The crypto industry is growing at an unprecedented rate. Every other day we come across something new happening in decentralized finance (DeFi) or around non-fungible tokens (NFTs). According to reports, as of September 2021, the decentralized finance (DeFi) industry held a value of $80 billion that was locked in the top 125 apps. At the time of writing, the total market cap of DeFi crypto is $126.02 billion according to CoinMarketCap. The tracking and measuring of the overall value of this market have become as important as following market cap figures. Crypto investors are constantly looking for indicators to evaluate projects. One of those indicators is Total Value Locked or TVL which has emerged as an important metric for evaluating the decentralized finance space. However, before we understand how significant a role TVL plays in the DeFi sector, let us first understand what TVL actually is.
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What is Total Value Locked (TVL)?
The total value held by the DeFi platform within its smart contracts is called the Total Value locked or TVL. It is representative of all the funds present across platforms in transactional, lending, and borrowing capacities. The overall TVL of the industry is the summation of all the TVL across various DeFi apps.
TVL of a DeFi app also shows how successful it is in gaining attention from active and monthly transacting users. While TVL is a measure only specific to DeFi projects the market cap is applicable for any blockchain-based platform that issues its own tokens. The calculation of TVL varies from platform to platform. TVL is an important metric for DeFi platforms specific to lending and swapping. Since it has the ability to directly impact the usability as well as yield of these applications for every end-user.
Applications like these always aim for higher TVL in general. Because higher TVL implies more efficient swaps as well as a more effective supply of liquidity to borrowers in the lending market.
Additional Read: How will DeFi Reshape the future of Digital Finance
Significance of Total Value Locked: TVL vs Market Cap
TVL is important because it is the most significant DeFi indicator. It denotes the popularity of a project with the number of active users. It is a good measure to evaluate the robustness of a project. Although the market cap provides the indication of the appreciation received by a protocol from active as well as passive investors but TVL is the most obvious indicator for the DeFi sector. The passive investors are those investors who invest in the protocol expecting the token to grow and succeed. However, they might not be using that protocol in itself. They buy the token of these protocols in hope of price appreciation and this leads to the increment of market cap. TVL on the other hand reflects the usability of a platform by its active players. The investors who actually transact using the platform. TVL can be thought of as an important alternative for market cap.
If someone wishes to gauge the future potential of a DeFi project then one needs to have a look at its market cap. However, if someone wishes to gauge the current scenario of a project, the TVL is the best indicator.
Also Read: Decentralized Finance vs. Traditional Finance
Types of DeFi projects and TVL for each type
1. Decentralized crypto exchanges (DEXes): Decentralized crypto exchanges allow users to trade or swap cryptos on an automated market maker (AMM). These users do not trade directly with each other while swapping crypto assets. Rather they conduct transactions with a liquidity pool that holds the requisite pair of cryptos. Some of the examples of these protocols are Curve Finance (CRV), Uniswap (UNI), and SushiSwap (SUSHI). For these platforms, TVL is the total value held in all the coin-pair pools within the protocol.
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2. Lending and Borrowing: The primary function of these protocols is the utility of the liquidity pools to lend crypto funds to its users and let them borrow funds from these pools. Some of the popular examples of such protocols are Maker (MKR), Aave (AAVE), and Compound (COMP). TVL for these protocols is the total value held in the lending and borrowing pools.
3. Yield optimization protocols: These applications use algorithms to optimize the investments of users across various borrowing and lending platforms. These behave as automated portfolio managers. Once the user deposits their funds into the protocols the algorithm accordingly allocates the funds to the pools that have the best-expected returns. One of the popular names in these types of protocols is Yearn.Finance (YFI). TVL for these applications is referred to as the value lent by the users to the application for yield optimization.
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Summing it UP!
TVL is one of the important measures to gauge the performance of a DeFi project. It is a great addition to the statistics of market cap to analyze the DeFi applications.
While the market cap gives you an idea about the future, TVL is a good indicator of the current performance of a project. However, readers must also take the volatility of the DeFi industry into account while analyzing the TVL statistics.
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