Cash Flows in Crypto
When you hear business and crypto, chances are you might think of two totally different subjects.
The history of crypto has been a rocky one: much trial, error, and bad actors beating to the pulse to grab a share of a digital future. This paper outlines the future of business being crypto. Further, how cash flow, seamless transactions, and protocols as a service are catalysts for a global economy without borders, bank fees, or silos.
There persists a widespread misunderstanding that crypto assets hold 0 intrinsic value due to their absence of cash flows. This fallacy arises from a public tendency to equate crypto solely with Bitcoin, and Bitcoin with digital gold — “Since gold does not produce cash flow, crypto can’t either” type of thing.
Below we look at the top 25 ‘crypto’ projects by revenue in the past year. In this graph, you can see layer 1 Blockchains & DeFi Protocols. The latter includes Layer 2 solutions, NFT marketplaces, Liquid staking derivatives, and more. By this chart you will see traditional business “cash flow” is now replaced by fees.
Fees
The name of the game is now access to services and products, and contributing to sustainable practice by micro fees. No, this is not the bank sneaking surcharges into your account so they can make a quick $. This is clear as day, operating, and action-oriented production fees allow a certain mechanism to stay standing. You’ll see fees can be paid to end users and protocols alike. Below will grid different examples of fees, revenue, and cash flow mechanisms in Decentralized Finance today:
Interested in seeing where all these different cash flows go and exist in crypto? Websites like https://cryptofees.info/ offer leaderboards on who has the most action going on.
Revenue Models
Now that it is confirmed and shown that revenue does, can, and will exist on a blockchain — let’s jump into different revenue models shown from the examples above.
- Ethereum (ETH)
Think of Ethereum as the world’s first mega, decentralized supercomputer. Applications can run on top of the network and facilitate a value exchange between two or more parties. This requires two key steps:
- Adding up who owes what to whom (i.e. compute) then ⬇️
- Validating / Verifying that a transaction has occurred -> updating the new account balance of both interactors (i.e. consensus)
Ethereum is the protocol of selling computation and consensus as two functions to settle transactions between parties.
How does this make money? It’s time to get gas.
Ethereum earns revenue through transaction fees, known as “gas fees”. Gas fees are paid by users of DApps to have their transactions computed and stored on the Ethereum ledger.
In the current state of the web, businesses bear the costs of computing and storage provided by cloud computing services like Amazon Web Services (AWS). In the blockchain world, users themselves shoulder these expenses, which are essentially Ethereum’s revenues.
Just as revenues are determined by Quantity sold * Unit price, Ethereum’s transaction fees are calculated by Gas used * Price per unit of gas, where:
- Gas is the measure of how much computational resource is required to process a transaction. Simple operations, like a user sending some ETH to another, have low gas intensity. Complex operations, like pricing derivatives with the Black-Scholes formula for an options protocol, are more computationally intensive and require higher gas.
- Price per unit of gas is denominated in Ethereum’s native currency ETH, specifically in gwei (a subunit of ETH). 1 billion gwei is equal to 1 ETH. The price per unit of gas consists of two components: the base fee, dynamically set by the network based on demand (higher during network congestion), and the priority fee, set by the user as a tip to the validator. Validators have the authority to prioritize transactions based on the gas prices offered (see diagram below). This means gas prices are determined through a competitive bidding mechanism where users compete to have their transactions included in blocks.
Wrapping the above text together, Ethereum’s transaction fee paid by users is Gas * (base fee + priority fee).
For example, let’s say Alice wants to send Bob 1 ETH. The transaction’s computational work is 21,000 gas, the base fee is 10 gwei and Alice includes a tip of 2 gwei. Then Alice’s total gas fee would be 21,000 x (10 + 2) = 252,000 gwei or 0.000252 ETH.
Transaction fees and analytics on gas prices are a leading indicator to understand demand and network congestion on Ethereum. The primary driver of this demand and congestion comes from Decentralized Finance. For this, we will next look at the Unicorn of DeFi, Uniswap.
2. Uniswap (UNI)
Uni who swap? An Explanation:
Uniswap solved one simple problem in decentralized finance and has pioneered: Swapping ERC 20 tokens. Uniswap by profile is a Decentralized Exchange (DEX) and in 2023, has rolled out expansion products such as a mobile wallet and UniswapX.
As you can see, Uniswap dominates trading on chain (DEX). Uniswap enables trading in a new-age fashion, as opposed to traditional centralized exchanges, with Coinbase as an example. Traditional exchanges utilize an order book, which lists the buy and sell orders of traders, then matches them based on compatible prices.
Uniswap, in opposition, relies on liquidity pools Liquidity pools are reserves of token pairs (e.g. ETH & USDC) that are contributed by Liquidity Providers (LPs). Anyone can become an LP by depositing an equivalent value of each underlying token. Traders then trade against these liquidity pools, rather than directly against each other. This design called an Automated Market Maker (AMM), has gained popularity in the DeFi ecosystem as an alternative to order book-based trading systems. Advantages of AMMs include no counterparty risk and lower barriers to becoming a market maker. A disadvantage however is that there could be a lack of price efficiency. AMMs operate based on a predefined mathematical formula to determine prices. As a result, prices offered may not always reflect the true asset value (although in reality, much of the price differences get arbitraged away by traders). This can lead to slippage and potentially unfavorable trading prices, particularly for larger trades.
So, what about cash flow?
Uniswap fees are a function of trading volume and take rate.
- Trading Volume: Uniswap, since launching in 2018, has facilitated ~$1.5 trillion in trading volumes. Trading volumes, which are positively correlated with crypto prices, have been negatively affected by the crypto market downturn.
- Take Rate: Uniswap’s take rate has changed with version upgrades. V1 and V2 had a model of fixed 30 basis point (bps) fees, while V3, released in May 2021, introduced a tiered system consisting of 5 bps, 30 bps and 100 bps for different pools. This mix shift has compressed the average take rate from 30 bps to approximately 15 bps. UNI token holders can propose and vote on additional fee levels.
Currently, Uniswap directs all trading fees to LPs without allocating any portion to the Uniswap DAO/token holders. This strategy aims to strengthen its network effect and maintain a competitive edge over rivals, perhaps similar to traditional tech platforms’ reinvestment model of sacrificing short-term profitability to build a moat. The optimal allocation of protocol fees between providers of work (in this case LPs) and providers of capital (i.e. token holders) is a recurring debate in crypto communities.
The Uniswap DAO has also previously discussed implementing a “fee switch” to redirect some fees to UNI token holders, but the proposal was not passed due to concerns about timing and the resultant liquidity levels. An added concern, particularly in the US, is whether sharing fees with the UNI holders would classify Uniswap as an unregistered security. As Uniswap solidifies its network effect and regulatory clarity improves, the fee allocation strategy may evolve.
Conclusion, Ocean Protocol, and the Future
Ocean Protocol is an open-source toolkit to enable the next generation of value flow on a blockchain and surcharge a New Data Economy. Leveraging web3 and AI: new business models and sustainable practices are now available to experiment with.
Tokens, like stocks and bonds, can have cash flows supporting their intrinsic value. Crypto, previously the domain of speculators and retail gamblers, is arguably entering a phase of maturation that enables analysts, entrepreneurs, and data scientists to evaluate the fundamental value of new businesses.
Blockchains are a foundational infrastructure facilitating frictionless value transfer over the internet. DApps built on blockchains (ie Ethereum using Ocean Protocol) are akin to internet-native businesses with unique revenue models, cost structures, competitive advantages, capital allocation strategies, and valuations.
As blockchain-based economies progress, we anticipate the value to align with project fundamentals in a valuation-conscious manner.
About Ocean Protocol
Ocean was founded to level the playing field for AI and data. Ocean tools enable people to privately & securely publish, exchange, and consume data.
Follow Ocean on Twitter or Telegram to keep up to date. Chat directly with the Ocean community on Discord. Or, track Ocean progress directly on GitHub.
