Cryptocurrency Total Value Lock (TVL): Explained

Total Value Locked (TVL) is a key indicator used by traders in the cryptocurrency space, especially in the decentralized finance (DeFi) space, to assess the potential and strength of a system.

If your goal is to become a successful cryptocurrency investor, you need to be aware of what TVL means in the cryptocurrency world.

If you’ve just come across the term Total Value Lock (TVL) and don’t know exactly what it means, that’s okay. This article details TVL, how it is calculated, and how it relates to cryptographic and DeFi protocols. Once you understand the essence of this important indicator and can use it to analyze different protocols, you will have the right tool when making important crypto-based investment decisions.

What is a total value lock?

The emergence and boom of decentralized finance (DeFi) in 2020 disrupted financial markets with new forms of investment vehicles. Since then, a number of cryptocurrencies have found themselves on a market roller coaster amidst a volatile period when crypto assets began to exit DeFi. Total value locked refers to the value of crypto assets held within all smart contracts on a DeFi platform.

Like a litmus test, TVL allows investors to recognize which of the many DeFi protocols it is ideal to invest in, as the higher the TVL of a platform, the more profitable it is.

The Total Value Locked range is therefore an important indicator of how popular a lending or DeFi swapping platform is, and how much attention and interaction it draws from active users and monthly transactions.

TVL also refers to the number of user funds deposited on a DeFi platform. The platform can be used for specialized crypto-backed features such as crypto staking, liquidity pools, and crypto lending.

Difference between TVL and market capitalization

A DeFi project’s market capitalization indicates how much support the protocol has among active and passive investors. Typically, some passive investors place their funds within the platform with the hope of a good return on investment at a later stage. TVL, on the other hand, showcases the performance of projects within the DeFi space.

Passive investors buy tokens and wait for the price to improve before selling, which helps the project’s market capitalization increase. Nevertheless, TVL is an accurate indicator of the actual ease of use of the platform among investors.

While most investors consider market capitalization to be an important indicator of how active a DeFi platform is, TVL reveals the robustness of a DeFi project and therefore the extent to which a project has active users. This is an indicator of popularity. If market capitalization is a good barometer for investors who want to gauge the future potential of a DeFi protocol, TVL is a yardstick to check the current status of a project.

The importance of the total amount locked in cryptocurrencies

A robust total value locked is a good indicator of the health of a DeFi protocol. If a DeFi platform has a high TVL, it has a healthy trust among investors who want to deposit their crypto assets. As the amount of crypto assets increases, more capital becomes available as a source of higher liquidity, thereby making the platform more attractive and easier to use for investors.

Suppose you are interested in making an informed investment decision and knowing the total locked value (including market share) of different DeFi projects. In that case, there are analytics platforms like DeFiPulse and DeFiLlama .

While the information you gather from DeFi aggregators can help determine the health of a particular cryptocurrency project, keep in mind that the tokenomics of a cryptocurrency are just as important. A good TVL alone does not necessarily indicate the performance of a token, so we need to look at the overall picture of the platform.

Current state of total amount locked in DeFi

Before we delve deeper into this topic and learn how to calculate TVL for a DeFi project, we need to take a look at the current state of TVL in the DeFi industry as a whole. 2021 showed incredible indicators for the entire cryptocurrency industry, and decentralized finance platforms were not left behind as they attracted significant capital flows.

However, the ongoing crypto winter has turned the tables on the DeFi industry in 2022, according to a report from crypto market data analysis firm CryptoRank . Specifically, the overall TVL of the DeFi market decreased by 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 offer DeFi investment options that repay interest and rewards to investors who participate in services such as providing liquidity pools, cryptocurrency lending, and staking as smart contracts. Potential investors analyze the total value locked by different platforms before deciding whether it makes sense to invest their crypto assets in a particular platform.

According to a report by CryptoRank, the growth TVL in the DeFi space experienced incredible growth in 2021, jumping 1,200%, with Ethereum holding the largest share at 62%. Although DeFi’s overall TVL at the beginning of 2020 was only $400 million, the DeFi industry experienced the most amazing leap from 2020 to 2021. Apart from Ethereum, other DeFi protocols such as Curve and Aave have significantly contributed to the growth of TVL in decentralized finance.

How is crypto TVL determined?

Due to the high profitability of the crypto space in general and the DeFi market in particular, there is a good chance that there will always be new DeFi platforms. This therefore highlights both the importance and difficulty for budding investors of establishing the exact total value locked across the market, in addition to determining the safety level of a particular platform. .

Nevertheless, potential investors should try to choose DeFi projects with a TVL of at least $1 billion, as it will be a fair enough safety net. In addition to choosing a protocol with a high TVL, which is a good indicator of a healthy platform, we also recommend considering a platform with a strong developer team. These are among the parameters that attract investors (lenders) and participants (borrowers), leading to a healthier TVL of the project.

Most importantly, potential users looking to lock in the total value of a cryptocurrency project should consider DeFi platforms that offer low TVL and unusually high yields as red flags. These could be promotions to get users’ attention about a new crypto platform, but if the platform has very little or no participation, they could be crypto scams like pulling the rug out from under them. The sex will also be higher.

Factors to consider when calculating TVL

The total value locked in DeFi can be calculated by considering three main factors: supply, maximum supply, and current price. TVL includes all coins deposited into all the features that DeFi protocols offer, such as staking, lending, and liquidity pools.

Factors to consider when calculating locked totals

There are three important factors to consider when calculating the TVL of a DeFi protocol.

• Project supply of assets (market capitalization)
• Maximum circulating supply of assets
• current price of the asset

Market capitalization is obtained by multiplying the protocol’s asset supply by its current price. We then take the TVL by dividing the market capitalization by the maximum supply.

How to calculate the total value locked to a project

Calculating the total value locked in a crypto project is relatively easy. The protocol takes the total number of crypto tokens stacked and multiplies it by the token’s current value (in USD). Suppose a DeFi project allows staking using different types of tokens. In that case, the TVL of each token must be calculated separately before summing the tokens so that the total locked value for the protocol can be determined.

Let’s imagine that your DeFi protocol of choice allows users to stake three different cryptos: Crypto X, Crypto Y, and Crypto Z. In this case, you need to calculate the total amount of staked cryptocurrency X and multiply it by the current market price of the token (in USD). Next, you need to repeat the same process for Crypto Y and Crypto Z and sum the results for the three crypto tokens to determine the TVL for the entire DeFi project.

This process can be summarized in the following simple steps:

• Step #1: Identify the market capitalization of your DeFi project. This is achieved by multiplying the project’s total supply of tokens by the current price.

• Step #2: Determine the total locked value by dividing the protocol’s market capitalization by the protocol’s maximum circulating supply. Divide the project’s market capitalization by the estimated TVL to determine the TVL ratio.

We want to know the TVL ratio of a project because it indicates whether a particular DeFi token is overvalued or undervalued. For example, if a token’s TVL ratio drops below 1, it means the token is undervalued, leading to a better outcome for investors.

However, if the TVL ratio is higher than the TVL estimate, the asset is overvalued. An easy way to learn your project’s TVL is to avoid doing the calculations yourself and visit a DeFi aggregation site like DeFiPulse , DeBank , or DeFiLlama .

Now that we know what TVL is and how it is calculated, let’s consider a hypothetical example.

Imagine that Shah deposits $2,000 of cryptocurrency into a staking pool to help validate transactions by connecting his cryptocurrency wallet to a DeFi platform using native tokens in anticipation of staking rewards. Let’s try it. Let’s also say he lends an additional $2,000 worth of cryptocurrency to a borrower on the same DeFi platform, leaving about $3,000 in the liquidity pool. If no other participants put money into the DeFi platform, the total amount locked in the protocol will be $7,000.

On the other hand, let’s say that 2 million ether (ETH) is deposited by various users in DeFi Protocol X’s liquidity pool and staking pool, and each ETH is worth $1,300. In this case, DeFi Protocol X’s TVL would be $2.6 billion. However, if the price of ETH changes to $1,500 in the next two hours, the TVL will be $3 billion, even though the amount of ETH remains the same.

Disadvantages of total value locking

While the total locked value can be a good indicator to help DeFi participants, there are situations where the proper health and correct position of a DeFi project can be disguised. A good example to keep in mind is that in some cases, a huge amount of crypto funds within a DeFi protocol may belong to a small number of individuals, usually referred to as “crypto whales.” Financial patterns such as HODL and withdrawal activity can disproportionately “change” with respect to the TVL metric.

Since TVL does not take into account the number of crypto assets owned and controlled by individual participants, the actions of a crypto whale that owns, for example, 90% of the funds could potentially control a significant prevention of locking in the total value of the project. there is. In such a situation, potential investors who rely solely on the TVL indicator of a DeFi protocol will be relying on a false perception about the health of the project.

To make matters worse, there are still situations where such crypto whales are financially motivated to park their funds in DeFi projects and hype TVL to attract new investors and crypto staking enthusiasts. There is a possibility that So while this remains an essential barometer for the crypto space, investors who analyze a project’s Total Value Locked should consider it alongside other metrics when considering investing in a particular DeFi platform. Care must be taken to combine them.

Why should you consider locked totals?

Potential investors need to gain market confidence in the token they plan to invest in before choosing from the large number of projects available on the market. Total Value Locked is a key metric used by investors to determine the strength of DeFi and crypto projects. Nevertheless, please note that TVL alone may not be 100% accurate. As an investor, you should do your own research before investing in any crypto project.

The Ethereum ecosystem remains the foundation for most DeFi applications and remains the dominant network as far as crypto TVL is concerned. Nevertheless, the cryptocurrency and DeFi landscape is changing and new projects and solutions emerge all the time. As standards and use cases continue to change, today’s leaders can easily give way to competitors and the total value lock can change in an instant.

After all, the ever-evolving cryptocurrency market, which operates in an unregulated environment, generates a large amount of on-chain activity by speculators seeking short-term profits. Any number of users who lock up their cryptocurrencies in an attempt to earn passive income can withdraw from the cryptocurrency project at a set time, potentially reducing the total value of the locked protocol.

last word

The importance of Total Value Locked in cryptocurrencies is mainly evident in that it indicates the immediate status of DeFi projects. Investors should consider this an important indicator, but not a sole guide, when questioning the value of existing or new crypto projects, as well as paving the way for increased adoption of cryptocurrencies. . Continuing to learn about Total Value Locked and its role in a decentralized environment remains essential for aspiring investors.