Decentralized finance (DeFi) protocols offer decentralized financial services via smart contracts and charge fees for those services. When a DeFi project’s revenue increases, it attracts more users and liquidity.
Choosing between different DeFi protocols can take plenty of time and effort. Many seem similar, so how do we know which one is the best for generating passive income from our crypto? An essential step is understanding a platform’s revenue and how much of it is shared with its users. You can then use this information to make an informed decision on where to invest your assets.
How DeFi Protocols Function
Decentralized finance (DeFi) protocols offer a range of financial services that operate via smart contracts. For example, a DeFi protocol could offer decentralized exchange services, loans, and liquidity pools, all run via smart contracts on a blockchain. All you need to access and use these services is a wallet and some crypto to cover your transaction fees.
There’s almost no limit to the financial services DeFi can offer. You can access exchange services, money markets, derivatives, and savings products in the DeFi world. All of these services are permissionless and disintermediated in nature.
How DeFi Protocols Generate Revenue
DeFi services’ operating costs come from the computing power needed to run smart contracts. Users typically cover this amount with the gas fees they pay. However, there are also other additional costs for services such as development and maintenance. DeFi protocols charge fees for their services to cover these costs and generate a profit.
Decentralized exchanges (DEXs)
Users swapping tokens on a DEX must pay a fee to utilize its services. For example, a trade may incur a 0.3% fee for the DEX operator's treasury or liquidity reserves.
Users who borrow from a lending protocol must pay a borrowing fee. Some of this will go to paying the liquidity provider (other users who have provided capital), while the rest will go to the protocol.
Why Revenue Is Important
Beyond covering a protocol’s costs, improved revenue and profits can also benefit stakers. DeFi projects often maintain a revenue-sharing model via their governance token holders. They also may use revenues to increase APRs for stakers or liquidity providers on their platforms.
For DEXs, higher revenue can attract more users and in turn, improve liquidity. It can also boost APY for yield aggregators if they benefit from combining users’ staked funds for “bribes” as network validators.
To summarize, we can describe a project’s inflows and revenues in a circular fashion:
Popular projects attract liquidity, which attracts more users and forms a virtuous cycle.
Higher trading traffic and liquidity lead to lower slippage and faster execution.
More users improve legitimate trading volume, which leads to more revenue.
Revenue is shared with staked users, which provides more liquidity.
This loop also attracts users who want to engage in yield farming. Those looking to invest their money can increase their chances of maximizing their gains with compound interest. The more successful a project is, the more liquidity and, in turn, the more yield farmers it will attract. This process generates more revenue that can be used to improve a protocol’s offering.
How to See How Much DeFi Protocols Generate
DeFi operates on-chain, which means almost all transactional information — depending on the blockchain used — is verifiable. Blockchain explorer is easily accessible by everyone, but that doesn’t mean we can always understand the extent of a protocol’s revenue. There are a number of blockchain data aggregators that simplify the task so you can better understand each protocol’s revenue.
With a Google search and some research from trusted sources, you should be able to find metrics, revenues, and stats on DeFi protocols’ revenues. These figures can help you make more informed investment decisions.
Revenue is a crucial metric to study, whether you’re looking at a project’s real yield or basic fundamentals. You can wisely invest only if you understand how a protocol generates and shares its revenue. You can further understand the topic by diving into DeFi 2.0, yield farming, and general financial topics on Binance Academy.