Decentralized finance (Defi) is one of the relatively new blockchain applications, and it can be confusing for newcomer investors. Be that as it may, the pace at which the space is growing leaves no time to ‘wait and see.’ DeFi is evolving crazy fast, and new metrics are being invented to help investors weigh their options. Given the novelty of the subject, there are no widely-accepted standards yet. Still, there are some common indicators that we can use to judge whether one DeFi protocol is better than the next.
This article looks at some of the top metrics that you can use to compare DeFi protocols.
#1. Total Value Locked (TVL)
This is perhaps the most-common indicator when it comes to evaluating DeFi protocols. TVL refers to the total of funds locked in a given protocol. An easier way to understand it is to think of it as the dollar value of all tokens held in a smart contract for a given DeFi project.
As an investor, you can know the general interest in a particular DeFi by just looking at its TVL. It is equally useful when evaluating the market size of different projects. In crypto, TVL would be the equivalent of market capitalization.
TVL is simple yet confusing. If a user deposits 10 BTC then borrows BTC 5 and thereafter deposits back the 5 BTC, the market would report 100 BTC. But, there have been deposits amounting to 140 BTC. That’s part of the confusion that’s associated with this metric.
TVL was created by DeFi Pulse, the world’s leading DeFi resource. Although liquidity providers usually fund DeFi projects in crypto, TVL is measured in dollars. As pointed above, there has been confusion abounds regarding the accuracy of TVL. However, as initially mentioned, DeFi and all its metrics are still evolving. Until such a time when there will be general agreement on these indicators, TVL remains a useful metric for evaluating the investment potential of a DeFi project.
#2. Token Supply
Token supply tells investors how many tokens are ‘floating’ in an exchange. When there’s a high number of tokens floating in an exchange, token holders are likely letting go of their tokens, which creates an increase in the supply. This could be happening for the same reasons it happens in other money markets. For example, investors could be fearing that the market is getting riskier.
A high volume of token supply could result from a whale selling off their shares in some instances. The same phenomenon could also be observed when investors use their holdings as collateral for a margin or futures trade. As such, while the token supply on exchanges can tip you off of an impending voluminous sale, it might not be as straightforward. Crypto is typically traded on centralized exchanges, although this trend is changing in favor of decentralized exchanges. The advantage of centralized exchanges is that they are usually able to maintain stronger liquidity.
#3. Changes in Token Balances
Tracking token supply on exchanges is a savvy move. And as a trader, you can complement this by finding out how balances are changing. Volume tracking is a bit static and does not accurately picture a market’s current financial trend. Evaluating the changes in token balances will likely give you a better picture of what is happening.
Typically, a large change in token balances tells you that the market is currently volatile. For example, if large holders are accruing tokens, you might notice large withdrawals from exchanges. As is the case with the other metrics discussed above, treat this only as a guide.
#4. Unique Address Count
Unique address count is the number of addresses that are holding a given token. A high number of addresses likely means that there is a high number of users on that market. By contrast, if you only see a relatively small number of addresses, it could be that the DeFi protocol has yet to gain widespread adoption.
Since the number of unique addresses is a static metric, it would be more meaningful to track the new addresses’ rate. This will give you a better picture of how fast users are joining the DeFi protocol. And just like how it works with bull runs in the money markets, the best time to join is when the adoption rate is high. This is the time when you would typically expect the fastest growth in your investment.
Beware, though: one user could create multiple addresses and distribute their tokens to all of them. Therefore, this indicator should also be used merely as a guide, and better yet, be used in combination with other indicators.
Inflation is the rate at which new tokens are being pumped into the ecosystem – just like with economic inflation. Usually, limited supply alludes to the rarity of tokens and hence a higher value. If new tokens are being minted easily and fast, existing ones will be devalued at the same rate.
However, it’s advisable to approach this indicator with some caution. In economics, rising inflation encourages people to spend and thus promotes economic growth. The same phenomenon can be observed in DeFi, where an increasing supply of tokens can boost investor sentiment and actually result in bullish activity. In the same way, limited supply could only be temporary. Thus, it would be best if you did not conflate token scarcity with value.
The price-to-sales ratio (P/S ratio) is used to assess whether an asset is undervalued or overvalued. In traditional finance, this ratio is obtained by dividing a company’s revenue by its stock price. In DeFi, it’s calculated by dividing the protocol’s market capitalization by its revenue. Generally, a relatively high value means that the DeFi project could be overvalued.
#7. Non-Speculative Usage
Non-speculative usage refers to the usefulness of a token beyond mere hype. When you’re evaluating a token’s value, it is important to check whether there is a solid project behind the token. It might be difficult to track whether token purchases are based on speculation or people are actually buying them for specific uses.
DeFi is a fast-rising financial tech that promises investors new and exciting opportunities. As a DeFi investor, it helps to be able to analyze and compare different protocols. The above indicators can steer investors in the right direction when it comes to evaluating different DeFi options. Always analyze each DeFi protocol by its merits or lack of them, and most importantly, do your own research.