- Use Cases
One of the more popular indicators used to evaluate DeFi protocols and platforms is Total Value Locked (TVL), which is the total value of the funds deposited. However, despite its popularity, TVL may not be the best decentralized finance metric.
"TVL generally inflates as the assets in the liquidity pool increase in value," says Amberdata CEO Shawn Douglass. "So it looks good when the market is up, making it a vanity metric."
For example, according to our data, the total value locked of Ethereum-based MakerDAO on 10/27/22 was $8.22 billion, while its peak TVL was almost $20 billion in November 2021. But much of that drop can be attributed to the decline in price of Ethereum, which went from approximately $4,500 to $1,500 in the same timeframe.
If price fluctuations make TVL a flawed metric, what else could be used for evaluating the overall value and health of DeFi protocols and projects? According to Chris Martin, Amberdata's Principal Analytics Engineer, "you want a metric that is immune to price fluctuations (unlike TVL and market cap) but is also difficult to manipulate (unlike the number of addresses)."
Chris suggests several alternative metrics that analysts can use when evaluating protocols instead of, or in addition to, total value locked:
For lending protocols, the utilization rate indicates the percentage of the deposits that have been lent out. A high utilization rate indicates more risk as there may be insufficient collateral left to cover depositor withdrawals or to allow liquidators to close positions.
Number of Liquidity Providers (LPs)
A higher number of liquidity providers is usually better. If a protocol has a large number of LPs, there is a "safety in numbers" effect, as it's less likely that any single departure could cause liquidity issues for the DeFi platform.
A high transaction count usually means more active pools. This is generally a good thing as it's a sign that the DeFi protocol is being used. Ideally, the transaction count trend is also upward, signaling an increase in popularity and adoption.
When paired with a high number of LPs, a higher transaction volume is generally a good metric for evaluation DeFi platforms.
Utilizing the ratio of TVL to market cap removes the price volatility inherent in both metrics. The ratio bases the TVL on the total market cap of the token, which can work as the "% of the token supply which is being utilized in a pool."
What You Need to Evaluate DeFi Protocols
In addition to the metrics above, many others can be combined to effectively evaluate protocols.
With Amberdata, you'll access granular, real-time, and historical data for over 75 protocols, providing a unique view into the DeFi ecosystem. Our platform enables users to view flows in and out of protocols, active users, transactions within and across protocols and pools, and more.
Download our Decentralized Finance Primer ebook to learn more about DeFi, the five key protocol types, and the opportunities for investors and financial institutions in this fast-growing and disruptive space.
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