TVL - Total value lock
In a DeFi project, the TVL (Total Value Locked) is the total value of all the assets that have been staked. It is one of the best indicators of the stability and health of a project.
Calculating TVL Ratio
To calculate the TVL, the amount of locked assets should be multiplied by its price in a stablecoin or fiat coin like the US dollar. For example, if a project has 100 tokens locked on stake and the price of the token is 2 USD, the TVL will be 200 USD.
The TVL ratio is the relation between the market capitalization and the value on stake. In other words, it reflects how many of the total tokens are locked.
TVL of different blockchains (September, 2021):
TVL of different blockchains, including Ethereum (September, 2021):
PROs
- It is a very good indicator of the health and stability of a project
- It shows trust from investors
- It shows the amount of short-term speculation
CONs
- It is not the most important indicator of risk, which depends on other factors
- It doesn't show the amount of long-term speculation
Conclusion
The TVL is a very important indicator, and one that should always be considered before investing in a decentralized finance (DeFi) project, but it only matters after evaluating more important elements:
- Staking protocol (rewards and lock time)
- Transparency of the project (established team, open-source code, KYC, audit)
- Improvements in comparison with similar projects
Analyst Opinion
It is very important to understand that the TVL of a project is only one of many indicators of its real value. A high TVL ratio (in relation to the market cap) is always a good sign, but it shouldn't be enough to make an investment decision. Other factors like transparency (having a well-known team and an open-source code) and improvements in relation to similar projects, should be considered first.
The TVL ratio can help determine how much of the value of the asset is a consequence of short-term speculation, and how much is a result of true utility and trust from investors. This is due to the fact that, if a high percentage of assets are locked (on stake), they cannot be easily sold. Therefore, the risk of investors selling off to make profit is much lower. In other words, the greater the TVL ratio, the more stability the asset price will have.
The TVL ratio can be used to determine if a project is undervalued or overvalued. The higher the TVL ratio is, the more undervalued the project is, so it could be a good idea to invest.
But there are two downsides to trusting the TVL ratio blindly
- It only indicates how many short-term speculators are raising the price, but it doesn't show how much of the locked assets belong to medium or long-term speculators, who plan to generate profit by staking in order to unstake the assets and sell them all after a period of time.
- TVL does not matter for some staking protocols that:
- Allow unstaking to be performed fast and easily, which means the assets are not actually locked
- Yield very small staking rewards, and there is not a lot of motivation to keep the assets locked
Ondřej Tittl
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