DeFi business models explained

Different DeFi protocol types have fundamentally different business models. A DEX generates revenue from trading fees; a lending protocol earns interest spreads; a perpetuals exchange captures trading and funding fees. Understanding these models prevents comparing apples to oranges and enables proper valuation.

DEX economics

Decentralized exchanges charge trading fees on swaps, typically 0.01% to 1% depending on the pool type and asset volatility. Revenue equals volume multiplied by fee rate. The challenge: most of this revenue goes to liquidity providers, not the protocol.

Uniswap pioneered the model with 0.30% swap fees going entirely to LPs, with no protocol fee until governance activated a fee switch. Current models vary: some protocols take 10-20% of LP fees; others have separate protocol fees. Gross margin is typically 5-20%—meaning the protocol keeps only a small fraction of total fees.

DEXs face intense competition. Liquidity is portable; if another DEX offers better rates, volume migrates. This commoditization pressures fees downward. Sustainable DEX economics require either dominant liquidity (network effects), superior routing (aggregation), or differentiated features (concentrated liquidity, advanced order types).

Lending protocol economics

Lending protocols earn the spread between borrower interest rates and depositor interest rates. If borrowers pay 8% and depositors receive 5%, the protocol captures 3%. Revenue scales with borrowed assets and interest rates, not total deposits.

Utilization drives economics. A protocol with $1B in deposits but 10% utilization earns interest on $100M. The same deposits at 50% utilization earn interest on $500M. Protocols optimize for high, stable utilization without running out of withdrawable liquidity.

Credit risk is the main cost. Lending protocols can suffer bad debt if collateral values drop faster than liquidations can execute. Large bad debt events (like the $100M+ losses some protocols experienced) can wipe out years of accumulated fees. Sustainable lending requires conservative parameters and effective liquidation mechanisms.

Perpetuals and derivatives

Perpetual exchanges generate revenue from trading fees and funding rates. Trading fees work like DEX fees but typically higher (0.05-0.10% per trade). Funding rates are periodic payments between longs and shorts that keep perpetual prices aligned with spot.

The economics are attractive: fees are higher than spot DEXs, and leverage means traders pay fees on notional value larger than their actual deposits. A trader with $1,000 taking 10x leverage pays fees on $10,000 in volume.

Perps protocols retain more revenue than DEXs because the "liquidity" often comes from the protocol itself (via liquidity pools or insurance funds) rather than external LPs requiring high fee shares. Gross margins of 50-80% are common, versus 5-20% for spot DEXs.

Liquid staking tokens

Liquid staking protocols stake user assets and return liquid receipt tokens. Lido stakes ETH and returns stETH. Revenue comes from taking a fee on staking rewards—typically 5-10% of the staking yield.

If ETH staking yields 4% and Lido takes 10% of rewards, Lido earns 0.4% annually on staked ETH. With $30B staked, that's $120M annual revenue. The model scales linearly with staked assets and staking yields.

LSTs have natural moats. Network effects matter: the most liquid LST gets the most DeFi integrations, attracting more stakers. Switching costs exist: unstaking takes time and may involve penalties. This creates stickier economics than commoditized DEX or lending markets.

L2 sequencer economics

Layer 2s earn sequencer margin: the difference between fees collected from users and costs paid to post data on L1. A user pays $0.10 for an L2 transaction; the L2 pays $0.03 to post data to Ethereum; the margin is $0.07.

Revenue scales with transaction count and complexity. More transactions mean more fee revenue. Complex transactions (DeFi, gaming) generate higher fees than simple transfers. L2s compete on fees, speed, and ecosystem—but sequencer margin provides meaningful protocol revenue.

L2 economics improve with scale. Data posting has fixed costs per batch, so more transactions per batch reduce per-transaction costs. High-activity L2s achieve better margins than low-activity competitors. This creates winner-take-most dynamics within each L2 ecosystem.

Related Concepts

• Protocol revenue: How to measure what protocols actually retain
• Fees vs revenue vs profit: The accounting framework for these models
• DeFi income statement: Full financial analysis template
• Prediction market fees: Economics of emerging prediction market protocols
• Take rate: The percentage protocols capture from activity
• Sequencer revenue: How L2s monetize
• Ethereum: The base layer for most DeFi
• Solana: High-speed alternative for DeFi