Investments should always be backed by thorough research and understanding. Before you divert your hard-earned money into any asset, you should look at all possible metrics. These include price-to-earnings ratios, historical returns, chart patterns, and so on.
A thorough understanding of these metrics will help you determine the current value and future potential of an asset. Total Locked Value or TVL is another such indicator. It is an essential factor that investors should know and understand if they want to succeed in the decentralized finance space.
What is Total Value Locked (TVL)?
Total value locked (TVL) is the amount of user funds deposited in a decentralized finance (DeFi) protocol. These funds could be invested in the project for various functions, e.g. B. for staking, liquidity pools or lending.
DeFi protocols are specialized and autonomous programs designed to address issues within the traditional finance industry. An example of a DeFi protocol is Uniswap – a leading decentralized exchange that allows investors to trade cryptos without a central oversite.
TVL does not disclose the number of outstanding loans or the yield on these deposits. It simply reflects the current value of deposits. Therefore, the total value locked will change as investors deposit or withdraw funds into the project. Also, it is constantly changing with the changing value of the US dollar.
DeFi protocols can operate on a single network or be distributed across different networks. When distributed across multiple networks, they have an independent TVL on each network. TVL’s largest network to date is Ethereum, with over five hundred projects currently on board, according to a CoinDesk report. It accounts for almost half of the TVL in the DeFi industry.
Why does it matter?
TVL indicates the overall health of the DeFi market. The TVL of individual projects indicates investor confidence in the protocol. A rapid rise in TVL shows that investors appreciate the project and more money is flowing through its network. It helps investors determine if a protocol is healthy and worth investing in.
A high TVL means high liquidity, high popularity, and high ease of use – the factors that define the success of a DeFi protocol. A rising TVL also benefits its investors as they enjoy significantly higher liquidity and yield.
However, a lower TVL results in lower availability of funds, which means that investors will not get enough rewards if they choose to stake this protocol’s token.
Investors can also use TVL to find out whether a particular protocol’s native token is undervalued or overvalued. A token can be over- or undervalued if its market cap is high or low relative to the TVL of the entire project/protocol.
Currently, the total value locked in the DeFi industry is a little less than $50 billion, with the MakerDAO protocol topping the table, according to data from DeFi Pulse.
The combined TVL of DeFi protocols has increased sharply in recent years. At the start of 2020, the combined value was $630 million, with MakerDAO owning more than half the shares. At the time of writing, MakerDAO’s total value is nearly $10 billion.
How do you calculate TVL?
Calculating a project’s TVL is easy. Multiply the number of tokens deposited in a project by its current price in USD and you will get the project’s TVL. If a project accepts deposits in multiple tokens, one needs to calculate the TVL for each token and then add them together to get the project’s TVL.
Next, we need to calculate the project’s TVL ratio to verify whether a project’s native token is undervalued or overvalued. To do this, we need to divide the market cap by the TVL of the token. Market cap is nothing more than the total number of tokens in circulation multiplied by their current price. An asset is undervalued when the TVL ratio is less than one and vice versa.
Is TVL accurate?
Like any other metric, TVL is not perfect. It can sometimes give a disproportionate picture of the health and activity of a particular DeFi protocol. This is because DeFi protocols often have large investors, known as whales, who can impact a project’s TVL with a single deposit or withdrawal. This would give investors a wrong understanding of the project.
Sometimes whales are also encouraged to overdo a project by making significant investments. This can give potential investors an inaccurate view of a project. Therefore, while TVL is important, investors need to consider several other metrics to decide whether a token is investable or not.
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