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Where does protocol revenue come from in the face of Liquidity decline? Could Token buyback and burn be the answer?
Author: Joel John, Decentralised.co
Compiled by: Yangz, Techub News
Money dominates everything around us. By the time people start talking about fundamentals again, the market is probably in a precarious position.
This article poses a simple question: should tokens generate income? If so, should the team buy back their own tokens? Like most things, there is no clear answer to this question. The path forward needs to be paved by honest dialogue.
This article was inspired by a series of conversations with Ganesh Swami, Co-founder of the blockchain data query and indexing platform Covalent. The content covers the seasonality of protocol revenue, evolving business models, and whether token buybacks are the best use of protocol capital. It is also a supplement to an article I wrote last Tuesday about the current stagnation in the cryptocurrency industry.
The private equity market, such as venture capital, always oscillates between excess liquidity and liquidity scarcity. When these assets transform into liquid assets and external funds continue to pour in, the industry's optimism often drives prices higher. Think about various new IPOs or token issuances, this newfound liquidity will make investors take on more risk, but in turn, it will drive the birth of a new generation of companies. When asset prices rise, investors will shift funds to early-stage applications, hoping for higher returns than benchmarks like Ethereum and SOL.
This phenomenon is a characteristic of the market, not a problem.
Where does the protocol revenue come from under the decline in liquidity? Will token buyback and burn be the answer?
The liquidity of the cryptocurrency industry follows a cyclical pattern with Bitcoin block reward halving as a milestone. Historical data shows that market rebounds usually occur within six months after the halving. In 2024, the influx of funds into Bitcoin spot ETFs and Michael Saylor's large-scale purchases (he spent a total of $22.1 billion on Bitcoin last year) have become the 'reservoir' for Bitcoin. However, the rise in Bitcoin prices has not led to a overall rebound in small altcoins.
We are currently in a period of tight capital liquidity, with the attention of capital allocators being dispersed among thousands of assets, while founders who have been working on developing tokens for years are also striving to find the meaning of all this, 'Since launching meme assets can bring more economic benefits, why bother to build real applications?'
In the previous cycle, L2 tokens enjoyed a premium due to their perceived potential value, supported by exchange listings and venture capital. However, as more participants enter the market, this perception and valuation premium are being eroded. As a result, the token value of L2 is declining, limiting their ability to subsidize smaller products with grants or token income. In addition, the overvaluation in turn forces founders to raise the old question that plagues all economic activities: where does the income come from?
) The operation mode of cryptocurrency project income
! [Where does the protocol revenue come from under liquidity decline? Will the buyback and burn of tokens be the answer?] (https://img.gateio.im/social/moments-60a7b440d1deefc0a316324fb2c60155)
The figure above explains well the typical operation of revenue for cryptocurrency projects. For most products, Aave and Uniswap are undoubtedly ideal templates. These two projects have maintained stable fee income over the years, thanks to the advantage of early entry into the market and the "Lindy effect." Uniswap even creates revenue by increasing front-end fees, perfectly confirming consumer preferences. Uniswap is to decentralized exchanges as Google is to search engines.
In contrast, the revenues of Friend.tech and OpenSea are seasonal. For example, the 'NFT Summer' lasted for two quarters, while the speculation frenzy of Social-Fi only lasted for two months. For some products, speculative income is understandable, provided that the income scale is large enough and consistent with the product's original intention. Currently, many meme trading platforms have joined the club of fee income exceeding $1 billion. This income scale is usually only achievable for most founders through token sales or acquisitions. For most founders focusing on developing infrastructure rather than consumer applications, this level of success is not common, and the revenue dynamics of infrastructure also differ.
During the period from 2018 to 2021, venture capital firms provided a substantial amount of funds for developer tools, hoping that developers could acquire a large number of users. However, by 2024, two significant changes occurred in the cryptocurrency ecosystem:
In Web2, the subscription model based on API works effectively because of the large number of online users. However, Web3 is a smaller niche market where only a few applications can scale to millions of users. Our advantage lies in the higher customer income per single user. Due to the nature of blockchain enabling capital flow, ordinary users in the cryptocurrency industry often spend more money at a higher frequency. Therefore, in the next 18 months, most companies will have to redesign their business models to directly generate revenue from users in the form of transaction fees.
Of course, this is not a new concept. Initially, Stripe charged by API calls, while Shopify charged a flat fee for subscriptions, but later both platforms switched to charging based on revenue percentage. For infrastructure providers, the API charging method of Web3 is relatively simple and straightforward. They erode the API market by competing to lower prices, even offering free products until reaching a certain transaction volume, then starting to negotiate revenue sharing. Of course, this is an ideal hypothetical situation.
As for how things will actually turn out, Polymarket is a case in point. Currently, tokens of the UMA protocol are tied to contentious cases and used to resolve disputes. The more prediction markets there are, the higher the probability of disputes, thus directly driving demand for UMA tokens. In the trading model, the required margin can be a very small percentage, for example, 0.10% of the total bet. Assuming a bet of 1 billion US dollars on the presidential election result, UMA can earn 1 million US dollars in revenue. In the assumed scenario, UMA can use this revenue to purchase and destroy its own tokens. This model has its advantages and also faces certain challenges (which we will further discuss later).
Apart from Polymarket, another example of a similar model is MetaMask. Through the wallet's embedded exchange function, there is currently about $36 billion in transaction volume, with revenue from exchange business alone exceeding $300 million. In addition, a similar model also applies to staking providers like Luganode, which charges fees based on the amount of staked assets.
However, in a market where API call revenue is decreasing, why do developers choose one infrastructure provider over another? And if revenue sharing is needed, why choose this oracle service over another? The answer lies in network effects. Providers that support multiple blockchains, offer unparalleled data granularity, and can index new chain data faster will become the preferred choice for new products. The same logic also applies to categories such as intent or gasless exchange tools. The more blockchains supported, the lower the costs and the faster the speed, the more likely they are to attract new products, as marginal efficiency helps retain users.
( Token Repurchase and Burn
It is not new to link token value to protocol revenue. In recent weeks, some teams have announced mechanisms to buy back or burn native tokens based on revenue ratios. Among them, notable ones include Sky, Ronin, Jito, Kaito, and Gearbox.
Token buyback is similar to stock buyback in the US stock market, essentially a way to return value to shareholders (token holders) without violating securities laws.
In 2024, the amount of funds used for stock buybacks in the U.S. market alone reached about $790 billion, compared to only $170 billion in 2000. Before 1982, stock buybacks were considered illegal. In the past decade, Apple alone has spent over $800 billion on buybacks of its own stock. Although the trend remains to be seen whether it will continue, we see a clear divergence in the market between tokens with cash flow and a willingness to invest in their own value, and those without either.
Where does the protocol revenue come from under the decline in liquidity? Will token buyback and burn be the answer?)https://img.gateio.im/social/moments-1c6ddaa046832385691ee73d9b34fdef(
For most early protocols or dApps, using revenue to buy back their own tokens may not be the most optimal capital utilization method. One feasible approach is to allocate sufficient funds to offset the dilution effect caused by the issuance of new tokens, and this is exactly what the founder of Kaito recently explained about their token buyback method. Kaito is a centralized company that incentivizes users with tokens. The company receives centralized cash flow from corporate clients and uses part of the cash flow to execute token buybacks through market makers. The amount of tokens repurchased is twice the number of newly issued tokens, thus putting the network into a deflationary state.
Unlike Kaito, Ronin adopts a different approach. The chain adjusts fees based on the number of transactions in each block. During peak usage, some network fees will flow into the Ronin Treasury. This is a way to monopolize asset supply without token buybacks. In both cases, the founders have designed mechanisms to tie value to economic activity on the network.
In future articles, we will delve into the impact of these operations on the prices of tokens participating in such activities and on-chain behavior. But for now, it is obvious that with the decline in token valuations and the reduction in venture capital inflows into the cryptocurrency industry, more teams will have to compete for marginal funds flowing into our ecosystem.
Considering the core attributes of the blockchain 'currency orbit', most teams will instead adopt a revenue model based on transaction volume percentages. When this happens, if the project team has already launched tokens, they will be motivated to implement a 'buyback and burn' model. Teams that can successfully execute this strategy will become winners in the liquid market, or they may buy their own tokens at a very high valuation. The results of everything can only be known afterwards.
Of course, there will come a day when all discussions about price, profits, and revenue will become irrelevant. We will continue to invest money in various 'dog Memecoins' and purchase various 'monkey NFTs.' But look at the current market situation, most founders who are worried about survival have begun to have in-depth discussions around revenue and token burning.