Crypto fundamentals 101 Chapter 2: Pricing power

1. Introduction

We dedicated the last chapter to analyze one of the most important metrics in revenue generation, and this week we will focus on the main profit lever, as that is what should be the main proxy to determine how good or bad a business is.

In the words of one of the best fundamentals investors out there….

“The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business”

Warren Buffet

We could agree it is quite important right? Are you still not convinced anon?

Let’s say we could define the profits of a company like:

Total profits = Profit/unit * Nºunits

Profit/unit = Price/unit - Cost/unit

This shows how powerful for a company is to be able to raise prices with damaging the demand for their product or service.

Apple is the perfect example, one of the best performing assets of the last 20 years and arguably the best example of pricing power capabilities.

2. Pricing power in crypto

Usually users are willing to pay a premium when they feel there is potential to gain more money.

It shows very clearly in the difference of fees between NFT marketplaces & general exchanges. Really difficult to charge 1% of fees on general exchanges with binance charging 0.1% while most NFT marketplaces get away with 2% fees. This is mainly due to the latter being less mature and with a higher appreciation potential (p.e. easier to pull a x50 in NFTs than listed coins)

Pricing power is influenced by many factors:

  • Brand: GMX commands a premium versus other new competitors, as LP & traders perceive it as “safer”

  • Industry and market segment: Binance & Coinbase have very different fees, because they target different users

  • Competitive landscape: Usually when an space is overcrowded with competitors, projects undercut each other in fees till there is little margin left

  • Others

Several metrics could be used to define pricing power in crypto, but we will use the following:

Pricing power = Fees / Volume

Basically this metric compares how many cents each user is willing to pay for each dollar traded in the protocol

3. Current state of the market

Biggest differences in crypto pricing power are driven by use case, there are of course differences within protocols in the same segment as we have stated in the previous section, but those tend to be small on average, so we will focus on analyzing each DeFi category to obtain a better insight.

Biggest categories in DeFi are the following:

Structured Products: Ribbon Finance, StakeDao, GLP products etc

Lending: AAVE, Compound etc

ETH staking: Lido etc

Options: Lyra, Premia, Hegic, Dopex etc

NFT marketplaces: Opensea, Looksrare, X2Y2, Blur etc

Spot DEX: Uniswap, Sushiswap, Balancer etc

Perp DEX: GMX, DyDx, GNS etc

After analyzing the market leaders in each segment we obtain the following numbers, which intend to be ball-park estimates:

Not all pricing powers are created equal though…

As you might have already noticed, there is another important variable that affects the profit generation of a protocol, and that is the average length of the “trade” - conceptually that volume is “locked” and cannot be reused by other users.

To explain this better, let’s use a couple of examples make it clearer. If you trade in Uniswap, the length of the trade is 1 second and you will pay 0,3% fee but if you deposit in AAVE, the average time of the deposit will be a year on average and you will be earning 5% of the deposit “volume” through that 365 days. That means that to make things comparable, we need to use another metric:

Pricing power corrected by time = Pricing power / Trade length

Once we have corrected the metric to include how powerful the pricing power is related to how frequently it can be enforced, a clear winner emerges, NFT marketplaces.

The fact that the average length is near instant and they command a 2% fee on average of all transactions makes it a real powerful contender.

On the other hand, lending and ETH staking are the laggards in this metric, but they compensate it being business that typically have lots of TVL.

4. Conclusions

NFT marketplaces are the best businesses regarding pricing power, time will tell whether they achieve to maintain such high pricing margins as the industry matures and more players compete, but if NFT volumes get back, these protocols will be among the biggest cash cows out there and I believe that those distributing part of that profits among token holders ($LOOKS, $X2Y2) could fare well, specially if the manage to grab more liquidity from Opensea.

Option protocols are also an interesting category specially in the altcoin pools that command higher premiums vs BTC/ETH pools.

5. Final remarks

Thanks for reading! Hope you enjoyed it reading as much as I writing it.

Next article will be focused on supply vs demand, specifically tokenomics :)

Crypto fundamentals 101 will always be free, but if you leverage trade and want to give GMX a try, feel free to use my ref code to obtain a 10% discount on fees and collaborate with content creation.

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