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Last updated on November 17th, 2022 at 01:39 pm

Investment decisions should always be supported by extensive research. Before investing your hard-earned money in any asset, you should consider all available indicators. Price-to-earnings ratios, historical returns, and chart patterns are some metrics you can use to understand an asset comprehensively.

You can determine an item’s current value and potential future worth by analyzing these metrics. Total Value Locked (TVL) is another such metric. You must be aware of and comprehend this critical indicator to succeed in the decentralized finance (DeFi) space.

This article explores the concept of Total Value Locked (TVL) in detail, outlining why it is an important metric to consider while investing in DeFi.

What is Total Value Locked (TVL) in DeFi?

TVL refers to the total value of the assets staked in a DeFi platform’s smart contracts. It serves as a gauge for the amount of money available on various DeFi platforms for use in transactions, borrowing, and lending. You can calculate the TVL for the DeFi sector by adding up the total value locked in all DeFi apps. The TVL of a DeFi app indicates how well it attracts interest from monthly active users for different transactions.

Despite being slightly similar, market capitalization should not be confused with TVL. It is important to remember that TVL is a specific indicator for DeFi projects. On the other hand, market capitalization is a measure of the market value of any blockchain-based platform that issues its own tokens. The TVL value in DeFi varies from platform to platform.

It is also an important key performance indicator (KPI) for DeFi systems connected to simultaneous lending and swapping. This is due to TVL’s ability to directly influence the usability and returns of DeFi apps for end users, highlighting its importance in DeFi.

DeFi applications typically aim for a higher TVL value to attract more users. Higher TVL indicates that the DeFi platform can handle swaps and provide the liquidity that loan markets demand.

Why is TVL Important in DeFi?

As previously stated, TVL indicates the overall health of the DeFi market. The TVL of specific projects reflects investor confidence in the protocol. A sharp rise in TVL suggests that investors think highly of the project since more money is moving through its network. It aids investors in deciding whether a protocol is stable and worth investing in.

A high TVL reflects the characteristics that determine the success of a DeFi protocol: high liquidity, high acceptance, and high usability.

A rising TVL is also advantageous to investors, as it provides them with significantly higher returns and liquidity.

However, if the TVL is low, there will be less money to go around, so investors who choose to stake this protocol’s token will not get enough money back.

Investors can use TVL to determine the cheap or overvalued status of a protocol’s native coin. If a token’s market cap is high or low compared to the TVL of the overall project or protocol, the token may be overvalued or undervalued.

Over the past few years, the total TVL of DeFi protocols has increased dramatically. In early 2020, the total value was $630 million, with MakerDAO owning more than half of the equity. At the time of writing, MakerDAO has a total value of $8.58 billion.

How to Calculate TVL Ratios

To fully grasp TVL, you must first understand how to calculate it. By examining the specific factors that influence a protocol’s total value and TVL ratio, you can better understand what the metric is truly measuring and what the data means for the platform under consideration.

To be calculated, the TVL of DeFi protocols must be measured across multiple product categories. Because each protocol or DeFi service has its own distinct method of operation, these differences influence how TVL is calculated.

For example, lending-based services prioritize deposited assets, whereas tokenization procedures involve newly created assets. Numerous techniques combine these elements in specific ways, necessitating a more thorough analysis to determine the TVL. In any case, the total value locked and TVL ratio are based on how these important DeFi elements are taken into account.

Difference Between TVL and Market Capitalization

This subject was briefly discussed earlier, but this section examines it in more detail.

DeFi projects are often discussed in terms of market capitalization, commonly referred to as “market cap.” You might be more familiar with using market capitalization rather than TVL as a measure of a project’s success. However, a DeFi protocol’s market capitalization essentially demonstrates the support for a protocol by both active and passive investors. A DeFi project’s market cap reflects its potential value. The more investors it attracts, the higher its market capitalization will be.

Passive investors may not use the protocol directly but invest in it to earn profits in the future. Passive investors purchase the protocols’ tokens in anticipation of a rise in token value, which raises the protocol’s token’s market capitalization.

DeFi projects aren’t just about raising funds and increasing market caps; they’re also about creating real, usable products and services. The success of these projects depends on their ability to get people to use those products or services, which means they must prioritize building a customer base that wants to use those products and services. TVL indicates how well a protocol performs in the DeFi space and shows investors the actual level of usage of the platform.

Platforms That Provide DeFi TVL Data?

DeFi Pulse

DeFi Pulse and other similar websites allow you to track TVL. DeFi Pulse established Total Value Locked as the industry standard.

However, keep in mind that the majority of money invested in yield farming products is not included in DeFi Pulse because it only keeps track of each protocol’s underlying smart contracts on the Ethereum blockchain. The entire balance of Ether (ETH) and ERC-20 tokens held by these smart contracts is pulled each hour to update the charts. These balances are multiplied by their price in USD to determine TVL. DeFi Pulse measurements are powered by open-source project adapters, which can be found here.

Llama DeFi

DeFi Llama estimates the TVL by using nearly all of the DeFi chains rather than occasionally only using Ethereum.

You can look up the TVL totals for the various chains. Naturally, yield farming may increase as more value is locked in because money flows to the areas with the highest returns. Like other data aggregators, DeFi Pulse and DeFi Llama use different data sources and operate under different rules, so their calculations differ.

Types of DeFi Protocols and Their TVL

Decentralized Crypto Exchanges (DEXs)

Users can trade or swap cryptocurrencies on decentralized cryptocurrency exchanges (DEXs) using automated market makers (AMMs). On DEXs, users do not engage in direct trading when exchanging crypto assets. Instead, they conduct transactions through liquidity pools holding the required number of tokens.

Among these protocols are Uniswap (UNI), Curve Finance (CRV), and SushiSwap (SUSHI). The total value held across all coin-pair pools on these platforms is the TVL of these assets.

Borrowing and Lending

The primary goal of these protocols is to utilize liquidity pools which allow users to borrow and lend cryptocurrency to one another. Aave (AAVE), Maker (MKR), and Compound (COMP) are a few examples of commonly used borrowing and lending protocols. The TVL is the total value stored in these platforms’ lending and borrowing pools.

Yield-Enhancing Protocols

These programs use algorithms to maximize customers’ investments across multiple borrowing and lending channels. These programs operate similarly to automated portfolio managers.

Once the user’s funds have been deposited into the protocols, the algorithm distributes them to the pools with the highest expected returns. Yearn.finance is one of such protocols. These applications require users to provide TVL data in order to determine which pools will maximize investment returns.

In Conclusion

TVL is one of the most important parameters for evaluating how successful a DeFi project is.
TVL data can be used to evaluate a system’s total assets or check the TVL ratio to see if a protocol’s tokens are discounted.
The role that TVL plays in demonstrating the immediate capabilities of a DeFi protocol highlights the importance of TVL in DeFi. As a result, it proves to be a more accurate predictor of success than the market capitalization of a particular DeFi project. TVL makes DeFi adoption easier and educates investors on the actual value of new or existing DeFi protocols.

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