What is Total Value Locked?
In the cryptocurrency space, several terms are commonly used by traders and investors to navigate the fast-changing market. From “hash rate” to “hard forks”, after just a little bit of research, most of these terms become second nature. Today, as Total Value Locked (TVL) hits an all-time high, we look at what this metric can tell us.
Definition
Total Value Locked (TVL) is a measure commonly used in the world of decentralized finance (DeFi) to evaluate the demand for a DeFi project. Specifically, TVL accounts the market value of assets that are currently being staked in a DeFi protocol. Since the process of staking requires user funds to be “locked up” for a defined period of time, or indefinitely, it can be used as a proxy to establish the market’s confidence in the longevity and security of a specific DeFi platform.
Example
Take Exchange A for example. Exchange A is a decentralized exchange (DEX) that allows users to exchange between cryptocurrencies without a third party mediating or managing the exchange. It functions by algorithmically executing “swaps” between users’ desired cryptocurrencies (e.g. Bitcoin and Litecoin), drawing liquidity from “pools”.
Each pool contains a certain amount of a given cryptocurrency that can be increased and decreased. So when a user wants to swap Bitcoin (BTC) for Litecoin (LTC), his/her BTC is sent from his wallet into a BTC pool, with the equivalent value of LTC taken from the corresponding LTC pool to enter his/her wallet and vice versa.
However, for these pools to exist, other users have to “stake” or “lock-up” their BTC and LTC. In return, they receive a portion of the transaction fee for each trade. The sum of the value of all the cryptocurrencies staked in all pools on Exchange A is called the Total Value Locked (TVL).
Evaluation
Users who stake their cryptocurrencies in DEX pools receive an income from the transaction fees collected when their funds are used to facilitate transactions. Since this income is proportional to the quantity of transactions executed on a given DEX, TVL can be used as a proxy to assess the demand for a given DEX.
More broadly, similar DeFi platforms that rely on staked pools (such as lending platforms) have a TVL that can be used in a similar way, however, note that the income on other such platforms can be arbitrarily set higher to attract more income seekers.
Given that most DeFi platforms require a relatively lengthy lock-up period, TVL can also reflect the confidence stakers have in a specific platform’s future; the longer the period and the more funds stakers are willing to lock-up, the more security or longevity they think the platforms have.
Variations
Like market capitalization, TVL can be compared with other metrics to give context to evaluations. One simple comparison is the ratio of market cap to TVL. The market cap reveals the amount of value the market “thinks” a project is worth and TVL shows the amount of value held on a platform.
Summary
Hopefully, this article has explained one of the most useful methods to assess the value of DeFi platforms that exist in the space.
- TVL measures the market value of assets that are currently being staked in a DeFi platform.
- It is used to evaluate the demand for a given platform, and the confidence its stakers have in it.
- It can be combined with other metrics, including market capitalization, to suggest whether a project is under or over-valued.
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