The Best Way to Evaluate a Crypto Protocol

Revenue is the most crucial metric for evaluating crypto protocols because it directly reflects economic activity and value capture, unlike Total Value Locked (TVL) which can be easily gamed and doesn't always correlate with actual utility.

• Revenue is the primary metric for evaluating crypto protocols, reflecting actual economic activity and value capture.

• TVL is an easily gamed, upstream metric that does not reliably translate into protocol value or price creation for token holders.

• Blockchain ecosystems have distinct revenue models across network, application, and asset layers, requiring differentiated evaluation.

Lily Liu, President of the Solana Foundation, argues that revenue, rather than Total Value Locked (TVL), is the 'North Star' metric for evaluating crypto protocols, especially for those acting as financial infrastructure. She explains that while TVL reflects market depth, it often fails to translate into actual value and price creation for token holders. Revenue, derived from fees and inflation, represents the true utility and economic activity on a chain, providing a more robust measure of a protocol's fundamental value.

Critique of TVL as a Metric

• 00:00:00 Total Value Locked (TVL) is insufficient for evaluating crypto protocols because it does not accurately indicate the value liquidity brings to the ecosystem or how it results in protocol value capture. TVL, while a useful 'seed stage' metric during DeFi Summer in 2020 to normalize new phenomena, can be easily gamed and does not reveal the frequency of transactions or the actual economic activity. This means a high TVL doesn't automatically translate to sustained fee generation or value for token holders.

Revenue as the North Star Metric

• 00:04:52 The actual mechanism for utility and usage of a blockchain to create value and price for holders is through chain revenue. For Layer 1 protocols, revenue typically comes from three sources: inflation, fixed base fees for transactions, and variable priority fees. These block rewards, split between validators and stakers, allow token holders to participate in the network's value creation. Focusing on revenue provides a clearer picture of real economic value (REV) and is less gameable than TVL because paying transaction fees represents a direct cost and active engagement.

Blockchain Ecosystem Components

• 00:17:55 Blockchain ecosystems consist of three distinct components, each with different revenue models: the network (chains), applications, and the asset layer. Chains, as Layer 1 protocols, generate revenue through priority and base fees, and inflation. Applications typically earn revenue from a cut of transaction or trading volume, similar to exchanges. The asset layer, encompassing stablecoin issuance and tokenization, often generates revenue from Assets Under Management (AUM), making its business model somewhat sympathetic to TVL as a proxy for AUM. It is crucial to disaggregate these three components as their profit-making mechanisms vary significantly.

Addressing Revenue's Criticisms

• 00:16:12 Focusing on revenue in a nascent industry like crypto does not hamper innovation, a critique disproven by the success of high-growth companies like Amazon. While Amazon famously reported losses for extended periods, it consistently demonstrated strong revenue. Similarly, protocols can pursue innovation while still tracking revenue as a measure of economic activity, supported by patient capital. Although every metric, including revenue, can be gamed through activities like wash trading, the direct cost associated with paying transaction fees makes it a more robust indicator than TVL.