Arca Chief Investment Officer: How should tokens be valued after the agreement starts making money?

Author: Jeff Dorman, Chief Investment Officer of Arca

Compiled by: Jiahua, ChainCatcher

Chart Source: TradingView, CNBC, Bloomberg, Messari

Crypto Protocols Are Starting to Make Real Money

Last week, Bitwise Chief Investment Officer Matt Hougan published an article, suggesting that as more protocols connect revenue to token holders through value capture mechanisms like token buybacks, the valuation of crypto assets could double or even reach higher levels.

We agree with this view. In fact, we have been waiting for a long time for the market to start accepting this logic.

For nearly a decade, Arca has believed that digital assets should ultimately be analyzed like any other investable asset, based on fundamental value and expected future cash flows. Tokens are not stocks, and the way token holders receive value is different from shareholders. However, the fundamental principles of investing do not suddenly become invalid just because an asset exists on a blockchain or because the issuer changes from a Delaware corporation to a protocol.

However, this viewpoint has not been easy to articulate in the past.

In July 2019, when most people still referred to almost all digital assets as "cryptocurrencies," 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 stated at the time, are "essentially akin to assets linked to equity in companies that can generate cash flow."

At that time, we specifically mentioned exchange tokens. These tokens have both product utility and an economic interest linked to the underlying business, such as allowing holders to indirectly share a certain percentage of revenue or profits through token buybacks.

Six months later, in our December 2019 annual review, we categorized digital assets into four types, one of which was "businesses that use tokens and can generate real cash flow." At that time, some centralized crypto companies had begun to generate significant revenue, but most decentralized protocols were still in the experimental stage. We wrote that decentralized protocols might still need "5 to 10 years" to truly create economic value.

Looking back now, we were not far off.

Six and a half years later, protocols like Hyperliquid (HYPE), Aave (AAVE), Aerodrome (AERO), and Maple Finance (SYRUP) have begun to earn real fees and revenue from real users. Moreover, in many cases, their profit margins and capital efficiency are enviable by most publicly traded companies.

The question is no longer whether decentralized protocols can create economic value, but how they should use that value. This is where things start to get interesting.

Revenue Does Not Equal Token Value

The generation of revenue by a protocol does not necessarily mean that its token has value. This is very important and is one of the issues we have repeatedly emphasized since we began studying digital assets.

In August 2020, when analyzing the emerging DeFi protocol Aave, we distinguished between two things: one is the incentives generated through token issuance, and the other is the economic benefits created by real users and business activities within the ecosystem. We wrote, "In our view, exogenous cash flow from real business is key to the long-term value growth of token holders."

Six years later, Aave is still around, and this issue still exists. If a protocol can generate $500 million in revenue each year, but that revenue never flows to the token, why should token holders care? This is precisely where digital assets differ significantly from stocks.

When you buy a company's stock, you own a portion of the residual claim on that company. The company can reinvest profits back into the business, return them to shareholders through dividends, or use them for stock buybacks. Even if the company never directly returns a dollar of capital to shareholders, shareholders still have another way to realize value: the entire company could be acquired.

A startup can reinvest every dollar it earns back into the business for years because investors believe that these investments will generate more profits in the future. Once the company matures, it can start paying dividends or buying back stock.

Alternatively, another company or private equity firm might acquire it directly at 20 times earnings, and shareholders would receive the acquisition payment, often with a premium relative to the stock price at that time.

But crypto protocols typically do not have such an exit.

No one is going to acquire the Aave protocol at 20 times EBITDA and then send a check to all AAVE holders. No one is going to buy Hyperliquid and then offer a 30% acquisition premium to all HYPE holders to exit. These protocols are decentralized networks, and at least in theory, they are designed to exist indefinitely, unlike companies that can ultimately realize value through acquisition.

Therefore, for tokens, the connection between protocol economics and token economics may be even more important than the connection between company profits and stocks.

Because if a protocol generates billions of dollars in revenue over its entire lifecycle, 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

Thus, we increasingly believe that token buybacks are currently one of the simplest and most direct mechanisms to connect protocol success with the value of token holders. However, this does not mean that every protocol should immediately use all its revenue to buy back its tokens. In fact, this can often be a poor capital allocation.

Many leading protocols today are still essentially in the startup phase. They are growing rapidly and have numerous opportunities to continue investing capital. They can improve products, provide liquidity incentives, enter new markets, acquire teams or technologies, build insurance reserves, subsidize new products, or invest in the entire ecosystem.

If a protocol invests $1 today and can create $5 in value in the future, then we clearly prefer it to choose 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 increased dividends and stock buybacks during its early high-growth phase. If reinvesting capital can yield higher returns, excellent companies will choose to keep profits in the company for further investment rather than returning them to shareholders.

Protocols should do the same.

But there is a significant difference between "We are not buying back tokens today because there are better uses for capital" and "There is no reason to believe that this revenue will flow to token holders in any form in the future."

The former may be a very good capital allocation decision, while the latter would make valuation nearly impossible. In other words, buybacks do not necessarily have to happen today, but investors must believe that they will happen someday.

Paul Frambot, founder of Morpho (MORPHO), recently reignited this discussion. He opposes aggressive token buybacks, arguing that young and rapidly growing protocols should reinvest profits back into the business rather than distribute them directly.

Last year, he expressed similar views in a blog post. We largely agree: assessing a protocol should be similar to assessing a company; when the expected return on new capital is sufficiently high, continue investing; when that return declines, return capital.

However, there is a very important distinction between Morpho and the tech companies Frambot uses for comparison. Meta shareholders own Meta. Even before Meta begins returning capital to shareholders, they already have a legal claim to the company's growing profits and assets.

In theory, they can ultimately realize this value through dividends, stock buybacks, or company acquisitions. MORPHO holders do not have the same clear path to value realization.

Therefore, reinvesting protocol revenue back into the business can delay the time at which token holders receive value, but it cannot indefinitely replace value capture itself. Ultimately, the economic value created by the protocol must somehow flow to the tokens.

And Crypto Twitter, as usual, has interpreted this issue as a black-and-white debate over whether "buybacks are good" or "buybacks are bad." In reality, the real question is timing, as we discussed in March 2025. Buybacks do not necessarily have to happen today, but protocols must ultimately answer one question: What do token holders actually own?

After Making Money, How Should Protocols Spend?

For most of crypto's history, "capital allocation" has hardly been an important topic because projects did not have much capital to allocate. Projects raised funds, burned cash, and then issued tokens to incentivize users. When the money ran out, they would raise more funds.

Now, that situation is changing.

Once a protocol begins to generate significant free cash flow, its founders and governance participants suddenly face a question that Jamie Dimon, Warren Buffett, and all publicly traded company CEOs have faced for decades: What should be done with this money?

• Should it continue to be invested in the business?

• Should it be used for acquisitions?

• Should it subsidize growth?

• How much reserve should be kept?

• Should it enter adjacent businesses?

• When the expected returns on these investment opportunities begin to decline, should excess capital be returned to token holders?

These are capital allocation decisions. Therefore, when digital asset investors assess a protocol in the future, they should not only look at how much revenue it generates but also at what it does with that revenue.

Assume there are now two protocols that each generate $100 million in revenue annually, with a revenue growth rate of 30%, and similar profit margins and competitive positions.

1. Protocol A reinvests all its earnings indefinitely, and there is no credible mechanism to ensure that these earnings will eventually flow to token holders.

2. Protocol B is also actively reinvesting at this stage, but its governance mechanism and token economic model clearly stipulate that after meeting reasonable reserve and growth investment needs, the remaining cash flow will be used to buy back its own tokens.

These two tokens should not have the same valuation multiples. Protocol B has established a credible mechanism for the flow of protocol revenue to token value, while Protocol A has not.

Buybacks Do Not Equal Value Return

Even the term "buyback" itself needs careful analysis. Suppose a protocol generates $100 million in revenue, uses $50 million to buy back its tokens, and then redistributes $50 million worth of similar tokens as incentives; this does not necessarily mean it has truly returned $50 million in value to token holders. This could simply be a cycle of token issuance and does not equate to a real return of $50 million to holders.

Buybacks and burns will permanently reduce token supply; distributing tokens to holders or stakers after a buyback will more directly transfer economic value. If a protocol places the repurchased tokens into a treasury, it may also create value, but the premise is that this treasury must ultimately be managed with the interests of token holders in mind. The specific mechanism is important.

But the underlying principle is actually very simple. If a protocol creates economic value, there must ultimately be a mechanism that allows token holders to share in that value. Otherwise, the so-called "protocol revenue" is merely an interesting statistic.

From Revenue to Valuation

By 2021, we began to see this framework operating in reality.

In July of that year, we introduced a batch of digital assets and described the projects behind them as "real companies, real cash flows, tokens that can capture economic value, and a way to measure their success." We believed that these projects were finally beginning to achieve something we had long anticipated for digital assets: allowing customers and users to share in the economic value created by the projects.

But the problem at that time was that such projects were far too few. Now, the situation is different. This is precisely why Hougan's perspective is so noteworthy.

The truly important aspect of his article is not the assertion that "revenue should flow to token holders." The real significance lies in the fact that just as these assets themselves have matured and this valuation framework has finally begun to work effectively, this framework has also started to become mainstream in the market. This will have a significant impact on valuations.

Valuation Discounts Should Begin to Narrow

If a protocol's revenue grows by 50%, its tokens may naturally become more valuable because the protocol's ability to generate profits is increasing. But at the same time, another thing may happen: the valuation multiple that investors are willing to pay for these profits may also rise.

Assume a protocol's profits grow by 50% annually, and as investors become increasingly confident that these profits will ultimately flow to token holders, its valuation rises from 8 times earnings to 16 times earnings.

In this case, the protocol's profits do not even need to double for the token price to potentially double. The reason is simply that the market is now willing to pay a higher price for every dollar of profit because investors believe the probability of these profits ultimately flowing to token holders has increased.

This is essentially the point Hougan made: as a clearer connection is established between protocol revenue and tokens, the valuation of crypto assets could double or even reach higher levels. We believe he is correct. For a long time, profitable crypto protocols have faced a significant valuation discount compared to similar publicly traded companies, and part of that discount is clearly justified.

Shareholders of stocks have legally protected ownership, the governance structures of companies are highly mature, financial statements are audited, securities laws provide protection for investors, management bears fiduciary responsibility, and through decades of practice, shareholders have a very clear institutional and legal foundation regarding what they actually own.

Token holders often do not possess these things. Therefore, a token relative to a stock with identical economic conditions is likely to inherently carry a certain discount.

But the question is, how large should that discount be?

If a protocol has hundreds of millions in sustainable revenue, extremely high profit margins, rapid growth, can reach global markets, has limited capital needs, and also has a transparent mechanism to continuously use excess cash flow to buy back its tokens, should it really only trade at a small fraction of the valuation multiple of a slower-growing publicly traded company?

Maybe.

But we are increasingly skeptical that the answer is yes. This suggests that one of the biggest opportunities in the digital asset space today may not just be finding protocols with growing revenues. A more important opportunity may lie in identifying those whose fundamentals have changed but are still being priced by the market using an outdated valuation framework.

Crypto Investment is Moving Towards Fundamentals

For nearly a decade, Arca has believed that digital assets will ultimately be valued using the same fundamental investment principles as all other assets.

• In 2019, we discussed businesses that have cash flows and use token buyback mechanisms.

• In 2020, we proposed that exogenous cash flow is key to the long-term value growth of token holders.

• In 2021, we began to focus on digital assets that truly generate revenue and can allow tokens to capture economic value.

This does not mean that the market at that time was suitable for fundamental investing. Frankly, most assets themselves were not ready. The issue was not that the framework was wrong, but that the entire industry was not mature enough to allow this framework to operate effectively.

Now, it is different.

Protocols have customers, they generate revenue, they create profits, protocol operators are beginning to need to make capital allocation decisions, and an increasing amount of excess cash flow is being used to buy tokens.

This means that the questions digital asset investors should be asking today have become remarkably familiar:

• How fast is revenue growing?

• What is the profit margin?

• How long can the competitive advantage be maintained?

• How much capital needs to be reinvested to sustain growth?

• What returns can these reinvestments achieve?

• After high-return reinvestment opportunities gradually decrease, how much excess capital will ultimately be returned to token holders?

In other words, crypto investment is finally beginning to transform into fundamental investment. After spending over 15 years trying to invent various new methods for token valuation, the next important "innovation" in the digital asset space may very well be the logic that stock investors are already familiar with: making money, growing profits, allocating capital wisely, and ultimately allowing asset holders to share in those profits.