Decentralized finance or DeFi represents a new stage in the development of the cryptocurrency industry. DeFi is based on protocols operating on the basis of smart contracts in the blockchain and providing users with access to various financial services without intermediaries — lending, investing, etc.
A distinctive feature of DeFi is the absence of centralized governance bodies. This ensures transparency of transactions and full control of users over their digital assets. To cover development and maintenance costs, DeFi protocols charge a fee for the use of their services.
Choosing the right DeFi platform requires a thoughtful approach, as many of them may be similar in functionality. The key factor in making a decision is the financial model of the project - the structure of income and profit distribution between participants. The more a DeFi protocol earns, the greater its ability to attract new users and provide liquidity. Understanding the sources of income allows you to assess the prospects of each specific project.
How do DeFi protocols function?
The functionality of decentralized finance is based on special «software codes» — smart contracts. In essence, they are computer algorithms that automatically implement the pre-defined conditions of a transaction or financial operation.
All settlements and movements of funds in DeFi protocols are made by smart contracts without the participation of any intermediary structures. At the same time, the code of the contracts is open for audit, which ensures maximum transparency of their operation.
Interaction with DeFi takes place through special decentralized applications (dApps). To access them, a user need only have a cryptocurrency wallet compatible with the relevant blockchain. The key advantage of dApps is to provide financial services to anyone in the world regardless of their location, status or other restrictions.
DeFi protocols currently offer extensive functionality similar to the traditional financial industry. Here you will find decentralized exchanges for trading crypto assets, lending platforms for borrowing or placing funds in liquidity pools, various derivative instruments like futures/options, services for storing and accruing interest income on assets, and much more. The main difference is that all these instruments work in automatic mode without control of centralized structures.
DeFi protocols revenue sources
Decentralized financial protocols are built to be self-sustaining and generate revenue by providing services to users. The main source of revenue for DeFi is commissions for various transactions through smart contracts.
As you know, all transactions on the blockchain require payment of a gas commission - rewarding miners/validators for processing data. In the case of DeFi protocols, this fee is charged when you interact with smart contracts, whether it’s to exchange tokens, obtain credit, or another service.
However, in addition to the gas fee, DeFi platforms impose their own fees for the use of their functionality to cover development costs, code auditing, marketing and revenue generation. The size and structure of these fees vary widely depending on the specific protocol.
Let’s look at the main monetization models in DeFi using examples.
Decentralized exchanges (DEX)
One of the most common monetization models in DeFi is charging a fee for trading on decentralized exchanges. DEX usually deducts a small fixed percentage, for example 0.2%, from each cryptocurrency exchange transaction. These funds are either allocated to the platform’s general budget to cover development and marketing costs, or to liquidity pools to incentivize liquidity providers.
Credit protocols
Two sources of fee income are present in credit DeFi platforms at once. First, borrowers must pay a certain fee for the use of the loan, a portion of which is distributed to the lenders who provided capital to the liquidity pool. The second part of this fee remains in the protocol as its income. In addition, lending protocols may charge a one-time fixed fee when opening or closing a credit position.
Staking platforms
The essence of staking services is that users place their crypto assets there and get rewarded for it in the form of interest accrual or new coins. Such platforms generate income by retaining a small percentage of these rewards.
Derivatives protocols
In the decentralized derivatives sector, which includes futures, options, swaps, and similar instruments, developers typically set a fee tied to the volume of each open position. For example, a protocol might charge 0.05% of the amount of each contract.
There are other, more specialized models for earning money with DeFi, but they are generally based on commission fees for the services provided. Protocols try to find the best balance between attracting liquidity and their own profitability.
Why is the revenue level of a DeFi protocol important?
The level of profitability is critical to the success of any DeFi protocol. Decentralized finances are not charity projects, but full-fledged business models that require a constant flow of funds to cover the costs of infrastructure support.
The more revenue a DeFi platform generates, the more attractive the rewards for its participants can be:
High profitability allows DeFi protocol to offer more favorable terms compared to competitors, thus attracting new users and increasing the total amount of liquidity in the system. Increased liquidity, in turn, makes DeFi service more efficient and in demand, which leads to an increase in the number of transactions and commission fees.
This results in a kind of cycle: increasing liquidity leads to increasing transaction volumes and fees, increasing the protocol’s revenue. This, in turn, makes it possible to increase the attractiveness of the platform through more favorable rates and charges for participants. Thus, a steady inflow of new funds is formed and conditions for scaling the project are created.
In conditions of serious competition in the DeFi market, the level of profitability often becomes a decisive factor in the choice of the platform by users and investors. Projects with low profitability risk being left without the necessary liquidity and funding for further development.
Ultimately, the ability of the DeFi protocol to generate a stable income lays the foundation for its improvement and functionality expansion in the future. Therefore, analysis of the financial model and monetization sources is of key importance when assessing the prospects of a DeFi project.
Profitability analysis: How to estimate the potential profit of the DeFi protocol
One of the key advantages of decentralized finance is its absolute transparency and open data. Since DeFi protocols are based on public blockchains, most of the information about their operational activities is available for public scrutiny.
The main source of information on the financial performance of DeFi projects are blockchain observers (blockchain explorers) — special services that allow tracking all transactions in a particular network. The most famous ones are Etherscan for Ethereum, BscScan for Binance Smart Chain, Solana, Avalanche scanners, etc. With their help, you can perform detailed analysis of contracts and wallets, studying the flow of receipts and expenditures of funds.
However, manual processing of «raw» data from blockchain explorers can be very labor-intensive. Therefore, to simplify the analysis of financial statistics of DeFi protocols, many specialized aggregator services have been developed that use automated methods to collect and structure relevant information. Examples of such resources are DeFi Llama, DefiPrime, CryptoDiffer, Zapper, Debank and many others.
On these platforms, you can find detailed reports on the revenues of various DeFi projects, broken down by revenue sources, protocols, and transaction types. Aggregators also often show slices of commissions received, distribution of fees between stakers/liquidity providers, volumes of funds under management and other relevant financial statistics.
In addition, many large DeFi protocols publish their own quarterly income and expenditure reports, making them publicly available. These reports are independently audited and can be considered a reliable source of information.
Final thoughts
When choosing investment strategies in DeFi, it is crucial to analyze the financial models of the protocols of interest. The focus should be on the following aspects:
In addition to profitability, it is necessary to evaluate the total volume of liquidity, the number of active users, technological advantages of the protocol and other non-financial metrics.
Today, DeFi traders and investors have at their disposal a lot of analytical services, blockchain scanners and reports from the projects themselves. A detailed study of this data can provide a complete picture of the protocol’s financial health and minimize investment risks.
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