Token Utility: Revenue Capture

Fee capture and revenue share are two mechanisms that are popular among cryptocurrency tokens to incentivize protocol engagement and generate demand for the underlying token.

Fee capture refers to the transaction or usage fees that a protocol charges its users, while revenue share refers to the portion of fees that the protocol and its tokenholders keep (using Token Terminal’s definitions).

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Does an increase in fees translate to an increase in value for tokens?

Simply increasing the fees charged by a protocol doesn't necessarily lead to a rise in token value, as the fees captured by a protocol don't directly benefit tokenholders. Some protocols charge fees for using the underlying protocol but don't distribute any of the captured value back to tokenholders.

Tokenholders lack any legal rights to the fees generated by the protocol, so there's no direct connection between the two. It's erroneous to assume a causal relationship between fee generation and token value unless tokens have some value accrual mechanism that allows them to benefit from increased revenues generated by fees, either directly or indirectly.

Some token buyers conflate an increase in protocol fees with the potential for more value accrual for tokenholders. Although a change to share the revenues with token holders could happen through protocol-level modifications, it's still only a possibility until it's actually implemented. Sometimes the speculation of this outcome is enough to increase demand for the token.

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Why revenue-sharing increases demand for tokens

The price of a token is determined solely by its supply and demand in the market. To determine the present value of an asset, one must compute the total discounted value of all future cash flows. Any increase in a token's cash flow will proportionally raise its value, which in turn increases demand until supply and demand reach a balance.

In the examples below, we’ll cover various tokens and how they implement fee capture with and without revenue sharing.

Example 1: GMX (with revenue sharing)

GMX is a decentralized exchange with two main tokens: $GMX and $GLP. Both tokens are able to capture the revenue generated from the fees paid by users of the exchange.

$GMX is the platform’s utility and governance token. It accrues 30% of the platform’s generated fees. $GLP is the platform’s liquidity provider token. It accrues 70% of the platform's generated fees. Token holders must stake their $GMX tokens in order to receive trading fees via $ETH and more escrowed $GMX (learn more).

According to Token Terminal, GMX has generated $18.3m in fees and $5.5m in revenue in the last 30 days (as of April 29, 2023). We assign a 30% revenue capture / fees ratio.

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Example 2: Lido Finance (minimal revenue sharing)

Lido Finance is a decentralized platform that provides staking services for proof-of-stake cryptocurrencies (like $ETH, $MATIC, $SOL, and more).

The Lido staking protocol applies a 10% fee (this can be changed by the DAO) on staking rewards that are split between node operators and the Lido DAO. The Lido DAO (made of the $LDO tokenholders) accrues value through staking rewards, with the DAO receiving 5% of all staking rewards (source).

According to Token Terminal, Lido Finance has generated $49.2m in fees and $4.9m in revenue in the last 30 days (as of April 29, 2023). We assign a 10% revenue capture / fees ratio.

Given the revenue capture %, we can assume any increase in usage (i.e. staking services) directly results in an increase in fees, which then flow proportionally to the DAO and tokenholders.

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Example 3: Uniswap (no revenue share… yet)

Uniswap is the largest of the decentralized exchanges (DEXs). With over 70% of the DEX market share by trading volume, Uniswap has the largest community of traders and liquidity providers.

Uniswap is the most well-known example of a protocol with significant value capture, but none of it (currently) is passed back to tokenholders.

According to Token Terminal, Uniswap has generated $48.0m in fees, but $0 in revenue in the last 30 days (as of April 29, 2023). We assign a 0% revenue capture / fees ratio.

In the past year, a “fee switch” proposal was introduced - reducing the fees accrued to the liquidity providers and passing some of the fees to the $UNI tokenholders.

This would be a significant move for DeFi and have significant implications for token design/launches. Tokens are currently faced with the dilemma of having no true value (due to a lack of demand for the governance utility) or the inability to distribute revenue (due to regulatory constraints).

Advocates of the fee-switch proposal argue that it could enhance the adoption of the UNI token and its utility, leading to a higher demand for it. However, some stakeholders have raised concerns about the potential risks associated with regulatory compliance and its organizational structure.

As a result, the proposal's adoption has been hindered by the need for careful consideration of securities compliance. The leadership of the Uniswap Foundation is currently exploring the possibility of implementing the fee switch via an opt-in mechanism to address these challenges.

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Evaluating the viability of tokens with revenue-sharing mechanisms

Fee capture and revenue sharing are two popular mechanisms for generating demand for cryptocurrency tokens. While an increase in fees charged by a protocol doesn't always lead to a rise in token value, revenue sharing is a way to increase token value by increasing cash flow, which leads to an increase in demand for the token.

Implementing revenue-sharing while maintaining compliance and managing capital allocation as a DAO poses a significant challenge. Protocols must carefully weigh the benefits and drawbacks of reinvesting fees into protocol growth versus redistributing them to token holders, similar to the growth versus dividend tradeoff.

As more tokens adopt revenue-sharing mechanisms, we may witness a shift toward fundamental valuation analysis based on revenue and cash flow metrics. This shift could potentially establish a new asset class grounded in fundamentals rather than speculation.

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