Total Value Locked (TVL) is a vital metric that traders use in the crypto sphere, especially in the decentralized finance (DeFi) space, to assess a system’s potential and strength.
If you’ve set your sights on becoming a successful crypto investor, you must become aware of what TVL means in the world of cryptocurrencies.
You’re covered if you just came across the term total value locked (TVL) and don’t know precisely what it means. This article will dissect TVL, how it is calculated and how it relates to crypto and DeFi protocols. Once you understand the essence of this critical metric and can use it to analyze different protocols, it will become your right-hand tool when making crucial crypto-based investment decisions.
What is Total Value Locked?
The emergence of Decentralized Finance (DeFi) and its boom in 2020 disrupted the financial market with a new form of investment vehicle. Since then, numerous cryptocurrencies had found themselves on the market’s roller-coaster ride amidst that volatile period when crypto assets started experiencing a pull-out from DeFi. The Total Value Locked refers to the Value of crypto funds held within all the smart contracts of a DeFi platform.
Just like a litmus test, TVL enables investors to recognize which one among the many DeFi protocols would beideal to invest in since the higher the TVL of a platform, the more lucrative it should be.
Therefore, the extent of the Total Value Locked is an important indicator that shows the popularity or otherwise of a lending or DeFi swapping platform and the magnitude of attention and interaction it draws from active users and monthly transactions.
TVL would also refer to the number of user funds deposited in a DeFi platform, which the platform can avail for specialized crypto-backed functions such as crypto staking, liquidity pools, or crypto lending.
The Difference between TVL and Market Capitalization
The market capitalization of a DeFi project shows how much support a protocol has between active and passive investors. Usually, some passive investors place their funds within a platform in anticipation of a good return on investment at a later stage. TVL, on the other hand, showcases a project’s performance within the DeFi space.
Passive investors buy tokens and wait for the price to improve before they can sell, thus facilitating a project’s market capitalization. Nonetheless, TVL is an accurate indicator of the platform’s actual usability among investors.
Whereas most investors consider market cap a vital metric that shows how active a DeFi platform is, TVL is the metric that indicates how popular the project is with active users as it reveals the robustness of a DeFi project. If the market cap is a good barometer for investors who want to gauge the future potential of a DeFi protocol, then TVL becomes the measure for checking the project’s current status.
The Importance of Total Value Locked in Crypto
A robust Total Value Locked is an excellent indicator of the well-being of a DeFi protocol. When a DeFi platform has a higher TVL, it has acquired healthy trust among investors willing to deposit their crypto funds with them. A more significant amount of crypto assets translates to more capital being available as a source of higher liquidity, thereby making the platform more attractive and usable for investors.
Suppose you’re interested in making an informed investment decision and knowing the Total Locked Values of different DeFi projects, including their market share. In that case, there are analytics platforms like DeFiPulse or DeFiLlama, among others.
While the information you garner from DeFi aggregators may help you decide the health of a particular crypto project, you want to remember that a crypto’s tokenomics are equally important. It’s necessary to look at the platform’s bigger picture since an excellent TVL alone may not necessarily indicate a token’s performance.
The Current State of Total Value Locked in DeFi
Before we can dive deeper into the subject and find out how you can calculate a DeFi project’s TVL, we must take note of the current state of TVL in the entire DeFi industry. The year 2021 showed tremendous metrics for the whole crypto industry, and decentralized finance platforms were not left behind as they attracted significant capital streams.
However, according to a report by crypto market data analytics firm CryptoRank, tables turned on the DeFi industry in 2022 due to the ongoing crypto winter. Specifically, the TVL of the entire DeFi market dropped 68.3% from $303.8 billion in December 2021 to at least $96.3 billion in September 2022.
There are currently several DeFi platforms, all of which offer different types of investment solutions. These platforms provide DeFi investment options that pay back investors with interest or rewards for participating in services like providing liquidity pools, crypto lending, and staking as smart contracts. Potential investors analyze the Total Value Locked by different platforms before deciding whether investing their crypto assets in a particular platform is reasonable.
Per the CryptoRank report, the growth TVL with the DeFi space experienced phenomenal growth in 2021, having surged 1,200%, with Ethereum taking the lion’s share at 62%. Whereas the entire TVL in DeFi amounted to only $400 million in early 2020, the DeFi industry experienced the most incredible leap between 2020 and 2021. Apart from Ethereum, other DeFi protocols like Curve and Aave contributed immensely to the growth of TVL in decentralized finance.
How is crypto TVL Determined?
Due to the lucrativeness of the crypto space in general and the DeFi market in particular, there’s every chance there will always be a new DeFi platform. This, therefore, underlines both the importance and difficulty of establishing the exact Total Value Locked within the entire market besides determining a specific platform’s safety level for budding investors.
Nonetheless, potential investors should endeavor to select DeFi projects with a TVL of at least $1 billion, as that would be a fair enough safety net. In addition to opting for a protocol with a higher TVL which is a good indicator of a healthy platform, it’s also advisable to consider a platform with a strong team of developers. These are among the parameters that attract investors (lenders) and participants (borrowers), leading to a healthier TVL for the project.
Most importantly, potential users considering a crypto project’s Total Value Locked should view a DeFi platform with a low TVL offering abnormally high yields as a red flag. While those could be promotions meant to create attention among users about a new crypto platform, there are also high chances it could be a scam such as a rug pull when the platform has very few or no participants.
Factors to Consider When Calculating TVL
The total value locked in DeFi can be calculated by taking three main factors into consideration: supply, maximum supply, and the current price. TVL includes all the coins deposited in all of the functions that DeFi protocols offer, including staking, lending, and liquidity pools.
Factors to Consider when Calculating Total Value Locked
There are three important factors you consider when calculating the TVL of a DeFi protocol:
- The asset’s project’s supply (market cap)
- The asset’s maximum circulating supply
- The asset’s current price
The market cap is obtained by multiplying the protocol’s asset supply by its current price. After that, you divide the market cap with its maximum supply to avail of its TVL.
How to Calculate the Total Value Locked in a Project
It’s relatively easy to calculate the Total Value Locked in a crypto project: you take the total number of crypto tokens the protocol has stacked and multiply that by the token’s current Value in USD. Suppose a DeFi project allows staking using different types of tokens. In that case, it’s necessary to calculate the TVL of each token individually before adding them together so you can determine the protocol’s Total Value Locked.
Let’s imagine your chosen DeFi protocol allows users to stake three different cryptos (Crypto X, Crypto Y, and Crypto Z). In this case, you should calculate the total amount of staked crypto X and multiply that with the token’s current market value in USD. You must then repeat the same process for crypto Y and crypto Z and then add up the results of the three crypto tokens to determine the TVL of the entire DeFi project.
We could summarize the process in the following simple steps:
- Step #1: Identify the market capitalization of the DeFi project. This is achieved by multiplying the total supply of the project’s tokens with its current price.
- Step #2: Find the Total Value Locked by dividing the protocol’s market capitalization by the protocol’s maximum circulating supply. Dividing the project’s total market capitalization by the estimated TVL will give you a clear picture of the TVL ratio.
You want to know a project’s TVL ratio because it shows whether a particular DeFi token is overvalued or undervalued. As an example, should the TVL ratio of a token go lower than 1, it means the token is undervalued and would offer better outcomes for investors.
However, an asset is overvalued if its TVL ratio is higher than its TVL estimate. The easier way of learning a project’s TVL is to avoid doing the calculations on your own and visit DeFi aggregation sites like DeFiPulse, DeBank, or DeFiLlama.
Since we’ve already understood what TVL is and how to calculate it, let’s consider a hypothetical example.
Let’s imagine that Shah deposits $2,000 in crypto into a staking pool to help validate transactions by connecting his crypto wallet to a DeFi platform using its native token in anticipation of staking rewards. Let’s also say that he lends out an additional $2,000 worth of crypto to a borrower on the same DeFi platform and places some $3,000 in a liquidity pool. If no other participant puts their money in the DeFi platform, then the protocol’s Total Value Locked will be $7,000.
On the other hand, let’s say DeFi protocol X has 2 million Ether (ETH) deposited by different users in its liquidity and staking pools, and ETH is worth $1,300 each. The TVL for DeFi protocol X will be $2.6 billion in this case. However, if the price of ETH changes to $1,500 in the next 2 hours, the TVL will be $3 billion even though the amount of ETH will still be the same.
The Downside of Total Value Locked
Total Value Locked may be a good metric that helps participants in DeFi, but there are situations when it could falsify the proper health and correct position of a DeFi project. A good case in mind is that in some cases, the enormous amount of crypto funds in a DeFi protocol could belong to a few individuals, usually called “crypto whales.” Their financial patterns, such as HODLing and withdrawal activities, could “move the needle” disproportionately regarding TVL metrics.
Since TVL doesn’t account for the number of crypto assets owned and controlled by individual participants, the actions of a crypto whale who, for instance, owns 90% of the funds could control a big prevent of a project’s Total Value Locked. In such a situation, potential investors who only depend on the TVL metrics of a DeFi protocol will have relied on a false sense of the project’s health status.
Worse, there could still be situations where such crypto whales become incentivized financially to deposit their funds in a DeFi project to overhype its TVL to attract new investors and crypto-staking enthusiasts. Therefore, while it remains an essential barometer for the crypto space, investors analyzing a project’s Total Value Locked should be careful to combine it with other metrics when considering an investment in a particular DeFi platform.
Why you should care about Total Value Locked
Any potential investor ought to gain market confidence with a token they intend to invest in before they can choose from numerous projects available in the market. Total Value Locked is an essential metric that investors use to determine the strength or otherwise of DeFi and crypto projects. Nonetheless, take note that TVL alone may not be 100% accurate, and you must do your own research as an investor before investing in a crypto project.
The Ethereum ecosystem remains the bedrock of most DeFi applications and remains the leading network as far as crypto TVL is concerned. Nonetheless, the crypto and DeFi landscape are on the move, and there will always be new projects and solutions. As standards and use cases keep changing, today’s leaders could easily give way to their competitors, and their Total Value Lock could change instantly.
Ultimately, the ever-evolving crypto market that operates in an unregulated environment creates a lot of on-chain activity from speculative players looking for short-term gains. Any amount of users who lock their crypto seeking to generate passive income could withdraw it from a crypto project at their set time which could decrease a protocol’s total Value locked.
The significance of Total Value Locked in crypto is primarily clear in showing the immediate status of a DeFi project. Investors should consider it an important indicator but not the solo guide when interrogating the value of existing or new crypto projects besides paving the road to increased crypto adoption. Continually learning more about Total Value Locked and its role in the decentralized landscape remains essential for all aspiring investors.