Original source: Kairos Research

Original translation: Luffy, Foresight News

Summary

This report aims to explore some of the most influential DeFi protocols from a financial perspective, including a brief technical overview of each protocol and an in-depth study of their revenues, expenses, and token economics. Given the unavailability of regularly audited financial statements, we use on-chain data, open source reports, governance forums, and conversations with project teams to estimate Aave, Maker (Sky), Lido, and ether.fi. The table below shows some of the key conclusions we reached throughout the research process, giving readers a comprehensive understanding of the current status of each protocol. While the price-to-earnings ratio is a common way to judge whether a project is overvalued or undervalued, key factors such as dilution, new product lines, and future profit potential can tell a more complete story.

Notes: 1. The DAI savings rate is included in the cost of revenue, but not in Aave's security module; 2. Ether.fi token incentives are not included because they are in the form of airdrops; 3. This is a rough result estimated by the growth rate, interest rate, ETH price appreciation and margin of new products (GHO, Cash, etc.) and should not be regarded as investment advice; 4. Aave is currently seeking to improve token economics, including AAVE buybacks and distributions

Through analysis, it can be concluded that after years of liquidity guidance and moat building, we are witnessing some protocols turning to a sustainable profit stage. For example, Aave has reached a turning point, has achieved profitability for several consecutive months, and is rapidly developing a new, higher-margin loan product through GHO. ether.fi is still in its infancy, but has already amassed over $6 billion in total locked value, securing its place among the top five DeFi protocols in terms of scale. The liquidity re-staking leader has also learned from some of Lido’s shortcomings, launching a number of other ancillary products with higher interest rates to make the most of its billions of dollars in deposits.

Problem Statement and Definition

Since the rise of DeFi in 2020, on-chain data and analytical methodological tooling have steadily improved, with companies such as Dune, Nansen, DefiLlama, TokenTerminal, and Steakhouse Financial playing a key role in creating real-time dashboards on the state of crypto protocols. At Kairos Research, we believe that an important way to cultivate credibility within the industry is to drive standardization across protocols and DAOs to demonstrate financial performance, health, and sustainability. Profitability is often overlooked in crypto, but value creation is the only way to sustainably align every participant within a protocol (users, developers, governance, and community).

Below are some of the terms we will use throughout this research to try to standardize the approximate costs of each protocol.

· Gross Revenue/Fees: Includes all revenue generated by the protocol, belonging to the protocol’s users and the protocol itself.

· Take: The percentage of fees the protocol charges its users.

· Net Revenue: The protocol’s revenue left after paying fees to protocol users and deducting revenue costs.

· Operating Expenses: Various protocol expenses, including salaries, contractors, legal and accounting, audits, gas costs, grants, and possible token incentives.

· Net Operating Revenue: The net dollar amount after subtracting all costs incurred by the protocol and token holders, including token incentives related to protocol operations.

· Adjusted Return: One-time fees are added back to returns to more accurately predict future returns, minus known future costs that are not currently expressed through returns.

Protocol Overview

We will provide a detailed analysis of the core products provided by each of the highlighted protocols in this report, which cover a range of the most mature protocols in the crypto niche.

Aave

Aave is a "decentralized, non-custodial liquidity protocol that users can participate in as suppliers, borrowers, or liquidators." Providers deposit crypto assets to earn lending yields and gain lending power themselves so that they can leverage or hedge their deposited positions. Borrowers are either overcollateralized users seeking leverage and hedging, or taking advantage of atomic flash loans. Borrowers must pay a fixed or floating interest rate for the specific assets they borrow. Aave's protocol fee is the total interest paid on open (unrealized), closed, or liquidated positions, which is then distributed between lenders/suppliers (90%) and the Aave DAO Treasury (10%). In addition, Aave will allow "liquidators" to liquidate positions when the position exceeds its specified loan-to-value ratio cap. Each asset has its own liquidation penalty, which is then distributed between liquidators (90%) and the Aave DAO Treasury (10%). A new product offered by Aave, GHO, is an over-collateralized, cryptocurrency-backed stablecoin. The introduction of GHO allows Aave to provide loans without relying on third-party stablecoin providers, giving them greater flexibility in interest rates. In addition, GHO cuts out the middleman and allows Aave to earn all borrowing interest from outstanding GHO loans.

Aave transparently displays all of the DAO’s revenue, expenses, and more through the TokenLogic dashboard. We extracted the “Financial Revenue” data from August 1 to September 12 and annualized the numbers to arrive at a net income of $89.4 million. To arrive at the total revenue figure, we relied on TokenTerminal’s P&L data to estimate profit margins. Our forecast for 2025 is based primarily on assumptions, including that an upward trend in crypto asset prices will lead to increased lending capacity. Additionally, Aave’s net profit margins increase in our model due to the potential replacement of third-party stablecoins by GHO and improvements to the protocol’s security module, which will be explained further below.

The leading lending marketplace for cryptocurrencies is on track to have its first profitable year in 2024. Multiple signs point to Aave’s profitability potential: supplier incentives have dried up, and active lending continues to trend upward, with active borrowings exceeding $6 billion. Aave is clearly a huge beneficiary of the liquidity staking and re-hypothecation market as users deposit LST/LRT, borrow ETH, exchange ETH for liquidity staking tokens, and then repeat the same process again. This cycle allows Aave users to earn a net interest margin (APY associated with LST/LRT deposits - Aave borrowing interest) without taking on huge price risk. As of September 12, 2024, ETH is Aave's largest outstanding lending asset, with over $2.7 billion in active loans across all chains. We believe that this trend driven by the concept of proof of stake + re-hypothecation has changed the landscape of the on-chain lending market, greatly increasing the utilization of protocols like Aave in a sustainable way. Before re-hypothecation-driven circular lending became popular, these lending markets were dominated by leveraged users who tended to only borrow stablecoins.

The launch of GHO has created a new, higher-margin lending product for Aave. It is a synthetic stablecoin with borrowing fees that do not need to be paid to suppliers. It also allows DAOs to offer slightly below-market interest rates, driving demand for lending. From a financial perspective, GHO is undoubtedly one of the most important parts of Aave to focus on in the future, as the product has: · High upfront costs (technical, risk, and liquidity)

· Costs of audits, development work, and liquidity incentives will slowly decrease over the next few years

· Relatively large upside

· The outstanding GHO supply is $141M, which is only 2.35% of Aave’s total outstanding loans and 2.7% of DAI supply

· Currently, there is nearly $3 billion in non-GHO stablecoins (USDC, USDT, DAI) lent on Aave

· Higher margins than Aave’s lending market

· While there are other costs to issuing a stablecoin, it should be cheaper than having to pay a third-party stablecoin provider

· MakerDAO’s net revenue margin is 57%, while Aave’s is 16.31%

The Aave protocol’s native token, AAVE, has a fully diluted valuation (FDV) of $2.7 billion, which is approximately 103 times its annual revenue (estimated $26.4 million), but we think this will change in the coming months. As mentioned above, favorable market conditions will increase lending capacity, stimulate new demand for leverage, and may be accompanied by liquidation revenue. Finally, even if GHO's market share growth is simply a result of cannibalizing Aave's traditional lending market, it should have a direct positive impact on profit margins.

MakerDAO

MakerDAO (now rebranded as Sky) is a decentralized organization that supports the issuance of stablecoins (DAI) collateralized by various cryptocurrencies and real-world assets, so that users can both leverage their assets and allow the crypto economy to gain a "decentralized" stable value store. Maker's protocol fee is the "stability fee", which is composed of the interest paid by borrowers and the yield generated by the protocol allocated to the yielding assets. These protocol fees are distributed between MakerDAO and depositors who deposit DAI into the DAI Savings Rate (DSR) contract. Like Aave, MakerDAO also charges a liquidation fee. When a user's position falls below the necessary collateral value, the assets are liquidated through an auction process.

MakerDAO has thrived over the past few years, fueled by liquidations during the speculative volatility of 2021. But as global interest rates rise, MakerDAO has also created a more sustainable, less risky business line, and the introduction of new collateral assets such as US Treasuries enables Maker to improve asset efficiency and generate returns above standard DAI lending rates. When exploring the DAO's spending, we have a clear understanding of the following:

· DAI is deeply rooted in the entire crypto ecosystem (CEX, DeFi), which allows Maker to avoid investing millions of dollars in liquidity incentives.

· The DAO has done an excellent job prioritizing sustainability

Throughout 2024, Maker is on track to generate approximately $88.4 million in net protocol revenue. MKR is valued at $1.6 billion, just 18x net revenue. In 2023, the DAO voted to modify the protocol’s token economics to return a portion of the proceeds to MKR holders. As DAI continues to accrue borrowing rates (stability fees) to the protocol, Maker has accumulated a system surplus, which they aim to maintain at around $50 million. Maker introduces a smart burn engine that uses surplus funds to buy back MKR in the market. According to Maker Burn, 11% of the MKR supply has been bought back and used for burns, protocol-owned liquidity, or treasury construction.

Lido

Lido is the largest provider of liquidity staking services on Ethereum. When users stake ETH through Lido, they receive “liquidity staking tokens” so that they can avoid both the waiting period for unstaking and the opportunity cost of not being able to use the staked ETH in DeFi. Lido’s protocol fee is the ETH revenue paid to validate the network, which is distributed to stakers (90%), node operators (5%), and the Lido DAO Treasury (5%).

Lido is an interesting case study for DeFi protocols. As of September 10, 2024, they have staked 9.67 million ETH through their protocol, which is about 8% of the entire ETH supply, more than 19% of the staking market share, and a total locked value of $22 billion. However, Lido still lacks profitability. What changes can be made to enable Lido to achieve cash flow in the short term?

In the past two years alone, Lido has made great progress in cutting costs. Liquidity incentives are very important in bootstrapping stETH, and advanced users will naturally gravitate to LST as it has the most liquidity in the entire ecosystem. We believe that with stETH having an impressive moat, Lido DAO will be able to further reduce liquidity incentives. Even with cost cutting, $7 million in profitability may not be enough to justify LDO's $1 billion+ FDV.

In the coming years, Lido must seek to expand earnings or cut costs to reach its valuation level. We see several potential growth paths for Lido, either ETH's total network staking rate continues to rise from 28.3% or Lido strives to expand outside the Ethereum ecosystem. We believe that the former is likely to be achieved over a long enough time frame. By comparison, Solana's staking rate is 65.5%, Sui's is 79.5%, Avalanche's is 49.2%, and Cosmos Hub's is 61%. By doubling ETH staking and maintaining its market share, Lido will be able to generate another $50 million+ in net revenue. This assumption is too simplistic and does not take into account the compression of ETH issuance rewards as the staking rate increases. While Lido's current market share increase is also possible, we see Ethereum's social consensus casting serious doubts on Lido's dominance in 2023, marking the peak of its growth trajectory.

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 validation service income, which is used to provide economic security through the Eigenlayer ecosystem. ETH staking income is distributed to stakers (90%), node operators (5%), and the ether.fi DAO (5%), and then Eigenlayer/re-staking rewards are distributed to stakers (80%), node operators (10%), and the ether.fi DAO (10%). ether.fi has many other ancillary products that can generate significant income, including "Liquid", which is a library of re-staking and DeFi strategies designed to maximize depositor returns. Liquid charges a 1-2% management fee on all deposits, which are charged to the ether.fi protocol. In addition, ether.fi recently launched a Cash debit/credit card product that allows users to use re-collateralized ETH to make payments in real life.

As of September 2024, ether.fi is the undisputed market leader in liquidity re-collateralization, with a TVL of $6.5 billion in re-collateralization and yield products. We have attempted to simulate the potential protocol revenue for each of its products using the following assumptions in the above financial statements: · Assuming that ether.fi’s current staking volume remains constant for the rest of the year, the average TVL staked in 2024 is approximately $4 billion · The average ETH staking yield will drop by around 3.75% this year · EIGEN’s pre-listing FDV is approximately $5.5 billion, and the re-staking rewards are scheduled to be 1.66% in 2024 and 2.34% in 2025, which means that ether.fi’s direct revenue from EIGEN is: approximately $38.6 million in 2024 and approximately $54.4 million in 2025 · By studying EigenDA, Omni, and other AVS reward programs, we estimate that approximately $500 million will be paid to Eigenlayer. Re-stakers pay a total of approximately $35-45 million in rewards, with an annual yield of 0.4%

Cash is the most difficult revenue source to model, as it has just launched and there is a lack of transparent precedent in the space. We, along with the ether.fi team, will make our best estimate for 2025 based on booking demand and the cost of revenue for large credit card providers, and we will be watching this closely over the coming year.

While we know that the ETHFI token incentive is a cost of the protocol, we decided to leave it at the bottom of the financial statements for the following reasons: these expenses are heavy upfront due to airdrops and liquidity bootstrapping, these expenses are not necessary costs to grow the business, and we believe that EIGEN + AVS rewards more than offset the cost of the ETHFI incentive. Given that withdrawals have been enabled for some time, ether.fi has seen significant net outflows, and we believe the protocol is closer to achieving a long-term sustainable TVL target.

Token Value Accumulation and Scoring System

Beyond simply assessing the profitability of these protocols, it is worth exploring where the proceeds of each protocol ultimately flow. Regulatory uncertainty has been a driver for the creation of a large number of revenue distribution mechanisms. Dividends to token stakers, buybacks, token burns, treasury accumulation, and many other unique methods have been used to try to keep token holders involved in protocol development and motivated to participate in governance. In an industry where token holder rights are not equal to shareholder rights, it is imperative that market participants thoroughly understand the role their tokens play in the protocol. We are not lawyers and do not take any position on the legality of any distribution method, simply exploring how the market would react to each method.

Stablecoin/ETH dividends:

Advantages: measurable benefits, higher quality returns

Disadvantages: taxable events, gas consumption, etc.

Token buybacks:

Advantages: tax-free, continuous purchasing power, growing funds

Disadvantages: prone to slippage and front-running, no guarantee of returns for holders, funds concentrated in native tokens

Buyback and destruction:

Advantages: Same as above, increase the return of each token

Disadvantages: Same as above + no fund growth

Treasury accumulation:

Advantages: increase protocol operating space, achieve fund diversification, still managed by DAO Participant Control

Cons: No direct benefit to token holders

Token economics is clearly an art rather than a science, and it is difficult to know whether distributing earnings to token holders is more beneficial than reinvesting them. For simplicity, in a hypothetical world where the protocol has maximized growth, having tokens that redistribute earnings would increase the internal rate of return for holders and eliminate risk every time a payout of some kind is received. We explore the design and potential value accrual of ETHFI and AAVE, both of which are currently undergoing token economics improvements, below.

Looking Ahead

Aave

Currently, GHO supply is 142M, the weighted average borrow rate for GHO is 4.62%, and the weighted average stkGHO incentive payout is 4.52%, with 77.38% of the total GHO supply staked in the Security Module. Therefore, Aave earns 10bps on $110M worth of GHO and 4.62% on $32M unstaked. Given global interest rate trends and the stkAAVE discount, there is certainly room for the GHO borrow rate to drop below 4.62%, so we also added a forecast for the impact on GHO of 4% and 3.5%, respectively. Aave should have many opportunities to foster growth in GHO over the next few years, and the chart below projects how the path to $1 billion in outstanding GHO loans will impact protocol earnings.

While Aave has growth potential, Marc Zeller has also proposed a temperature check within Aave’s governance forum to improve the protocol’s payouts as well as the native token, AAVE. The premise of the improvements is that Aave is quickly becoming a profitable protocol but is currently overpaying for 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 imperfect assets that cannot cover bad debts due to slippage and decoupling risk. Additionally, through token issuance, the protocol is incentivizing secondary liquidity for AAVE so that slippage can be minimized if stkAAVE must be used to cover bad debts.

This concept could change radically if the DAO votes to use aTokens like awETH and aUSDC as security modules while isolating stkGHO to only pay off GHO debt. stkGHO would never need to be sold to cover bad debts, just confiscated and burned. The aforementioned aTokens are extremely liquid and make up the majority of the protocol’s debt. If undercollateralized, these staked aTokens could be confiscated and burned to cover bad debts. The goal of this proposal is to reduce the payout of the security module and liquidity incentives. Zeller further explains the role of stkAAVE under the new scheme in the diagram below.

If this proposal passes, it should have a favorable impact on the AAVE token as it will have a more stable demand while also allowing holders to earn rewards without the risk of stkAAVE being confiscated to cover bad debts. We are unsure of the tax implications of the staking contract, but it greatly benefits long-term AAVE holders through continued purchasing power and redistribution of tokens to stakers.

ether.fi

Given ether.fi’s success in quickly creating a sustainable business model, it’s tempting to build multiple profit initiatives. For example, the protocol’s development team and DAO moved very quickly to propose that the company buy back 25%-50% of the revenue generated by its Restaking & Liquid products into ETHFI for liquidity provision and treasury reserves. However, given the lack of AVS rewards, the large upfront startup costs, and the fact that much of its product suite is brand new, using 2024 earnings figures to calculate a fair valuation is likely futile and complicated.

The ETHFI token has a FDV of $1.34 billion and is expected to be slightly profitable this year (excluding liquidity incentives), making it very similar to Lido’s LDO. Of course, ether.fi must stand the test of time, and the protocol has the potential to become profitable faster than Lido and has a higher ceiling given the continued success of its broader products. The following is a conservative analysis of how AVS rewards will contribute to protocol earnings. AVS Reward Yield is the reward that re-stakers receive solely from AVS spending.

As seen on Lido, liquidity staking/re-staking is a highly competitive industry with relatively thin margins. ether.fi has fully recognized this limitation and is exploring building a wider range of yield-ancillary products while taking market share. Here are the reasons why we believe these other products fit into its broader re-staking and yield generation thesis.

· Liquid: We firmly believe that LRT power users are familiar with DeFi legos and want to maximize their yield, attracting them to products that can automate their DeFi strategies. Once AVS rewards are truly "live", dozens of risk/reward strategies and a new native form of yield will emerge in the crypto economy.

· Cash: Similar to LST, LRT is a superior form of collateral than regular ETH, and they have sufficient liquidity. Users can use liquidity re-mortgage as a profitable checking account or borrow assets at almost zero cost for daily expenses.

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