Make Income Great Again

Author of the article:Decentralised.CoArticle compilation: Block unicorn

The inspiration for this article comes from a series of conversations withGanesh Swami, covering the seasonality of revenue, the evolution of business models, and whether token buybacks are the best use of protocol capital. This is a follow-up to my previous article on the stagnation of cryptocurrencies.

Private capital markets such as venture capital oscillate between excess liquidity and scarcity. When these assets become liquid and outside capital pours in, market frenzy drives prices up. Think of a newly launched IPO or token offering. The newfound liquidity allows investors to take on more risk, which in turn drives the creation of a new generation of companies. $22.1 billion was spent buying Bitcoin last year. But Bitcoin's price surge last year did not translate into a rebound in the long tail of small altcoins.

We are witnessing an era where capital allocators are liquidity-strapped and attention is spread across thousands of assets, while founders who have been working hard on tokens for years are struggling to find meaning in them. When launching meme assets can generate more financialOpenSea's revenue is seasonal. In the NFT summer, the market cycle lasted two quarters, while social financial speculation lasted only two months. Speculative revenue from products makes sense if the scale of revenue is large enough and consistent with product intent. Many meme trading platforms have joined the club with fees exceeding $100 million. The scale of this number is what most founders can expect in the best case scenario through tokens or acquisitions. But for most founders, this kind of success is rare. They are not building consumer applications; they are focused on infrastructure, where the revenue dynamics are different.

Between 2018 and 2021, VCs heavily funded developer tools in the hope that developers would attract a large number of users. But by 2024, two major changes have occurred in the ecosystem. First, smart contracts enable unlimited scaling with limited human intervention. Uniswap or OpenSea do not need to scale teams in proportion to trading volume. Second, advances in LLMs and AI have reduced the need to invest in cryptocurrency developer tools. Therefore, as a category, it is at a moment of reckoning.

In Web2, API-based subscription models worked because there were a huge number of users online. However, Web3 is a smaller niche market, and few applications scale to millions of users. Our advantage is a high revenue per user metric. The average user of cryptocurrency tends to spend more money at a higher frequency because blockchains enable you to do this - they make it possible for money to flow. As a result, over the next 18 months, most businesses will have to redesign their business models to capture revenue directly from users in the form of transaction fees.

This isn’t a new concept. Stripe initially charged per API call, Shopify charged a flat fee for subscriptions, and both later moved to charging a percentage of revenue. For infrastructure providers, this model translates fairly directly in Web3. They will cannibalize the market on the API side by racing to the bottom — perhaps even offering their product for free until a certain volume, and then negotiating revenue share after that. That’s the ideal hypothetical scenario.

What would this look like in practice? One example is Polymarket. Currently, the UMA protocol’s token is used for dispute resolution, and the token is tied to the dispute. The greater the number of markets, the higher the probability of a dispute. This drives demand for the UMA token. In a trading model, the required margin can be a fraction of the total bet amount, such as 0.10%. For example, a $1 billion bet on the outcome of the presidential election would generate $1 million in revenue for UMA. In a hypothetical scenario, UMA could use this revenue to buy and burn their tokens. This approach has its benefits and challenges, as we will see shortly.

Another player doing this is MetaMask. The transaction volume processed through its embedded exchange function is about $36 billion. The exchange revenue alone is over $300 million. A similar model applies to staking providers like Luganode, where fees are based on the amount of assets staked.

But in a market where the cost of API calls is decreasing, why would a developer choose one infrastructure provider over another? Why would one oracle over another if revenue sharing is required? The answer lies in network effects. Data providers that support multiple blockchains, provide unparalleled data granularity, and can index new chains faster will become the first choice for new products. The same logic applies to transaction categories like intent or gas-free exchange facilitators. The more chains supported, the lower the margins, the faster the speed, and the higher the likelihood of attracting new products, as this marginal efficiency helps retain users.

Burn All

The shift to tying token value to protocol revenue is not new. In recent weeks, several teams have announced mechanisms to buy back or burn tokens in proportion to revenue. Notable among them are SkyEcosystem, Ronin Network, Jito SOL, Kaito AI, and Gearbox Protocol. Token buybacks are similar to stock buybacks in the U.S. stock market - essentially a way to return value to shareholders (or in this case, token holders) without violating securities laws. In 2024, the U.S. market alone will have spent about $790 billion on stock buybacks, compared to $170 billion in 2000. Whether these trends will continue remains to be seen, but we are seeing a clear bifurcation in the market between tokens that have cash flow and are willing to invest in their own value, and tokens that have neither.

For most early-stage protocols or dApps, using revenue to buy back their own tokens may not be the best use of capital. One way to do something like this is to allocate enough capital to offset the dilution from newly issued tokens. This is how the founders of Kaito recently explained their approach to token buybacks. Kaito is a centralized company that uses tokens to incentivize its user base. The company receives centralized cash flow from its corporate clients. They use a portion of that cash flow to perform buybacks through market makers. The amount purchased is twice the amount of newly issued tokens, so in effect the network becomes deflationary.

Ronin takes a different approach. The blockchain adjusts fees based on the number of transactions per block. During peak usage, a portion of the network fees goes into the Ronin treasury. This is a way to control the supply of an asset without necessarily buying back the tokens themselves. In both cases, the founders designed mechanisms to tie value to the economic activity of the network. In future posts, we will dive deeper into the impact these operations have on the price and on-chain behavior of the tokens participating in such activities. But what is clear at the moment is that - as valuations are suppressed and the amount of venture capital flowing into crypto decreases, more teams will have to compete for the marginal funds that flow into our ecosystem. Since blockchains are essentially funding rails, most teams will move to a model where they charge a fee proportional to transaction volume. When this happens, teams will have an incentive to issue a buyback and burn model if they are tokenized. Teams that do this well will be the winners in the liquidity market.

Of course, one day, all this talk of price, earnings, and revenue will become irrelevant. We will once again spend money on dog pictures and buy monkey NFTs. But if I look at the current state of the market, most founders who are worried about survival have already started a discussion around revenue and destruction.