Author: Jeff Dorman, Arca Chief Investment Officer
Compiled by: Jiahuan, ChainCatcher
Chart Source: TradingView, CNBC, Bloomberg, Messari
Crypto Protocols Are Starting to Truly Make Money
Last week, Bitwise Chief Investment Officer Matt Hougan published an article suggesting that as more protocols connect revenue to token holders through value-capturing mechanisms like token buybacks, crypto asset valuations could double, or even reach higher levels.
We agree with this view. In fact, we've been waiting a long time for the market to finally accept this logic.
For nearly a decade, Arca has believed that digital assets should ultimately be analyzed like all other investable assets: based on fundamental value and expected future cash flows. Tokens are not stocks, and the way token holders receive value differs from that of shareholders. However, fundamental investment principles don't suddenly become invalid just because an asset exists on a blockchain, or because the issuing entity changes from a Delaware corporation to a protocol.
However, this viewpoint was not easy to argue in the past.
In July 2019, when most people still habitually lumped nearly all digital assets under the umbrella term "cryptocurrency," we pointed out that this definition was unreasonable. Digital assets represent a range of different types of economic rights. Some are currencies, some are utility tokens, and others, as we said at the time, "are essentially assets linked to the equity of cash-flow generating companies."
Back then, we specifically mentioned exchange tokens. This type of token has product usage value and also has an economic interest link to the underlying business, for example, by allowing holders to indirectly share a certain percentage of revenue or profit through token buybacks.
Six months later, in our December 2019 annual review, we categorized digital assets into four groups, one of which was "enterprises using tokens and generating real cash flow." At that time, some centralized crypto companies were already generating substantial revenue, but decentralized protocols were mostly still experimental. We wrote then that decentralized protocols might need "5 to 10 years" to truly create economic value.
Looking back, we weren't far off in our guess.
Six and a half years later, protocols like Hyperliquid (HYPE), Aave (AAVE), Aerodrome (AERO), and Maple Finance (SYRUP) have started generating real fees and revenue from real users. And in many cases, their profit margins and capital efficiency would be the envy of most public companies.
The question is no longer whether decentralized protocols can create economic value, but rather how they should use that value. This is where things get interesting.
Having Revenue Does Not Mean the Token Has Value
A protocol generating revenue does not mean its token inherently has value. This is very important and one of the key points we have emphasized repeatedly in our research on digital assets.
In August 2020, when analyzing the then-emerging DeFi protocol Aave, we distinguished between two things: incentives generated by token inflation, and economic profits created by real users and business activities within the ecosystem. We wrote at the time: "In our view, exogenous cash flow from real business is key to long-term value growth for token holders."
Six years later, Aave is still here, and this issue persists. If a protocol generates $500 million in annual revenue, but none of that profit ever flows to the token, why should token holders care? This is a major difference between digital assets and stocks.
When you buy a company's stock, you own a portion of its residual claim. The company can reinvest profits back into the business, return them to shareholders via dividends, or use them for share buybacks. Even if a company never directly returns a dollar of capital to shareholders, there is another way for shareholders to realize value: the entire company could be acquired.
A startup can reinvest every dollar it earns for years because investors believe these investments will create more profit in the future. Once the company matures, it can start paying dividends or buying back shares.
Alternatively, another company or a private equity firm might acquire it outright at, say, 20 times earnings, with shareholders receiving the acquisition proceeds, typically at a premium to the prevailing stock price.
But crypto protocols generally don't have such a final exit.
No one is going to acquire the Aave protocol at 20 times EBITDA and mail a check to all AAVE holders. No one is going to buy Hyperliquid and let all HYPE holders exit at a 30% acquisition premium. These protocols are decentralized networks, at least in theory designed to exist indefinitely, unlike companies which can ultimately realize value through acquisition.
Therefore, for tokens, the link between protocol economics and token economics may be even more important than the link between company profits and stock.
Because if a protocol generates tens of billions in revenue over its lifetime, but not a single dollar flows to token holders, there may never be a final event to bridge the gap between "protocol value" and "token value."
Protocol Profits Must Ultimately Flow to Tokens
Therefore, we increasingly believe that token buybacks are one of the simplest and most direct mechanisms to directly link protocol success with token holder value. However, this doesn't mean every protocol should immediately use all its revenue to buy back its own tokens. In fact, this would often be poor capital allocation.
Many leading protocols today are still essentially in the startup phase. They are growing very fast and have numerous opportunities to deploy capital. They can improve products, provide liquidity incentives, enter new markets, acquire teams or technology, build insurance reserves, subsidize new products, or invest in the entire ecosystem.
If a protocol can invest $1 today to create $5 of value in the future, we'd obviously prefer it to continue investing rather than using that $1 to buy back tokens.
This is not a problem unique to the crypto industry.
Amazon became one of the most successful investments in history not because it aggressively raised dividends and stock buybacks during its high-growth early years. When capital reinvestment yields a higher return, good companies choose to retain profits for investment rather than return them to shareholders.
Protocols should do the same.
But there is a huge difference between "We are not buying back tokens today because there are better uses for capital now" and "There is no reason to believe this revenue will ever flow to token holders in any form."
The former can be a very sound capital allocation decision, while the latter makes valuation nearly impossible. In other words, buybacks don't have to happen today, but investors must believe they will happen someday.
Morpho (MORPHO) founder Paul Frambot recently revived this discussion. He opposes aggressive token buybacks, arguing that young, fast-growing protocols should reinvest profits into the business rather than distributing them.
Last year, he expressed similar views in a blog post. We largely agree: a protocol should be judged like a company—reinvest when the expected return on incremental capital is sufficiently high; return capital when that return declines.
But there's a crucial difference between Morpho and the tech companies Frambot compares it to. Meta's shareholders own Meta. Even before Meta started returning capital to shareholders, they legally owned the residual claim on the company's growing profits and assets.
In theory, they can ultimately realize this value through dividends, stock buybacks, or a company acquisition. MORPHO holders do not have the same clear path to value realization.
Therefore, reinvesting protocol revenue into the business can delay when token holders receive value, but it cannot indefinitely substitute for value capture itself. Ultimately, the economic value created by the protocol must be transmitted to the token in some way.
And Crypto Twitter, as usual, has framed this as a black-and-white debate: "Are buybacks good?" or "Are buybacks bad?" The real issue is timing, as we discussed in March 2025. Buybacks don't have to happen today, but protocols must eventually answer one question: What do token holders actually own?
After Making Money, How Should Protocols Spend It?
For most of crypto's history, "capital allocation" wasn't even an important topic because projects didn't have much capital to allocate. Projects raised money, burned it, and then issued tokens to incentivize users. If they ran out of money, they raised more.
Now, that's changing.
Once a protocol starts generating significant free cash flow, its founders and governance participants suddenly face a question that Jamie Dimon, Warren Buffett, and CEOs of all public companies have faced for decades: What should we do with this money?
-
Should we reinvest in the business?
-
Should we make acquisitions?
-
Should we subsidize growth?
-
How much reserve should we keep?
-
Should we enter adjacent businesses?
-
After the expected returns on these investment opportunities start to decline, should excess capital be returned to token holders?
These are capital allocation decisions. Therefore, when evaluating a protocol today, digital asset investors shouldn't just look at how much revenue it creates, but also at what it does with that revenue.
Imagine two protocols, each generating $100 million in annual revenue, both growing revenue at 30%, with roughly similar profit margins and competitive positions.
-
Protocol A reinvests all earnings back into the business indefinitely, with no credible mechanism to ensure these earnings will ever flow to token holders.
-
Protocol B also actively reinvests at this stage, but its governance mechanism and tokenomics explicitly state that after meeting reasonable reserve and growth investment needs, remaining cash flow will be used to buy back its own tokens.
These two tokens should not have the same valuation multiple. Protocol B has established a credible mechanism for transmitting protocol revenue to token value; Protocol A has not.
Buybacks Do Not Equal Value Return
Even the term "buyback" itself requires careful analysis. Suppose a protocol generates $100 million in revenue, uses $50 million to buy its own tokens, but then reissues $50 million worth of the same type of tokens as incentives. This doesn't necessarily mean it has truly returned $50 million in value to token holders. This might just be a recycling of token emissions, not equivalent to actually returning $50 million to holders.
A buyback and burn permanently reduces token supply; a buyback followed by distribution of tokens to holders or stakers transfers economic value more directly. If the protocol puts the bought-back tokens into a treasury, that can also create value, but only if that treasury is ultimately managed for the benefit of token holders. The specific mechanism matters.
But the underlying principle is actually very simple. If a protocol creates economic value, there must ultimately be a mechanism for token holders to share in that value. Otherwise, so-called "protocol revenue" is just an interesting statistic.
From Revenue to Valuation
By 2021, we were already starting to see this framework operating in reality.
In July of that year, we introduced a group of digital assets, describing their underlying projects as: "Real companies, real cash flow, tokens that capture economic value, and a way to measure their success." We believed then that these projects were finally starting to achieve what we had always hoped digital assets would ultimately do: allow customers and users to share in the economic value created by the project.
But the problem then was that there were far too few such projects. Now, the situation is different. This is precisely why Hougan's viewpoint is so noteworthy.
The truly important part of his article isn't the idea that "revenue should flow to token holders." What's truly important is that just as these assets themselves have matured, and this valuation framework has finally begun to work in practice, it also happens to be going mainstream. This will have a very significant impact on valuations.
Valuation Discounts Should Start Shrinking
If a protocol's revenue grows 50%, its token may naturally become more valuable because the protocol's ability to generate profit is increasing. But simultaneously, another thing can happen: the valuation multiple investors are willing to pay for those profits may also rise.
Suppose a protocol's profit grows 50% annually, and at the same time, as investors increasingly believe these profits will ultimately flow to token holders, its valuation rises from 8 times profit to 16 times profit.
In this case, the protocol's profit doesn't even need to double for the token price to double. The reason is simply that the market is now willing to pay a higher price for each dollar of profit, because investors believe the probability of those profits eventually flowing to token holders has increased.
This is essentially the point Hougan made: as clearer links are established between protocol revenue and tokens, crypto asset valuations could double or reach even higher levels. We think he's right. For a long time, crypto protocols that generate profits have traded at significant valuation discounts relative to similar public companies. Part of that discount is clearly reasonable.
Stockholders have legally protected ownership; corporate governance structures are highly mature; financial statements are audited; securities laws protect investors; management has fiduciary duties; and after decades of practice, shareholders have a very clear institutional and legal basis for understanding what they own.
Token holders often don't have these things. So, a token likely should trade at some discount relative to a stock with identical economic conditions.
But the question is, how big should that discount be?
If a protocol has hundreds of millions in recurring revenue, extremely high profit margins, rapid growth, access to global markets, limited capital needs, and a transparent mechanism for consistently using excess cash flow to buy its own tokens, should it really trade at a small fraction of the valuation multiple of a slower-growing public company?
Maybe.
But we increasingly suspect the answer is no. This means that one of the biggest opportunities in digital assets today may not just be finding protocols whose revenue is still growing. The more important opportunity may lie in identifying protocols whose fundamentals have changed, but whose market pricing still uses an outdated valuation framework.
Crypto Investing Is Moving Towards Fundamentals
For nearly a decade, Arca has believed that digital assets would ultimately be valued using the same fundamental investment principles as all other assets.
-
In 2019, we discussed enterprises with cash flow that used token buyback mechanisms.
-
In 2020, we argued that exogenous cash flow was key to long-term value growth for token holders.
-
In 2021, we began focusing on digital assets behind projects that actually generated revenue and allowed tokens to capture economic value.
This didn't mean the market was ripe for fundamental investing back then. Frankly, most assets themselves weren't ready. The problem wasn't that the framework was wrong, just that the industry wasn't mature enough for the framework to work reliably.
Now it's different.
Protocols have customers, they generate revenue, they create profit, protocol operators are starting to face capital allocation decisions, and more and more excess cash flow is being used to buy tokens.
This means the questions digital asset investors should ask today have become very familiar:
-
How fast is revenue growing?
-
What are the profit margins?
-
How durable are the competitive advantages?
-
How much capital needs to be reinvested to sustain growth?
-
What returns can these reinvestments generate?
-
As high-return reinvestment opportunities diminish, how much excess capital will ultimately be returned to token holders?
In other words, crypto investing is finally starting to become fundamental investing. After spending over 15 years trying to invent new token valuation methods, the next major "innovation" in digital assets may be precisely the logic stock investors have long been familiar with: Make money, grow profits, allocate capital wisely, and ultimately let asset holders share in those profits.
