How do DeFi protocols make money?

DeFi is an umbrella term for financial services like loans, lending, liquidity pools, and exchange services via smart contracts. For every service, projects can earn revenue by charging gas fees to make up for operating costs. But it’s all not that simple. More often than not, expenses exceed revenues, making profitability a challenge for DeFi protocols.

Within the DeFi ecosystem, there’s a big sea of change in defining profitability and sustainability. This article will dig into the revenue strategies of DeFi projects, the challenges they face in staying profitable, and what might be next for DeFi. 

Making sense of profitability

Let’s look at what profitability means outside DeFi. Profits work the same for these projects, even with different classifications for DeFi applications. Profitability is revenue minus cost. In the same equation, it’s money in and money out. But like most company books, there’s more to the equation than just capital cost. After revenue, projects still have to account for emissions.

DeFi protocols need to create and release new tokens into circulation, but this involves a complex process called token emissions. It’s a costly operation that needs careful consideration of emission rate, total supply, distribution, inflation, governance, and sustainability. Without proper consideration, excessive emissions can cause misalignment in the project’s goals - so a cost-benefit analysis is crucial for profitability and sustainability.

Understanding protocol revenues

Revenue streams enable DeFi protocols to cover operating costs, fund project growth, and remain competitive. For some DeFi protocols, transaction fees are the bread and butter in their revenue activity. These are fees charged to users for transaction activities. For instance, fees can be charged for lending and borrowing activities, or when trading in decentralized exchanges (DEXes).

Here are common protocol revenue streams:

• Transaction fees
• Interest income
• Flash loan fees
• Treasury asset management income
• Liquidity provider (LP) fees

Case studies of profitable protocols

Some protocols are known for fees attributed to their unique selling point. For instance, Maker is known for its stability fee, which Maker charges to borrowers for maintaining the stability of their stablecoin. This gave them a 100% profit margin, as they allocated all revenue from stability fees to their MakerDAO treasury.

It’s a different story for Uniswap, which relies on transaction fees. Instead of relying on emitting tokens and paying for emissions, Uniswap has not paid any emissions for six months, so they may be on the right track to a profitable margin.

BeethovenX is another profitable protocol that markets to users with the best pricing options. It also relies on transaction fees and income from partnerships with other projects, earning referral fees or shared revenue from collaborations. 

Case studies of unprofitable protocols

Some DeFi protocols find it a challenge to achieve profitability. Aave is a lending platform that takes a bit of interest, but not enough to make huge profits. In fact, interest income only makes up about 10.8% of their lending platform. So, while it’s their main source of income, it’s not a huge amount compared to the total cost flowing out of their system. 

Another example is Lido, a liquid staking protocol. Unlike the profitable examples, Lido’s revenue from token emissions and incentives exceeded its revenue from the fees it took to operate them - costing them a loss of $33.34M.

Curve is another unprofitable protocol that had the same fate as Aave. It’s a liquidity aggregator that brings together assets like stablecoins. However, even though it operated a lot of trades, it retained only a fraction of the profits generated from these transactions. So, while it’s busy and popular, it couldn’t leverage that opportunity and generate substantial profits relative to its overall trading volume.

Challenges faced by DeFi protocols

Before you point out the fact that there are plenty of revenue-generating opportunities for DeFi protocols, let’s first look at the challenges they face in achieving profitability.

Here are some DeFi limitations:

• Intense competition
• Adapting to user needs
• Saturated market and disconnected platforms
• Market adoption and building trust

Examining the perspective from Haven1

DeFi protocols operate in a competitive environment where sustainability and profitability are very crucial. Within Haven1, application fees are not only a means for revenue stream but also the viability of new projects - ensuring that only viable ones are launched on the platform. Within Haven1, developers are given the flexibility to set their fees, so new protocols can generate income from the onset and establish early growth on the platform. 

The future of DeFi presents both challenges and opportunities. The key to moving forward in DeFi is to maintain sustainability and profitability for long-term success. Regulatory uncertainty and scalability concerns indeed surround DeFi, but that opens plenty more room for opportunities like scaling solutions, enhanced interoperability, and improved user experiences.

‍