DeFi Protocols Put Their Own Spin On Tried-And-Tested TradFi Strategies

Buybacks are widely employed by publicly traded companies to try and boost the value of their stocks and boost their earnings per share, and they’re now being adopted by decentralized finance protocols with similar aims. 

In the last year, token buybacks have emerged as a popular strategic tool for DeFi protocols looking to demonstrate greater resilience amid the never-ending volatility of the cryptocurrency market. Just like traditional share repurchases, buybacks involve snapping up tokens from the open market to reduce the circulating supply. In doing so, protocols aim to boost the value of their tokens, but the strategy has been criticized by some, who argue that it diverts resources from more worthwhile initiatives. 

DeFi projects like Juniper and dYdX say their token buybacks are designed to support a more robust and sustainable tokenomics model that will boost the health of their underlying exchange platforms. 

The goals of token buybacks are multifaceted. Proponents say that by reducing the circulating supply of tokens on the market, they’ll increase scarcity and therefore put upward pressure on its price. This benefits token holders and incentivizes long-term holding and staking, attracting more investors. In addition, protocols that implement buybacks signal they’re generating substantial revenue and are financially healthy, increasing investor confidence. 

Inspired By TradFi 

The emergence of token buybacks in DeFi mirrors the rise of stock repurchases in traditional finance. This year, publicly-traded U.S. companies such as Apple, Amazon, Alphabet and Meta Platforms are forecast to spend more than $1.2 trillion on share repurchases, with executives commonly citing reasons including capital efficiency and shareholder alignment. 

DeFi protocols don’t have executives – they’re decentralized, which means they’re led not by a board of directors but by their communities, often through a decentralized autonomous organization or DAO. Increasingly, DAOs are following in the footsteps of TradFi, using smart contracts to buy their native tokens off the open market at regular intervals and programmatically reduce token supply. 

For instance, the DEX aggregator Jupiter announced a buyback program in February, saying it will allocate 50% of its operational revenue to snap up $JUP tokens each month. It said at the time it aims to create a direct feedback loop, where the success of the protocol translates to increased support for its token price, delivering more value to long-term holders. 

In March, dYdX’s community implemented a similar program, but capped its token repurchases at 25% of its network fees each month. Whereas Jupiter intends to lock up repurchased tokens for a period of three-years to alleviate near-term downward pressure on its token, dYdX has opted to stake the $DYDX tokens it acquires each month to enhance the security of its network and generate rewards that will be fed into its treasury. According to dYdX, the program will help $DYDX’s value to appreciate over time, in-line with the growing adoption of its DEX platform. 

Over time, dYdX plans to increase the amount of revenue it directs towards token repurchases, and may one day commit 100% of its platform fees in this way. The repurchases are carried out fully on-chain in a transparent way, so anyone can verify it’s sticking to its commitment. 

A more recent example is Aave’s structured buyback program, which was announced in October. Under the initiative, it plans to allocate $1 million per week on token repurchases for an initial period of six months, meaning it will spend approximately $26 million on the pilot project. It has its own ideas on what to do with the tokens, saying it will distribute them proportionally to everyone who is staking $AAVE, incentivizing the community to enhance its network security. It means Aave’s stakers will gain extra tokens beyond the usual staking rewards. 

Following its buyback plan announcement, the value of $AAVE soared by almost 40%, underscoring its community’s strong support for the plan.  

A Demonstration Of Economic Health 

Token buybacks are a relatively new concept in DeFi, but there is a broad consensus that the upwards price pressure can be beneficial to protocols, so long as their tokens have strong fundamentals and genuine demand. 

The idea is that success breeds success, and as protocols grow and increase their revenue, they’ll be able to invest even more funds in token buybacks. The buybacks increase the token’s value and make it more attractive to investors. As more investors buy the token, that should help revenue to increase, which means more money is available for token buybacks, creating a kind of virtuous cycle. 

Protocols that implement buybacks are making a very public statement about their profitability, and the revenue they generate can be surprising – for instance, dYdX has so far spent around $1.86 million to buy back over 5.3 million $DYDX from the open market, illustrating solid profitability. These kinds of revenue-based buybacks showcase how the protocol is delivering value to its users and serve as a great advertisement.

The concept of token buybacks has taken flak from some quarters, with Messari arguing that they’re a poor use of protocol capital in many cases. Nonetheless, established projects have been careful to justify them with a comprehensive economic rationale that explains how they support long-term value accrual. Still, buybacks may not suit every DeFi protocol, and communities need to carefully consider if they represent the best use of their revenue by studying how it contributes to long-term growth and sustainability. 

DeFi’s Push Towards Sustainable Incentives 

While still experimental, initiatives such as Aave’s planned weekly repurchases and dYdX’s bold plan to eventually spend 100% of its revenue on token buybacks illustrate the DeFi industry’s strong desire to offer more sustainable rewards for investors. 

With buybacks, protocols are trying to forge more robust tokenomics models that link token supply to revenue generation, so they can provide incentives that go beyond mere speculation. There’s a growing emphasis on real revenue distribution, rather than the inflationary mechanisms that were a hallmark of the early DeFi industry. 

To date, DeFi has cumulatively spent around $2 billion in token buybacks this year. It’s still a drop in the ocean compared to the trillion dollar-plus spent on share repurchases by traditional companies. But DeFi is not trying to compete with TradFi in terms of scale. Rather, what sets it apart is the innovative way it executes these strategies on-chain – discussed and implemented by DAOs, initiated by smart contracts and distributed via treasuries in a fully automated and transparent process.