Independent of corporate structures and DAOs, how should we understand the positioning of crypto protocols?
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Independent of corporate structures and DAOs, how should we understand the positioning of crypto protocols?
Why are crypto protocols different from both companies and DAOs? Why is understanding this distinction crucial?
Navigating Web3 tides with focused insightsWritten by: Leighton
Compiled by: TechFlow
Crypto protocols are a new way of providing services. They deliver autonomous services without relying on any individual or company. This makes them more efficient, scalable, and fair than other alternatives.
Crypto protocols are the most important innovation in the past 200 years.
But they are also deeply misunderstood.
The mindset of companies is incorrectly applied to protocols. Recently, the poorly defined term "DAO" has been wrongly applied to crypto protocols with tokenized governance.
This article explains why crypto protocols are different from both companies and DAOs, and why understanding this distinction is crucial.
Crypto protocols are not companies
When discussing crypto protocols, there's a common tendency to use familiar corporate concepts like "revenue" and "expenses." These terms can be helpful as mental shortcuts, but they lead to the mistaken view of protocols as businesses, overlooking their unique characteristics.
A well-designed protocol is a piece of software that autonomously runs on a blockchain. Their uniqueness lies in the fact that they do not require revenue to operate or scale. They don't "go out of business," they have no expenses, and no employees.
Yet these terms are frequently used when discussing protocols. Partly because protocols may involve fees associated with their usage. For example, executing a trade on Uniswap requires someone to pay a transaction fee—but this fee is not revenue for the protocol. Similarly, a protocol might pay people to use it, but that doesn’t mean the protocol itself incurs costs. Liquidity providers on Uniswap receive transaction fees paid through the protocol, but those fees aren't expenses of the protocol.
Some protocols may have some form of value accrual, but unless explicitly designed, this should not be equated with fees or revenue. For instance, the Compound protocol retains a small portion of interest paid, but this is neither a fee nor revenue. The purpose of retaining tokens is to provide greater value to users. These retained tokens serve as an insurance fund for the protocol and can enhance liquidity during periods of high utilization—very different from profit-driven fees or revenue in a traditional corporate sense.
Likewise, in the V3 PoolTogether protocol, the concept of a "reserve" retains a portion of yield. This is not a fee or revenue. It is a mechanism designed to strengthen the protocol by making prizes larger than the base yield generated.
In theory, a protocol could arbitrarily extract value and charge fees like a traditional business. This could be considered "revenue," but doing so raises several issues.
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First, it contradicts the core rationale for crypto protocols, especially in decentralized finance. The promise of DeFi is to replace profit-seeking banks with autonomous code, delivering more efficient and cost-effective solutions. A fee-charging protocol may still be better than off-chain banks in many ways, but it undermines a key value proposition.
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Second, extracting fees and placing them under the control of some entity (likely token holders) may create complex tax, regulatory, and legal challenges.
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Third, fee extraction can stifle protocol growth. By definition, extracting fees from a protocol and holding them for arbitrary future use drains value from the protocol. To reiterate an earlier point: if any value is retained by a protocol, it should be to strengthen the protocol itself.
In summary, crypto protocols differ from companies because they have no revenue, expenses, employees, or risk of going out of business. Where they are similar is in providing services to users. They do so far more efficiently than companies by operating autonomously according to immutable rules.
Crypto protocols are not DAOs
Another source of confusion is the rise of the popular but ill-defined term "DAO." In common understanding, a DAO essentially refers to a shared bank account with token-based voting. DAOs have proven to be highly useful tools for pooling and distributing capital (think Constitution DAO or Nouns DAO). However, they differ from protocols in two critical ways.
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First, DAOs have full discretionary control over their assets. This contrasts sharply with protocols, which enforce immutable rules and grant token holders only limited ability to adjust those rules. For example, POOL token holders cannot influence or access deposits in the PoolTogether protocol.
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Second, a DAO is a general-purpose template for coordinating around a goal, whereas a protocol already exists to autonomously deliver a specific service.
Protocols with tokenized governance and DAOs sometimes share one similarity—decision-making via token voting. However, this similarity should not obscure their fundamental differences.
The distinction matters. Calling a crypto protocol a "DAO" makes it sound like a human-centered organization, more akin to a company. It overlooks what makes protocols revolutionary—their ability to operate without humans, governed by immutable rules.Humans are at the center of a DAO; humans are at the periphery of a protocol.
Conclusion
Companies, DAOs, and crypto protocols are all world-changing innovations. Crypto protocols possess the most novel properties, and therefore require language and mental models that reflect this reality. Failing to recognize the uniqueness of crypto protocols risks underutilizing their transformative potential.
This article helps define what a crypto protocol is. I hope it helps builders, policymakers, and users better understand crypto protocols.
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