By Larry Wright
Innovations in the crypto market have solved many problems for investors and have also raised a few new problems of their own. The main reason for the introduction of cryptocurrency was that it could help transform the current financial market for the better. This is possible only because of the features like transparency, decentralization, and cryptography. These features and benefits have helped the cryptocurrency market make lots of progress in recent times.
The significance of TVL or Total Value Locked is attached to DeFi and NFTs, amongst other decentralized solutions related to the blockchain network. TVL is thought of as an important indicator in the emerging decentralized finance market.
This article discusses what TVL actually means and how it can be used in a beneficial manner.
Definition of TVL
In order to understand the core working principles and ideology behind TVL, one must dive deep into its definition and learn more about it. Total Value Locked is a system designed to show you the total value of staked assets in the smart contracts of a particular DeFi project/ platform.
This means it tells us about the number of assets available for lending/ borrowing and for any type of transaction. TVL of the whole Decentralized Finance industry can also be calculated by adding all the TVL values of all the DeFi projects. Higher the TVL of a DeFi platform, the higher user trust and user engagement that platform has.
Market capitalization or market cap is another important indicator in the DeFi industry. Keep in mind that the TVL indicator is exclusive to the DeFi industry only. Market value is related to the total value of a blockchain-based platform that issues its own tokens. Total Value Locked in the DeFi market depends on the total staked tokens and differs for every DeFi platform.
TVL is an important indicator related to lending and swapping on DeFi platforms. That’s because it helps the end-users determine how much they can actually earn by investing in a DeFi platform. That is the main reason why every DeFi platform strives to have more TVL in order to attract more investors. This metric helps increase an investor’s confidence in the platform because it shows that platform is a well-performing model.
Current TVL of the DeFi Market
If you are interested in TVL, you must understand the current TVL of the DeFi market. The DeFi market came into the limelight in 2020 and proved to be a good platform to invest in. This market mainly deals with liquidity, staking, and other things and rewards users for participating in the staking process. Amongst all this, TVL came forward as an important metric that can tell a potential investor if a specific DeFi asset is worth investing in or not.
The sum of all the TVL in DeFi platforms around the globe currently sits at around $170 billion. Just two years ago, the whole TVL was just around $400 million. By looking at these numbers, it won’t be wrong to say that the TVL industry saw immense growth in just two years.
One of the main protocols in DeFi is MakerDAO, and it has the most amount of TVL. There are lots of other protocols which contribute to the total TVL of the DeFi market as well.
Why is TVL Important for DeFi?
TVL is important in the DeFi market because it shows the overall potential and volume of the market at any given time. Having lots of investment is very important for every DeFi platform because it needs that for liquidity and collateral in trading. Higher TVL indicates that a specific DeFi platform is popular and attracts more users quickly.
Higher levels of TVL are an indicator that a DeFi platform is more liquid and usable for its users. It helps improve the performance of a DeFi platform in several ways.
More TVL directly means more capital invested in a DeFi platform. Therefore, any user investing in the platform can hope for higher returns as well. Low TVL means that every investor should hope for a lower yield. It is an indicator better than market cap, particularly in the case of DeFi.
As an investor, you should find out the reason why TVL tells us more about an asset as compared to its market capitalization. It tells us more about the active users on a platform and how the platform is rewarding them back for investing in it. This is the main reason why we can never ignore TVL when talking about the DeFi market.
Market Cap Vs TVL
Many investors might think that market capitalization is the only useful indicator telling us about the feasibility of investment. However, in the case of DeFi projects, market capitalization only tells us about the active and passive participation and trust by investors. On the other hand, the performance of a decentralized finance project is showcased by the total value locked.
A passive investor always invests in different decentralized finance projects in hopes of making a big return later on. This way, the more passive investors buy tokens of a DeFi project, the easier it’d be for that platform to appreciate in market capitalization. On the other hand, the TVL shows us the usability of a platform for active investors.
So, we can conclude that while market capitalization shows us the potential for growth in a DeFi project in the future, its TVL shows how the platform is performing now.
Calculating TVL of a DeFi Project
If you want to find the TVL of different DeFi projects already calculated, you can visit different platforms, like DeFi Pulse. On these platforms, you will be able to find the TVL of every individual DeFi protocol around the globe. These platforms make it really easy for investors to find DeFi platforms with the most amount of TVL. The method for calculating TVL might vary depending on the platform you are using.
For example, DeFi pulse calculates the TVL of a DeFi project by tracking and calculating every smart contract transaction on the ETH blockchain. ERC-20 tokens and Ether are calculated in the process. Just like this, other platforms use various other methods of calculating the total TVL of DeFi protocols.
The Calculation Process
Just because the number of DeFi projects is increasing significantly, the process of calculating the TVL of these protocols has become increasingly difficult. It is very difficult for newcomers to calculate the total value locked for any decentralized finance project. This is the reason why it has become even more difficult for investors to determine which type of decentralized finance protocols to invest in. So, the safest way to proceed in the market is to stick with decentralized finance protocols with a total value locked above $1 billion.
If a platform has a very high total value locked, it is an indication that the project is very useful for its users and has good growth potential in the future. However, if a decentralized finance project is providing you with higher returns despite its low total value locked, it should be scrutinized by the authorities. Platforms like these can scam new users into investing in them just to grow their market cap and TVL and to lure newbie investors towards them.
Total value locked is proving to be very beneficial in lots of decentralized finance projects, and this shows us the importance of calculating the TVL for every DeFi project. Therefore, you should learn how to calculate the total value locked for any decentralized finance protocol.
Here are some of the main points you should keep in mind when calculating the total value log before any protocol.
- The current supply volume of a DeFi protocol.
- Current price of the protocol.
- Max circulating supply of a DeFi protocol.
Calculating the total value locked of a decentralized finance protocol is not as difficult as it might seem to be. First, you will have to calculate the total current market capitalization of the protocol by multiplying its total circulating supply with its current price. Once you have a number in hand, you should then divide that number by the maximum circulating supply of a DeFi project to find its TVL. In order to calculate the total value lock the ratio, you can divide the market capitalization of a protocol by its TVL.
TVL ratio is an important indicator which helps you understand whether a specific decentralized finance protocol is overvalued or undervalued. If you are an investor, you should ideally look for protocols with a TVL ratio lower than one. This indicates that the project is still undervalued, and you have a good chance of making a reasonable profit from this investment. However, if the ratio is more than 1, it means that the asset is overvalued, and you should not invest in it.
Biggest DeFi Protocols in Terms of TVL
If you are an investor looking to invest in the DeFi marketplace, you should definitely learn more about total value locked and which decentralized finance protocols have the most amount of total value locked.
As we already mentioned, the total value locked of the whole decentralized finance industry was sitting around $650 million. One of the major players of that time was MakerDAO.
These days, platforms like Curve have surpassed MakerDAO. For example, Curve alone has a TVL of about $17 billion, and MakerDAO is sitting at $11 billion.
Why Invest in DeFi?
Decentralized Finance or DeFi is a new approach to Blockchain-based finance. The idea has become so popular that the DeFi market grew from $1 billion to $100 billion in just one year (2019-20). The market attracted 1 million investors during that process. Moreover, it is still growing at a rapid pace in 2022, and with the help of new institutional investors, the market is predicted to reach $800 billion by the end of 2022.
The widespread growth in the decentralized finance market has called for regulation in every country. However, the market is still largely unregulated because most of the institutions are still unclear about whose job it is to regulate the DeFi market.
Before investing in this market, you should learn a few things about an investor. One total value locked was an essential step; there is much more to learn.
Let’s discuss a few more things you should consider before you start investing in the Decentralised finance market and use the total value locked metric to determine whether you should invest in a DeFi protocol or not.
DeFi uses a mixture of blockchain features and other services to provide a solution that competes with banks and other traditional financial institutions. It eliminates all middlemen and makes it easier for you to transact your money across borders without much regulation.
Smart contracts are one of the main things used by decentralized finance platforms to perform their operations. These contracts prove to be useful when different parties want to set terms of financial agreements. Moreover, these contracts can automatically execute certain tasks on the Blockchain when required and directed by the terms agreed upon by the parties.
For example, if you take a loan, the lender can enter a smart contract with you, and the collateral is paid back to you automatically once you make all the repayments. The agriculture industry can also use these smart contracts to automatically pay the insurance amount if a specified amount of rain doesn’t fall.
DeFi solutions are being used in various services like loans, investments, insurance, management, and payments. The list is growing rapidly and is challenging the traditional financial services sector. This is the main reason. Why are many banks adopting the decentralized finance system to stay relevant? As an investor, you should always rely on indicators like TVL to see whether a specific decentralized finance protocol is eligible to be invested in.
Advantages of DeFi
There are lots of use cases and advantages of decentralized finance protocols. These benefits can not be provided by the traditional financial sector, which uses fiat money.
Let’s take a look at some of the most obvious advantages of DeFi.
Transactions are done instantly when you are using a decentralized finance platform. Moreover, depending on the value of a specific token, interest rates are adjusted in real-time.
There are no limits and barriers to entry in the decentralized finance market. If you have a smartphone or computer and a stable Internet connection, you can easily join the game. You can stake and unstake your assets easily without asking for anyone’s permission. Moreover, there are minimal fees on every transaction.
Every transaction on the DeFi network is completely transparent. That is because transactions are regularly uploaded on the public Blockchain and are verified by every user on the network. Any regular user can easily check all the transaction data without any restrictions and at any time.
Almost every decentralized finance project is done with open source code. This lets everyone audit the code and contributes to the platform. This gives developers an open hand to develop new decentralized finance applications and attach them easily to the network.
Because of the cryptography used in the decentralized finance market, no one can tamper with the data. Once a transaction is listed on the public ledger, no one can edit or delete the transaction data.
Smart contracts are very effective and can automatically execute certain tasks when specific requirements are met. This opens the door for many industries to build upon and benefit from the Blockchain and DeFi system.
Even when you stake specific DeFi tokens, you are still in the custody of those tokens. This promotes a sense of trust amongst investors.
Risks Associated with DeFi
Along with its advantages, the decentralized finance industry has its own risks as well. Let’s take a look at a few of them.
The decentralized finance technology is still very new and is yet to be tested on every level. Glitches in the code can easily devoid you of your money.
While decentralization is beneficial for users on many different levels, this also means that you are left with zero hope for help in the case of anything going wrong. There are no insurance programs covering your DeFi loss or theft.
Hackers can also steal your assets if you aren’t careful enough with the security of your account and password. Hackers steal millions of dollars worth of crypto every year.
Conclusion
We can safely conclude that while the decentralized finance industry has shown incredible progress and potential in recent years, you should still act cautiously when investing in any DeFi protocol.
In addition to other steps of due diligence, you should also learn more about TVL and use this important metric before investing in any DeFi project. Total value locked is even more important than the total market cap in the case of decentralized finance. It can tell you whether an asset is overvalued or undervalued.
So, before you dive into the world of decentralized finance, you must learn more about this novice industry and also about useful metrics like TVL to assess an asset before investing.