate that a total of ~$35-45M in rewards will be paid to Eigenlayer restakers, with an annual yield of 0.4%.
Cash is the most difficult revenue line to forecast, as it has just launched and there is a lack of transparent precedent in the industry. We worked with the ether.fi team to assess booking demand, as well as costs with large credit card providers to come up with our best estimate for 2025 - something we will be watching closely over the coming year.
Although we understand that ETHFI token incentives are a cost of the protocol, we decided to leave them at the bottom of the financial statements for several reasons: these expenses are heavily front-loaded due to airdrops and the bootstrap phase and are not necessary operating costs in the future; in addition, we believe that EIGEN and AVS rewards will be sufficient to offset the gradually decreasing ETHFI issuance. Given that withdrawals have been open for some time and ether.fi has also experienced the heaviest net outflows, we believe that the protocol is closer to determining a long-term sustainable TVL target.
3. Token value accumulation and scoring system
In addition to simply evaluating the profitability of these protocols, it is also very important to explore where the revenue of each protocol ultimately goes, which is closely related to the crypto industry. Regulatory uncertainty has been a driving factor in the diversification of revenue distribution mechanisms. Many unique approaches have been adopted to try to allow token holders to participate in the upside potential of the protocol and incentivize them to participate in governance, including dividends to token stakers, buybacks, token destruction, accumulation of revenue in the treasury, etc. In an industry where token holder rights are not equal to shareholder rights, market participants must deeply understand the role of their tokens in the governance protocol. We are not lawyers and do not express opinions on the legality of any distribution method, but are simply exploring how the market may react to each method.
1) Stablecoin/ETH dividends
Benefits: Measurable benefits, higher quality payments
Disadvantages: taxable events, gas claims, etc.
2) Token repurchase
Benefits: Tax-free, constant buying pressure, growing funds
Disadvantages: Subject to slippage and front-running, holders cannot guarantee returns, and the treasury is concentrated in the native token.
3) Buyback and destruction
Benefits: Same as above, increase the revenue of each Token
Disadvantages: Same as above + no vault growth
4) Treasury accumulation
Pros: Increases protocol runway, diversifies treasury, still under control of DAO participants Cons: No direct benefit to token holders
Token economics is clearly more of an art than a science, and it is indeed difficult to judge when it is more efficient to distribute earnings to token holders than to reinvest them in growth. For simplicity, in a hypothetical world, assuming that a protocol has maximized its growth, having a token that redistributes earnings will increase the internal rate of return for holders and reduce risk every time some form of payment is received. We will explore the design and potential value accumulation of ETHFI and AAVE, both of which are currently undergoing refactoring.
4. Foresight
1) Aave
As of today, the supply of GHO is 142M. Current dynamics show that the weighted average borrowing rate for GHO is 4.62%, while the weighted average stkGHO incentive payment is 4.52%, with 77.38% of the total GHO supply staked in the Security Module. Therefore, Aave earns 10 basis points on $110M of GHO and 4.62% on the unstaked $32M. Given global interest rate trends and the stkAAVE discount, it is possible that the borrowing rate for GHO will drop below 4.62%, so we have also added impact forecasts for GHO at 4% and 3.5%. Aave has many opportunities to promote the growth of GHO in the coming years, and the chart below details the impact of reaching $1 billion in outstanding GHO loans on the protocol's earnings.
While Aave is clearly well-positioned for growth, Marc Zeller proposed a restructuring of protocol payouts and Aave’s native token, AAVE, on Aave’s governance forum. The premise of the restructuring is that Aave is quickly becoming a profitable protocol but is currently overpaying on an imperfect security module. As of July 25, Aave had $424 million in its security module, primarily comprised of stkAAVE and stkGHO, both of which are not ideal when dealing with bad debts due to slippage and decoupling risks. Additionally, through token issuance, the protocol is incentivizing secondary liquidity for AAVE, thereby minimizing slippage when stkAAVE must be used to cover bad debts.
If DAO The vote to replace the current Security Module with aTokens similar to awETH and aUSDC, while stkGHO will be used exclusively to cover GHO debt, which will fundamentally change the concept. Instead of needing to be sold to cover bad debts, stkGHO will be directly confiscated and destroyed. The aforementioned aTokens are extremely liquid and make up the majority of the protocol's debt. In the event of undercollateralization, these staked aTokens can be confiscated and destroyed to cover any bad debts. The goal of this proposal is to reduce the expenses of the Security Module and liquidity incentives while obtaining more effective guarantees. With the current annual expenses of the Security Module being approximately $44.3 million, achieving a 10-20% efficiency improvement will have a huge impact on the profitability of the protocol and AAVE. Zeller further explains the role of stkAAVE under the new plan in the figure below.
If the proposal is voted through, it should have a beneficial effect on the AAVE token as it will now have more sustained demand, but will also allow holders to earn rewards without the downside risk of having stkAAVE confiscated to cover bad debts. We are unsure of the tax implications of the staking contract wrapper, but it greatly benefits long-term holders of AAVE through sustained buying pressure and redistribution of tokens to stakers.
2) ether.fi
It is tempting to build a revenue multiple for ether.fi given the protocol’s success in quickly creating a sustainable business model. For example, the protocol’s development team and DAO moved extremely quickly and attempted to demonstrate their financial position with a successful proposal that would use 25*-50% of revenue from the Restake and Liquid products to buy back ETHFI for liquidity provision and treasury . However, using 2024 revenue figures to arrive at a fair valuation may be futile and complicated given the lack of AVS rewards, heavy upfront startup costs, and the fact that much of its product suite is brand new.
ETHFI Token has a fully diluted valuation of 1.34 billion and is expected to be slightly profitable this year (barring liquidity incentives), making it very similar to Lido's LDO. Of course, ether.fi must stand the test of time, but given the continued success of the broader product base , the protocol seems likely to achieve profitability faster than Lido and with a higher ceiling for profitability . Below is a conservative breakdown of how AVS rewards will contribute to the protocol's earnings, beyond just ETH staking and EIGEN incentives, which should add a much-needed yield boost with a cost base that is not much different than Lido. The AVS reward yield is the reward restakers receive from AVS payments alone.
As Lido sees it, liquidity staking /re-staking is a highly competitive industry with relatively low profit margins . With a deep understanding of this limitation, and a focus on simultaneously dominating market share while building out ancillary products that fit into their broader restaking and yield generation thesis. Here are the reasons why we think these other commodities are a good fit for ether.fi:
Liquidity: We firmly believe that LRT power users are familiar with DeFi Lego blocks and want to maximize their returns, attracting them to products that can automate DeFi strategies. Once AVS rewards are truly "live", there will be dozens of risk/reward strategies and a new native form of yield in the crypto economy.
Cash: Very similar to LST, LRT is a better form of collateral than regular ETH because they have sufficient liquidity. Users can use liquid staking as a checking account that generates income, or borrow against their assets for daily consumption at almost zero cost (staking rate - stablecoin borrowing rate).
5. Summary
Many of the numbers used in this report are subjective as they are projections based on partial year data, trends, market conditions, and discussions with development teams. We plan to follow up this report at the end of 2024 to paint a more accurate picture of the full year and analyze the market's response to the growing gains of these top DeFi protocols.
Link to this article: https://www.hellobtc.com/kp/du/10/5451.html
Source: https://x.com/Kairos_Res/status/1841148057372508555
