What Makes DeFi Tokens Valuable?
The decentralized finance, or DeFi, industry is one of the biggest in crypto and has a total value locked in the hundreds of billions. Many DeFi platforms have their own native token that is used for making governance decisions on the protocol or earning a percentage of the fees. These tokens can be critical to the success of a platform, yet do not have a simple valuation model. Let’s look at a few different metrics that should be considered to properly assess a DeFi token as an investment.
DeFi tokens have long been considered a higher-risk cryptocurrency, even though the transactions they facilitate are growing at a rapid pace. For example, the UNI token, native token of the Uniswap decentralized exchange, is down almost 90% from its all-time high, even though Uniswap is continuing to break volume records and has surpassed over $1 trillion in total volume. Additionally, the Optimism OP token, which fuels the second largest Ethereum layer 2, was dumped immediately on release and has little buy pressure. Why are the tokens powering some of the most important tools in DeFi not being priced accordingly?
As it turns out, these tokens may have less of a use case than it appears at first glance. Both UNI and OP have a similar token model that gives holders of the token governance rights over the platform. This allows users to vote on issues like how the treasury is used, gas fees on the platform, and in the case of UNI whether Uniswap expands to support new blockchains. Even though governance rights may seem valuable, there is a key piece missing from both of these DeFi tokens: profit sharing.
In the traditional finance world, holding a stock entitles the holder to a share of any future profits of the company. This gives the stock a fundamental value based on the profits generated by the company and the monetary value of those profits. Some companies directly give their profits to shareholders through dividends. This makes these stocks yield-generating assets that will always create cash flow for their holders, regardless of their price action.
In the case of a lot of DeFi tokens, this dividend system is not in place, and the token’s only value to the holder is in the power of governance. To be clear, this is not completely worthless — UNI holders could vote to direct some of the transaction fees to themselves as a type of dividend, for example. However, in the case of UNI specifically, the community has voted down the idea of profit-sharing on numerous occasions, instead opting to focus on the continued growth and adoption of the ecosystem.
The AAVE token, on the other hand, is an example of a DeFi token with a dividend-esque model. The fees collected by the Aave protocol are used to buy and burn the AAVE token, making it deflationary. This model has helped support the price of AAVE against extreme downturns and incentivizes users to hold during bear markets as well as bull markets. Dividends or buybacks also make a token easier to value, as math can be done to determine the base value of a token is given platform volume metrics.
CRV, the token of the Curve protocol, also has interesting tokenomics that have been adopted by many other new projects. It has several different use cases, including allowing users to vote on what liquidity pools they think to deserve to have CRV emissions as rewards. The power of a user’s vote is based on how long they freeze their tokens, and tokens can be frozen for up to four years. Users who have staked tokens also get 50% of the protocol fees as a dividend and have their yields on liquidity provided to Curve boosted.
With all of the different tokenomics models for DeFi tokens, it is important to ensure that the token of a platform you are thinking about investing in has a token that reflects the value of the platform. There could be a DeFi platform with revolutionary technology that serves an important use case, but without good tokenomics, the token is doomed to mediocrity. Ensuring that a DeFi token will have value in both bull and bear markets is arguably the best way to protect and grow DeFi investments.
By Lincoln Murr