Original: 《Lifetime Value for Crypto Businesses》

Author: KERMAN KOHLI, Founder of ARCx

Compiled by: Deep Tide TechFlow

About this time last year, I started writing articles about crypto businesses and how their unit economics were being broken in a way that made most industries look like a joke. It wasn't until the FTX collapse that people really started paying attention.

Since then, I have not only been thinking about these issues but also building the necessary components to address them. Before that, I will share some additional thoughts I have had on the conceptual frameworks that help in thinking about these issues.

Lifetime Value (LTV)

One of the most important metrics for any business. It represents the value of the fees a customer generates for the business over their lifetime. The key here is that each business earns fees in different ways, so a deep understanding of its mechanisms is needed to grasp the creation of value and the subsequent capture. Below is a rough conceptual framework for thinking about different categories of issues.

These are all based on each user, so of course, more users will generate more revenue, which is common sense, but the key factor here is that the quality of these users matters.

Chain

While networks do not equate to businesses in their purest sense, knowing how much each user brings in fees on average can tell you a lot about the health of the chain. This is a challenge for high-throughput L1 and L2 networks, as their fees are much lower compared to Ethereum. They need to show higher activity levels or add supplementary services that earn most of the revenue (like cinemas, where the cost of movies is low, but the real profits come from the snack bar).

For chain/general computing platforms, our formula is: Fees Paid = Complexity of Transactions (Gas) * Price of Computation (Gas Price).

This means that the two dimensions that computing platforms (chains and L1) should think about are:

• How to increase the complexity of transactions? DeFi is one example, and blockchain gaming is another (as long as the gameplay occurs on-chain).

• How to continuously increase the average price of computation (Gas Price)? When Ethereum's Gas prices are extremely volatile, transaction fees on Ethereum can spike significantly. Additionally, sustained activity is another dimension that increases the transaction fees paid by each user.

This is not an exhaustive framework but rather levers that should be studied.

DEX

Decentralized exchanges (DEX) have a simpler framework for understanding their customer lifetime value because there are really only two aspects to consider: Fees Paid = Transaction Size * Transaction Fees (Rate %).

The two dimensions that DEXs need to optimize are:

• How to increase the average transaction size occurring on my DEX? This can be achieved by focusing on specific verticals (like the strategy of stablecoin Curve) or long-tail speculative coins (Uniswap). While both try to capture each other's market share.

• How to increase the average transaction fee I can charge per transaction? This is where NFT markets have been hit hard, as they are in a "race to the bottom," where transaction fee rates are not only 0% but the unit economics are negative due to the incentives paid.

Lending

Any lending protocol has the same unit economics, and how they address these challenges depends on themselves, but from a key perspective, their equation is as follows: Fees Paid = Profit Earned by Lenders (%) * Fee Ratio of Profits (%).

For these two dimensions, you need to operate at scale to achieve meaningful operations:

• How to increase the profit that lenders can earn? This may be the least optimized variable, as in a market where the underlying asset can grow tenfold in a year, borrowers are relatively insensitive to price (but stablecoins are an exception). However, few borrowers are willing to pay fees above double digits, meaning the best-case scenario is 10% (which is already considered high).

• How to capture a portion of the profits earned by lenders? This complicates things because the profits are already very small, and capturing a portion of the profits will make things even harder. For example, Aave takes 10% of the profits earned by lenders, but if the lender earns 5% on stablecoins, then 50 basis points is Aave's pure profit and the value of that customer.

Stablecoins

Stablecoins are a business that everyone loves because it means you have a money printer, and typically, to drive these businesses, you need to spend a lot on liquidity incentives to attract customers. However, to demonstrate why these businesses are profitable, you only need to look at their fee structure: Fees Paid = Interest Charged * Value of Borrowed Assets.

That's it. You set the interest rate and encourage borrowers to take as many assets as possible. When considering your two levers, you only need to understand:

• How to ensure I can charge the highest possible interest rate while still being competitive? This largely depends on the practices of competitors (money markets) and the costs I pay for liquidity.

• How to get borrowers to take as many assets as possible? This is challenging because the quality of the assets will determine the platform's risk and your ability to remain solvent.

Any money you earn is your profit. The only question is how your costs are used to ensure your stablecoin remains pegged or has built-in strong demand support.

Yield Aggregators

This essentially covers any service that claims "give me your money, and I will make you the most money." These businesses are excellent when first launched, but the biggest challenge lies in defensiveness and negative network effects. The fee structure is similar to lending businesses, but their underlying business mechanisms differ.

Fees Paid = Deposit Size * Profit Earned by Depositors * Performance Fee (%).

The reason I include deposit size here is that the more funds a yield aggregator has, the less yield it generates for other users. In fact, it has a negative network effect!

• As a yield aggregator, you definitely want to have a large amount of funds so you can earn more profits and capture performance fees. The only challenge is that you don't want too much capital because it will be difficult to generate growing profits for all depositors, which will reduce your performance fees.

• To increase the profits earned by depositors, your biggest challenge is that any strategy you deploy on-chain can be copied by anyone - and very quickly. Moreover, you are squeezed on both sides.

• Performance fees. This is also a very difficult vector to optimize because any percentage you charge depositors, technically, they can exclude you and go directly to the source. It's like limited partners directly investing in the startups discovered by their venture capital fund.

Conclusion

As you can see, each crypto primitive offers very similar businesses to those seen in the real world, but due to the nature of their environment, they have slightly different mechanisms. Additionally, the relationship between costs and profits is a subtle one, where an element of "incentive elasticity" exists.