Interest Income provides a predictable, recurring revenue stream derived from borrower payments. Protocols like Aave and Compound have demonstrated the stability of this model, with Aave generating over $150M in annual interest revenue during peak market cycles. This model excels in steady-state markets, offering protocol sustainability through consistent fee accrual from utilized capital. However, it is directly tied to borrowing demand and can stagnate during bear markets or low-yield environments.
LABS
Comparisons
Revenue Streams from Liquidations vs Interest Income
A technical analysis for protocol architects on designing for revenue from liquidation penalties versus interest rate spreads. Covers risk profiles, capital efficiency, and sustainability for protocols like Aave, Compound, and MakerDAO.
Chainscore © 2026
introduction
THE ANALYSIS
Introduction: The Core Revenue Dilemma for Lending Protocols
A foundational look at the two primary revenue engines for DeFi lending, where protocol design dictates financial resilience.
Liquidations Revenue offers a high-variance, event-driven income source, triggered when collateral values fall below health thresholds. Protocols like MakerDAO and Euler historically derived a significant portion of their income from this mechanism, with Maker's Surplus Buffer often swelling from auction proceeds during volatile downturns. This approach capitalizes on market inefficiencies and volatility but introduces revenue unpredictability and requires robust, low-latency keeper networks to ensure system solvency.
The key trade-off: If your priority is predictable treasury growth and protocol stability, design for interest income. If you prioritize capital efficiency and capturing value from market volatility, optimize for liquidations revenue. The most resilient protocols, like Compound v3 and Aave v3, strategically balance both, using interest for baseline operations and liquidation penalties as a critical backstop during stress events.
tldr-summary
Liquidation Revenue vs. Interest Income
TL;DR: Key Differentiators at a Glance
A direct comparison of two core DeFi revenue models, highlighting their risk, predictability, and ideal protocol conditions.
01
Liquidation Revenue: High-Yield, Event-Driven
Specific advantage: High, concentrated payouts from collateral auctions. This matters for protocols with volatile assets (e.g., LSTs, memecoins) and low collateral ratios, where liquidations are frequent. Revenue is tied directly to market volatility and risk management efficiency.
Event-Driven
Revenue Model
High Volatility
Ideal Condition
02
Liquidation Revenue: Capital Efficiency & Protocol Health
Specific advantage: Acts as a non-dilutive fee that directly protects the protocol's solvency (e.g., MakerDAO's Surplus Buffer). This matters for lending/borrowing protocols (Aave, Compound) where maintaining the health of the credit system is paramount. Revenue scales with borrowing activity and market stress.
Systemic Protection
Primary Role
03
Interest Income: Predictable, Steady Yield
Specific advantage: Consistent, accrual-based revenue from borrower interest rates. This matters for protocols seeking stable, forecastable cash flows to fund treasury operations or token buybacks. Performance is tied to utilization rates and stablecoin demand.
Accrual-Based
Revenue Model
High Utilization
Ideal Condition
04
Interest Income: Scalable with TVL & Product-Market Fit
Specific advantage: Revenue scales linearly with Total Value Locked (TVL) and sustainable product adoption. This matters for generalized money markets and yield-bearing stablecoins (like Ethena's sUSDe) where attracting and retaining capital is the core growth loop. Less dependent on market crashes.
TVL-Linked
Growth Driver
HEAD-TO-HEAD COMPARISON
Feature Comparison: Liquidation Revenue vs Interest Income
Direct comparison of revenue mechanics for DeFi lending protocols.
| Metric | Liquidation Revenue | Interest Income |
|---|---|---|
Revenue Trigger | Loan Under-Collateralization | Continuous Loan Utilization |
Predictability | Volatile (Market-Dependent) | Stable (Rate-Dependent) |
Avg. Annual Protocol Yield | 0.5% - 5% of TVL | 2% - 10% of TVL |
Capital Efficiency | Requires Idle Safety Capital | Uses Active Lending Capital |
Key Risk | Liquidation Inefficiency (Bad Debt) | Interest Rate Volatility |
Primary Protocols | Aave, Compound, MakerDAO | Aave, Compound, Morpho |
pros-cons-a
Revenue Streams from Liquidations vs Interest Income
Pros and Cons: Prioritizing Liquidation Revenue
Key strengths and trade-offs at a glance for protocols like Aave, Compound, and MakerDAO.
01
Liquidation Revenue Pros
High-margin, event-driven income: Liquidations generate 5-20% penalty fees on the liquidated collateral, often resulting in higher revenue per event than daily interest. This is critical for protocols with volatile collateral assets (e.g., LSTs, memecoins) where undercollateralization is more frequent.
5-20%
Liquidation Penalty
02
Liquidation Revenue Cons
Volatile and unpredictable cash flow: Revenue is tied to market volatility (e.g., Black Thursday, LUNA collapse). This creates budgeting uncertainty for protocol treasuries and DAOs. Over-reliance can lead to insolvency if liquidators are inefficient or network is congested, as seen in early MakerDAO incidents.
03
Interest Income Pros
Predictable, recurring revenue stream: Interest (supply-side spread) provides steady, composable yield from assets like USDC, DAI, and wETH. This is essential for protocols prioritizing stability and predictable treasury income, such as Compound's cToken model or Aave's stablecoin pools, enabling reliable budgeting for grants and development.
~$200M
Annual Interest (Aave v3)
04
Interest Income Cons
Lower margin, highly competitive: The supply-borrow spread is often slim (1-3% APY), compressed by rivals like Morpho and Euler. This demands massive TVL to generate significant revenue and is vulnerable to yield farming cycles and stablecoin de-pegs, reducing net income.
1-3%
Typical Net Spread
pros-cons-b
Liquidations vs. Interest Income
Pros and Cons: Prioritizing Interest Income
Key strengths and trade-offs for two primary DeFi revenue streams. Choose based on your protocol's risk tolerance and market conditions.
01
Liquidations: High-Yield, High-Volatility
Specific advantage: Asymmetric, event-driven returns. Profit from collateral auctions during market downturns (e.g., MakerDAO's Stability Fee and auction premiums). This matters for protocols with over-collateralized lending pools (Aave, Compound) seeking to capitalize on market stress and protect the system.
Spikes >1000% APR
During volatility
0%
In stable markets
02
Liquidations: Protocol-Defensive Mechanism
Specific advantage: Non-correlated with bullish sentiment. Revenue activates precisely when it's needed to cover bad debt and maintain solvency. This matters for risk engineers prioritizing protocol safety over predictable cash flow, as seen in Euler's resilience mechanisms.
03
Interest Income: Predictable Cash Flow
Specific advantage: Steady, accrual-based yield from borrow fees (e.g., Aave's reserve factor). Provides consistent treasury inflows for DAOs like Compound Grants. This matters for protocols needing reliable runway for grants, development, and marketing, independent of market cycles.
3-10% APY
Typical range
04
Interest Income: Scalable with TVL
Specific advantage: Linear revenue growth tied directly to Total Value Locked. Doubling your protocol's TVL reliably doubles interest income. This matters for growth-focused VCs and treasuries (e.g., Uniswap DAO) building sustainable models around fee switches and protocol-owned liquidity.
05
Liquidations: Operational Complexity
Specific weakness: Requires sophisticated keeper networks and optimal auction parameters to avoid bad debt. Failed liquidations (e.g., early Maker auctions) can lead to systemic risk. This is a poor fit for teams lacking deep MEV or market-making expertise.
06
Interest Income: Yield Compression Risk
Specific weakness: Vulnerable to rate competition. Aggressive yield farming on competitors (like Solend or Morpho) can drain TVL and compress margins. This is a challenge for mature protocols in crowded markets where users chase the highest APY.
CHOOSE YOUR PRIORITY
Decision Framework: When to Choose Which Model
Revenue from Liquidations\nVerdict: Choose this model for capital efficiency and risk management.\nStrengths: Generates revenue during market volatility, directly incentivizes protocol health (e.g., Aave, Compound). Revenue scales with TVL and leverage, not just asset supply. Requires robust oracle infrastructure (Chainlink, Pyth) and sophisticated keeper networks (Gelato, Keep3r).\nKey Metric: Liquidation Volume / TVL ratio indicates system stress and revenue potential.\n### Interest Income\nVerdict: Choose this model for predictable, stable cash flows.\nStrengths: Revenue is a direct function of supplied assets, offering predictability for treasury planning (e.g., MakerDAO's Stability Fees). Simpler economic model with fewer moving parts. Highly dependent on sustainable demand for leverage (borrow APY).\nKey Metric: Net Interest Margin (Borrow APY - Supply APY) determines core profitability.
REVENUE STREAMS
Technical Deep Dive: Mechanism Design and Implementation
A core architectural choice for DeFi lending protocols is the primary revenue model: reliance on liquidation penalties versus steady interest rate spreads. This section compares the mechanism design, stability, and risk implications of each approach.
Interest income is fundamentally more predictable. It provides a continuous, steady-state revenue stream based on the total borrowed amount and the interest rate spread (e.g., Aave's supply/borrow APY differential). Liquidation revenue is highly volatile and event-driven, spiking during market crashes (like the LUNA collapse) but potentially being near-zero in stable markets. Protocols like Compound and Aave rely on a hybrid model, where interest is the baseline and liquidations act as a critical, non-linear safety net.
verdict
THE ANALYSIS
Verdict and Strategic Recommendation
Choosing between liquidation revenue and interest income depends on your protocol's risk tolerance, capital efficiency goals, and market positioning.
Liquidation Revenue excels at generating high-margin, non-linear returns during periods of market volatility because it capitalizes on forced selling. For example, protocols like Aave and Compound have generated millions in liquidation fees during sharp market downturns, with spikes in revenue directly correlated to BTC and ETH price drops of 15%+. This model is ideal for protocols with robust oracle systems (e.g., Chainlink) and deep liquidity pools to absorb the liquidated collateral.
Interest Income takes a different approach by providing predictable, yield-based returns from borrowing demand. This results in a more stable, recurring revenue stream, as seen with MakerDAO's DSR or Compound's supply-side APYs, but it is heavily dependent on sustained protocol usage and TVL. The trade-off is lower per-event profitability but significantly reduced operational complexity and dependency on market stress events.
The key trade-off: If your priority is capital efficiency and high-risk, high-reward scenarios during volatile markets, architect your protocol to optimize for liquidation fees. Choose Interest Income when you prioritize predictable cash flow, user retention, and building a stable financial primitive less susceptible to market cycles. For many protocols, a hybrid model—using interest as a base and liquidations as a bonus—strikes the optimal balance.
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