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Here’s how Snapchat makes money from disappearing videos

With more than 150 million daily users and a nearly $17 billion valuation, Snapchat is worth more (on paper) than a number of other well-known public tech companies like Twitter or Yelp.

But what makes investors so confident that Snapchat — a company known for disappearing messages and quirky face filters — will someday become a big business? Because the little business it currently has looks to be growing quickly.

The company plans to make somewhere around $300 million in revenue this year, up from a $50 million revenue target last year. It's also telling investors that it could be a $500 million to $1 billion business in 2017. That's a massive jump.

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How, exactly, does Snapchat plan to make all that money?

The same way other internet companies like Google and Facebook make money: Advertising!

Snapchat shows users ads in a number of key places inside the app.

  • Discover: You'll see ads alongside the channels that Snapchat's publishing partners produce.
  • Stories: This includes Live Stories — like the montages it curates around major events like the Olympics — and now users' stories, too, which means you'll see ads as you jump from one friend's story to another.
  • Filters and lenses: Snapchat sells sponsored filters for specific events (Recode bought one for its annual Code Conference this year) but also sells sponsored lenses, which are the face-distorting features that let users turn into a dog or a zombie. A sponsored lens from Taco Bell turned users into tacos.

The key challenges facing Snapchat are twofold. First, it doesn't do a great job of measuring the success of these ads for its advertisers. And that's a problem. If people spend money to advertise inside your app, they want to know their ad is working. While Snapchat doesn't do well at quantifying that right now, lately it has been partnering with third-party measurement companies to try to fix that issue.

The other challenge — and this one could be a doozy — is that Snapchat CEO Evan Spiegel doesn't like ads that target users based on things like their internet browsing history. These ads, called retargeting ads, are a staple for companies like Facebook and Google; the big benefit of digital advertising is that marketers like to know exactly who they're reaching.

Snapchat's reluctance to get super personal with its ads isn't an issue at this early stage, but it's definitely worth paying attention to down the line.

By Kurt Wagner, Recode.net.

CNBC's parent NBCUniversal is an investor in Recode's parent Vox, and the companies have a content-sharing arrangement.