In the fast-changing world of digital currencies and decentralized finance (DeFi), understanding important metrics is crucial for both investors and enthusiasts. One such metric is Total value Locked (TVL), a pivotal metric in the digital currency and decentralized finance (DeFi) sectors, representing the total dollar value of assets secured within smart contracts on various platforms. TVL provides insights into user engagement, liquidity, and overall market health by quantifying the capital staked or locked in these protocols.
As DeFi continues to gain traction, understanding TVL becomes essential for investors and enthusiasts alike. It reflects the trust users place in these platforms and serves as a barometer for market sentiment and investment potential. In this article, we will explore what TVL is and why it matters in the crypto landscape.
What Does The Total Value Locked Mean?
Experts in the financial markets have accepted a new investment type and examined methods to gauge its success since decentralized finance (DeFi) took off in 2020. One cryptocurrency indicator that is widely used by DeFi investors to evaluate the total value of assets deposited across all DeFi protocols or in a single DeFi project, whether in US dollars or any other fiat currency, is total value locked (TVL), in addition to market capitalization, trading volume, and total and circulating supply.DeFi assets, which are offered in the form of smart contracts, consist of incentives and interest derived from standard services like lending, staking, and liquidity pools.
TVL increased from $400 million in the preceding two years to around $2 billion globally in 2022. As DeFi’s value and popularity in the cryptocurrency sector have grown, TVL has emerged as a crucial metric for investors looking to determine whether a single protocol or the entire ecosystem is healthy and worthwhile. There are underlying factors that could impact the value of cryptocurrency locked in a smart contract. Other than deposits, withdrawals, and the actual amount held by a protocol, several factors agree on TVL’s value. The value of the native token or fiat currency also affects the TVL.
How Is TVL Calculated?
Calculating TVL consists of gathering the value of assets locked in various DeFi protocols. Below is the step-by-step process to calculate TVL:
- Recognizing the assets: List out all the assets locked in the DeFi protocol, such as stablecoins, native tokens, and other digital currencies.
- Determine the quantity: Identify how many units are locked in the protocols for each asset.
- Calculate the value: To find its value, multiply the quantity of each asset by its current market price.
- Sum up the values: Add the values of all the assets to find the total value locked (TVL).
Why Does TVL Matter In Crypto?
TVL is a vital sign of a DeFi blockchain’s or decentralized application’s general health and popularity. A consistently high TVL often indicates a decentralized program that is reliable, stable, and highly useful, as well as having the confidence and trust of its users. Since they draw in more users, these elements may help the application succeed overall.
On the other hand, a lower TVL may indicate less capital available, which could make the situation less alluring for participants. Since a project’s dominance in the market is indicated by a bigger total value locked in DeFi, TVL also aids in determining a project’s market share.
Financial health: The total value of assets deposited and locked within a protocol is represented by TVL. Greater user confidence in the security and dependability of the platform is indicated by a higher TVL.
Liquidity: TVL is a crucial metric for assessing the liquidity of a protocol’s liquidity pools. Users can trade assets more easily and with less price slippage when there is more TVL, which translates into higher liquidity.
Growth and adoption: A crypto project’s or the large DeFi ecosystem’s growing popularity and adoption are reflected in TVL growth. It shows that more people are using the platform and making investments in it.
Staking rewards: The value locked determines how many DeFi protocols allocate staking rewards. Users may be encouraged to lock more assets if a higher TVL results in larger payouts.
Limitations Of TVL
Despite being a popular statistic in the DeFi area, TVL still has drawbacks. Although TVL offers information about the amount of capital locked in a platform, certain factors may compromise its accuracy and dependability.
Market Fluctuations
The market value of the underlying assets has an impact on TVL. Even in the absence of new deposits or withdrawals, a platform’s TVL can be dramatically changed by fluctuations in the price of cryptocurrencies like Bitcoin and Ethereum (ETH). This may present an inaccurate image of the platform’s stability and growth.
Manipulation
In some circumstances, actors aiming to draw attention to their platform may overstate TVL. Investors may be misled by this deception into exaggerating the popularity or security of a DeFi scheme.
Multiple Counting
If the same assets are utilized on several platforms, the total value locked on a chain may be exaggerated. Inflated TVL figures could result, for example, from assets staked in one protocol being tallied twice if they are used as collateral in another.
Conclusion
Total Value Locked (TVL) is an essential metric for understanding the dynamics of the DeFi landscape. It offers insights into investor confidence, market sentiment, and liquidity levels across various platforms. However, while it serves as a useful tool for evaluating DeFi projects, investors should consider it alongside other indicators to make informed decisions in this rapidly evolving market.