The continuous improvements in the crypto industry have introduced many unprecedented benefits and challenges. Cryptocurrencies arrived with a solid claim for transforming conventional financial infrastructures, systems, and processes. With the benefit of decentralization, cryptography, and transparency, cryptocurrencies have been able to climb to the top value-based charts in modern financial markets.
At this point in time, the discussions on total value locked in DeFi would draw references to the rise of NFTs, DeFi, and other decentralized solutions. What is the significance of total value locked in the emerging world of decentralized finance? The following post offers a detailed explanation of total value locked and its importance, as well as the methods for calculating TVL.
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What is Total Value Locked?
The first thing you must note in a discussion on Total Value Locked or TVL in the domain of DeFi focuses on its definition. TVL basically denotes the total value of the assets staked in the smart contracts of a DeFi platform. It works as an indicator of the funds available throughout different DeFi platforms for transactional, borrowing, and lending capacities. You can estimate the TVL for the DeFi industry by evaluating the sum of the total value locked in all the DeFi apps. The TVL associated with a DeFi app showcases a promising indicator of its effectiveness in garnering attention from monthly active users for different transactions.
You must have another notable confusion regarding the total value locked in DeFi, especially with respect to market capitalization. It is important to note that TVL is a specific indicator for DeFi projects only. On the other hand, market capitalization is an indicator of market value for any blockchain-based platform issuing its own tokens. Most important of all, the TVL value in DeFi differs from one platform to the other.
At the same time, it is also one of the critical metrics for DeFi platforms associated with swapping and lending. Why? The importance of TVL in DeFi becomes quite clear with the ability to directly influence usability and returns from DeFi applications for end-users. DeFi applications generally seek a higher TVL value to draw in more users. How? Higher TVL suggests the capabilities of the DeFi platform for efficient swaps alongside the desired supply of liquidity in lending markets.
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Existing State of Total Value Locked in DeFi
Before you dive deeper into questions like “How important is TVL?” you need to check the existing state of TVL. Decentralized finance, or DeFi, skyrocketed in popularity in 2020, with many new solutions evolving as new forms of investment. DeFi assets are generally associated with interest and rewards from services like staking, liquidity pools, and lending, available as smart contracts. For example, TVL could show investors whether it is reasonable to stake their assets in the concerned DeFi platform.
As of now, the TVL in DeFi amounts to almost $172 billion throughout different DeFi applications worldwide. The growth of TVL in the domain of DeFi has been phenomenal, considering the fact that TVL amounted to around $400 million two years ago. One of the biggest phases of growth in the TVL for decentralized finance happened between 2020 and 2021. The most popular protocol accounting for a major share in the total value locked for the DeFi sector is MakerDAO. In addition, many other popular protocols such as Aave and Curve also contribute to the growth in TVL for the domain of decentralized finance.
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Significance of TVL for DeFi
The importance of TVL in DeFi is an integral highlight for the growth of the overall DeFi landscape. DeFi platforms need capital in the form of liquidity or collateral in the trading pools. The total value locked in a specific DeFi platform is not only an indicator of the value of assets in the protocol but also its appeal to users.
A better TVL is an obvious indicator of effective usability for investors and traders. The growth in TVL for a particular DeFi protocol brings about plausible improvements in usability, liquidity, and popularity for the platform. All of these factors can result in credible chances for the success of the DeFi project.
Higher TVL indicates that a DeFi protocol has more capital locked in the platform. As a result, users could capitalize on a wide range of benefits and better yields. On the contrary, a lower TVL obviously implies a lack of capital, which ultimately translates to lower yields for users. The answer to “How important is TVL?” ultimately rounds up how it is better than the market capitalization estimate.
First of all, you must have figured out how the total value locked for a DeFi platform serves as a credible indicator of its performance. It serves as an effective and simple metric for evaluating the popularity of a project by identifying an estimate of the number of monthly active users. Therefore, you cannot deny the significance of total value locked in DeFi for finding out the robustness of a project.
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Difference between TVL and Market Capitalization
You might wonder about market capitalization as an indicator of a project’s performance. However, market capitalization of a DeFi protocol basically showcases the support for a protocol by active alongside passive investors. On the contrary, the total value locked serves as a clear indicator of the performance of a protocol in the DeFi domain.
Passive investors might not use the protocol itself and must have invested in the protocol for favorable returns at a later stage. Passive investors purchase the tokens of protocols in anticipation of appreciation in the price of the tokens, thereby facilitating growth in market capitalization. However, total value locked or TVL showcases the actual usability of the platform with investors.
Can you ignore the market capitalization of DeFi projects as an indicator of their value? Market capitalization offers an impression of the future potential of a specific DeFi protocol. On the other hand, the total value locked in a decentralized finance project showcases how the protocol is performing now.
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Where Can I Find the Total Value Locked for a DeFi Protocol?
The analytics firm platforms such as DeFi Pulse and DeFi Llama can help you find the TVL for a specific decentralized finance protocol. These platforms provide a detailed display of the total value locked in DeFi protocols worldwide. You can easily identify the DeFi protocols with the highest volume of crypto assets staked in the platforms. Interestingly, the two different analytics firms use distinct ways of monitoring the TVL of decentralized finance protocols.
DeFi users must know that DeFi Pulse tracks the smart contract transactions of the DeFi protocol on the Ethereum blockchain. It figures out the TVL value by using the total balance of ERC-20 tokens and Ether in the protocol. On the other hand, DeFi Llama utilizes a different method for calculating the TVL. DeFi Llama takes the combined balance of all DeFi chains or every individual platform distinctively for calculating TVL.
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How to Calculate Total Value Locked in Decentralized Finance?
The continuous arrival of new DeFi protocols has emerged as one of the challenges for evaluating TVL in DeFi protocols. It is difficult for aspiring users to figure out the exact estimate of total value locked for the overall market. You can also face difficulties in determining which DeFi protocol would be a safe choice right now. For starters, users can look for the popular protocols with TVL amounting to almost $1 billion.
Higher TVL is an obvious indicator of the high demand for the DeFi protocol, alongside suggestions that the protocol offers valuable use cases and has the backing of a strong developer team. On the other hand, DeFi projects with lower TVL must come under scrutiny if they offer higher yields. For example, such instances might be promotional scams where new DeFi platforms want to gain trust and market shares.
The importance of TVL in DeFi serves as a clear impression of the necessity to come up with a TVL estimate for DeFi projects immediately. However, it is also important to know how to calculate the total value locked for a decentralized finance protocol. What are the important factors that help you calculate the TVL for a decentralized finance protocol? The three critical aspects in determining the total value locked for a DeFi protocol include,
- The existing supply of the DeFi protocol
- Maximum circulating supply of the DeFi protocol
- The existing price of the DeFi protocol
You don’t have to go through complicated steps to determine TVL in DeFi protocols. The process begins by identifying the market capitalization of the DeFi project by multiplying the supply of the DeFi project with its existing price. In the next step, you must divide the market capitalization by the maximum circulating supply of the protocol for finding out the TVL. Division of the total market capitalization of a locked asset by the TVL estimate can provide a clear impression of the TVL ratio.
If you are still wondering about “how important is TVL?” you must know the significance of the TVL ratio. The TVL ratio is an important indicator of whether a particular DeFi asset is overvalued or undervalued. For example, if the ratio falls lower than 1, the asset is undervalued and better suited to investors. On the other hand, an asset could be overvalued if the market cap crosses beyond the TVL estimate.
Highest TVL in DeFi Landscape
Since the total value locked is specific to the DeFi landscape, it is important to look for the best project with the highest TVL. Somewhere around the beginning of 2020, the total value locked in DeFi platforms amounted to almost $630 million. Interestingly, MakerDAO was one of the first protocols that led the tables in terms of DeFi TVL estimates.
As of now, new protocols such as Aave and Curve have also entered the market and surpassed the previous leaders. For example, Curve has a total TVL of almost $17 billion, while MakerDAO has a TVL of $11.5 billion. Other popular DeFi protocols with a high TVL estimate include Lido and Anchor. Lido has a TVL estimate of $15.4 billion, while Anchor sits with a $12.6 billion TVL.
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The Ethereum network is the leading force of DeFi applications and is the biggest network in terms of DeFi TVL. However, you should note that the DeFi landscape is constantly evolving with the introduction of new protocols and solutions. The leaders of yesterday have paved the road for new competitors in terms of TVL based on their valuable use cases.
The importance of TVL in DeFi becomes clear on the grounds of its role in showcasing the immediate potential of a DeFi protocol. As a result, it turns out to be a better indicator than the market cap of a specific DeFi project. It not only guides investors regarding the actual value of new or existing DeFi protocols but also paves the road to easier DeFi adoption. Learn more about TVL and how it plays out in the broader decentralized finance landscape.
*Disclaimer: The article should not be taken as, and is not intended to provide any investment advice. Claims made in this article do not constitute investment advice and should not be taken as such. 101 Blockchains shall not be responsible for any loss sustained by any person who relies on this article. Do your own research!