Decentralized finance may have evolved over the years but the space remains largely unregulated. Anyone can launch a DeFi protocol, a decentralized application (dApp), or even a new blockchain. This freedom creates both opportunities and risks for users making it hard to assess the reliability of protocols.
One crucial metric that investors use to evaluate the popularity and safety of a DeFi protocol is Total Value Locked (TVL). This metric shows the amount of value locked into a protocol or on different blockchains. It offers insights into its adoption and security.
In this article, we’ll take a quick look at TVL, its use cases, and where you can find more information about it.
Total value locked is a metric that describes the total value of assets (cryptocurrencies) locked into a DeFi protocol or blockchain. It represents the sum of all funds deposited into the smart contracts for purposes such as staking, lending, or providing liquidity.
Essentially, TVL shows how much confidence users have in the protocol: the higher the amount, the more users are committing their capital. For this reason, many investors see TVL as an indicator of the platform’s health. Higher TVL usually means that the protocol has built trust within its community.
This metric is particularly important for protocols in decentralized finance because they rely on liquidity to function effectively. Without a sufficient amount of locked value, the protocol may experience liquidity shortages. As a result, this could lead to inefficiencies or increased risk for the users.
Decentralized finance functions without any intermediaries and the user base is what drives the protocol’s growth. TVL is an important metric in DeFi for a few major reasons:
TVL has become a widely accepted benchmark for understanding the size and strength of DeFi protocols. It provides a way for investors to evaluate the level of risk when engaging with new or existing platforms.
TVL is calculated by summing the value of all the assets locked into a DeFi protocol. These assets can include different cryptocurrencies like Ethereum (ETH), stablecoins, or other altcoins that users have deposited into the platform’s smart contracts. The formula for calculating TVL is as follows:
For example, if a protocol has 10,000 ETH locked, and each ETH is priced at $2,000, the protocol’s TVL in ETH alone would be $20 million. Most platforms offer multi-token support, so the TVL will sum up all assets across different blockchains and tokens.
Since TVL is so important for DeFi, numerous platforms are providing vital TVL data. Some of the most widely used platforms are:
TVL measures the total value of assets locked into a protocol while market capitalization (market cap) reflects the total value of a protocol’s token in circulation. Market cap is calculated by multiplying the supply of a protocol’s native token by its current price:
Market Cap= Supply of Tokens×Token Price
When it comes to market cap, there are two types: current market cap and fully diluted market cap (FDMC). The current market cap is calculated by taking the currently circulating supply of tokens. In contrast, the fully diluted market cap takes into account the total supply of tokens that will ever be in circulation.
For example, Bitcoin’s current market cap is $1.23 trillion while the fully diluted one is $1.31 trillion. In some cases, the current market cap is equal to the FDMC because all tokens are already in circulation.
Going back to the comparison between TVL and market cap, the key difference is that TVL measures the value locked within a platform. At the same time, market cap doesn’t take that into account, only the market value of the platform’s token.
TVL helps assess how much liquidity or assets are locked in the protocol, while the market cap is used to evaluate the token’s value on the open market. A protocol may have a high TVL but a relatively low market cap if its token is undervalued, or vice versa.
Comparing the two metrics can help investors determine whether a token has a fair price or if a protocol’s popularity justifies the value of its token.
TVL provides critical insights for DeFi investors. Some of the key takeaways include:
While TVL is a valuable metric, it has some limitations:
Aside from TVL, investors should consider additional metrics when assessing DeFi protocols. Other relevant data includes:
This metric shows how many unique users interact with a protocol daily. Consequently, a higher number of active users often indicates a healthy protocol with strong adoption and regular usage. Platforms like DappRadar track DAU data.
Transaction volume shows the total value of assets transacted through the protocol over a given period. As a result, it also indicates how often users engage with the platform and how frequently they use the protocol. You can find this type of data on sites like CoinGecko or DeFi Llama.
A smart contract audit reviews the code of a DeFi protocol to identify potential vulnerabilities or flaws. Furthermore, a protocol with audited smart contracts provides more security and reduces the risk of hacks. Look for audit reports on the protocol’s official website or third-party audit firms like CertiK or Hacken.
The longer a protocol has been operational without major incidents, the more trust it tends to garner from the community. Older protocols are generally more secure, as they’ve had more time in the field. You can find protocol age on blockchain explorers such as Etherscan by looking at the protocol’s token launch date.
Understanding the distribution of governance tokens can provide insight into how decentralized a protocol is. If a small group holds the majority of the tokens, they may have too much influence over key decisions. This data is typically available on token analytics platforms like Token Terminal or Bubblemaps.
Total value locked is one of the most important metrics in DeFi. It offers key insights into the liquidity, trust, and health of a protocol. Despite that, investors should not rely on TVL alone as this can be misleading. Instead, users should consider TVL along with other vital metrics such as DAU, volume, audits, protocol age, and distribution.