Follow the money. It is not only a legendary phrase from the political drama “All the President’s Men.” It is also a widely used saying among crypto investors.
In a highly saturated cryptocurrency market, knowledge of where money is moving is among the main keys to success.
Total value locked (TVL) is an important indicator to follow. It helps to identify which DeFi protocols have attracted investors’ attention and confidence.
What Is the Meaning of TVL?
Total Value Locked (TVL) is one of the most popular metrics used to measure how big and popular the decentralized finance (DeFi) market or certain DeFi protocols are.
Basically, TVL is a figure that represents the dollar value of cryptocurrencies currently locked up on DeFi or on a single application’s smart contracts. The digital assets are most often locked through staking, yield, and lending protocols or liquidity pools.
The total value locked indicates how much capital is in custody on DeFi protocols, which is a highly important metric for them, simply because it may affect the yields and usability among DeFi application end users.
Why Total Value Locked Is Important in Crypto
The TVL shows how much money is locked in DeFi protocols and thus helps to get a clear view of the overall health of the DeFi market. It is a type of DeFi adoption indicator.
TVL also is an effective metric to compare the market share of different DeFi protocols. Platforms like DeFi Pulse and DeFi Llama display the TVL of numerous DeFi protocols, thus it is easy to check which protocol has the highest amount of crypto assets locked in their smart contracts.
Naturally, the more value is locked, the more active the DeFi protocol is, and thus the more yield it may generate for participants. And on the contrary, the lower TVL means lower activity and lower potential gains.
Sometimes it might be tricky to evaluate whether the DeFi protocol’s TVL is high enough since the whole DeFi ecosystem is young and evolving. However, market experts agree that audited DeFi protocols starting with $1 billion TVL can be treated as safer use options.
How to Interpret TVL Growth
Many investors and analysts measure the DeFi protocol by the amount of the TVL. Thus the higher the total value is locked on it, the better general health the project has.
Logically, this means that the project has demand. It likely has a strong developer team, strong use cases, and a strong user experience behind it, which attracts the most users and increases the size of the TVL, and consequently the value of the project itself.
The TVL and the token price of the DeFi protocol often correlate. Typically, as the TVL increases, so does the price, and vice versa.
The Downsides of the TVL Indicator
The majority of decentralized finance applications is built on the Ethereum blockchain. As a result, more than 61% of the total TVL on DeFi is tied up in the Ethereum network at the time of this writing.
However, the TVL growth of DeFi dApps on Ethereum does not necessarily mean that the number of dApps or user engagement with them is increasing.
As said, the size of the TVL is correlated with the price of the protocol. Consequently, when the ETH price increases, so does the amount of the total value locked on the underlying blockchain.
In addition to that, the size of the TVL might be artificially boosted by double counts of the same capital. This happens when users deposit their cryptos in the dApp-1, which grants them their own synthetic tokens. The user then deposits these synthetic assets into another protocol or dApp-2. Both deposits will be calculated in TVL. However, only the first crypto deposit would be from the real capital here.
Another reason why TVL should be taken with a grain of salt is the presence of whales. Large capital investors like hedge funds, entities that hold large amounts of crypto, or even project developers themselves, are capable of faking large value transactions and thus driving up the project’s TVL artificially.
Finally, DeFi is still an evolving market operating in an unregulated environment. This leads to a lot of on-chain activity focused on speculations and short-term gains. Users who lock their crypto to generate passive income may withdraw it after a set period of time, leading to a decrease in total value locked.
Why You Should Care
TVL is one of the most popular metrics used to value the strength of the crypto and DeFi protocol. It is always worthwhile for investors to know which direction the market confidence is going before making a decision on which decentralized finance (DeFi) protocol is worth their investment.