What is Total Value Locked (TVL) in DeFi?

You can determine the present value and possible future worth of an item by having a thorough grasp of these indicators and metrics. TVL, or total value locked, is another such metric. If investors want to be successful in the decentralized financial industry, they must be aware of and comprehend this crucial aspect.

What is TVL?

TVL (Total Value Locked) represents the overall value of crypto assets deposited in a DeFi protocol. The assets include all rewards, interest, and new tokens from typical services such as lending, staking, and liquidity pools. It is an indicator that can be used to determine an asset's present worth as well as its future potential.

It can also be defined as the total value controlled by the DeFi platform within its smart contracts. It is a representation of all assets available on platforms for transactional, lending, and borrowing purposes. The industry's total TVL is the sum of all the TVL from various DeFi applications.

The TVL indicator is more significant since higher the TVL, greater the likelihood of good long-term investment. Crypto, like a bond, CD, or savings account, is lent for yield, and as long as the income continues, an investment can be backed.

Significance of TVL in DeFi

TVL is the most important of all the Defi metrics and helps the users analyze a DeFi asset. Given that it is exclusively applicable to DeFi projects, it differs from market capitalization. If you want to predict a DeFi project's future potential, then you should look at its market cap. However, if you wish to access the current incarnation of the project, then you must consider TVL.

TVL is a measure of the overall health of the DeFi project. The TVL of particular projects represents the level of investor confidence in the protocol. A quick rise in TVL indicates that investors value the project and that more money is moving through its network. It assists investors in determining whether a procedure is healthy and worth investing in.

A high TVL indicates strong liquidity, popularity, and usability—the qualities that constitute a DeFi protocol's success. A rising TVL also benefits its investors, who aid from increased liquidity and returns. However, a smaller TVL implies less money available, which means investors will not receive adequate returns if they opt to stake the protocol's token.

Additionally, TVL can also be used by investors to determine if a protocol's native token is undervalued or overpriced. A coin might be overpriced or undervalued if its market cap is high or low in comparison to the total project/protocol TVL.

To function, DeFi systems require capital to be placed as loan collateral or liquidity in trading pools. TVL is important since it reflects the capital's influence on the earnings and usability of DeFi apps for traders and investors. The market share of DeFi protocols can be easily determined using analytics businesses' platforms, which give statistics on the number of crypto assets locked in their respective smart contracts.

How is TVL calculated?

Considering the rapid development in the DeFi arena, it is difficult to calculate the precise TVL of the whole market or a specific DeFi protocol. To calculate TVL, we should know the maximum circulating supply available and the current price of the token.              

First, the market cap of an asset must be calculated by multiplying the supply of the DeFi project by the current price. The TVL is calculated by dividing the market cap by the maximum circulating supply.

How to use the TVL metric?

Participants can use more established methods with a TVL metric of $1 billion, which should be a safe bet. A greater TVL is preferable since it should imply a robust, in-demand platform with a competent developer team and a significant use case. All of these should entice more participants and investors, leading to the TVL's ascent.

When DeFi protocols with lower TVL give high yields, however, a red flag should be raised. These might be marketing for new platforms looking to increase market share, but they could also be frauds because few or no participants have trusted them with their assets.

The TVL ratio is calculated by dividing the total market cap of a locked asset by the total value locked. TVL ratio can assist in determining if a DeFi asset is undervalued or overpriced. When the ratio is less than one, the asset is frequently undervalued and more appealing to investors. When the market valuation of a cryptocurrency surpasses the TVL, the asset may be overpriced, leaving little to no possibility for growth.