DeFi Indicator Analysis: How to Evaluate Blockchain Projects through Data
Introduction
In the previous issue, I introduced what on-chain data is, its uses, and the on-chain data platforms that can be used. Following that, it is essential to understand what key on-chain data and indicator analysis are worth looking at.
Similar to fundamental analysis in stocks, by analyzing these data and indicators, investors can better assess the strengths and weaknesses of cryptocurrencies, find suitable investment opportunities and entry points. However, it is important to note that indicators are only for reference and other factors should still be considered when evaluating a project. I will divide the content into two main themes: trading and DeFi, and this article will focus on DeFi.
TVL (Total Value Locked)
TVL (Total Value Locked) refers to the total value of assets locked in a DeFi protocol. It is typically used to measure the scale and attractiveness of a DeFi protocol. A higher TVL indicates that more funds are locked in the protocol, demonstrating users’ trust and activity in the protocol.
- High (over $1 billion): Generally speaking, the higher the TVL, which stands for Total Value Locked, the more attractive and larger the scale of a DeFi protocol. However, it is important to consider its growth rate and its proportion relative to other indicators.
- Low (less than $100 million): A low TVL may indicate lower liquidity and attractiveness of the protocol, posing risks.
MarketCap (Mcap) & Mcap/TVL
Mcap/TVL is a metric used to measure the ratio between the market capitalization and the Total Value Locked (TVL) of a DeFi project. Mcap refers to the market value of the token, calculated by multiplying the current price of the token by the circulating supply of tokens. This ratio can help determine if a project’s market value aligns with its actual usage, with a high ratio possibly indicating overvaluation in the market.
- High: A ratio higher than 1 may indicate that the market has overvalued the project, showing high confidence in the project and high trust from users. However, it could also mean that the market has overestimated the project.
- Low: A ratio lower than 1 may indicate that the project is undervalued, the market lacks confidence in the project, and users have a lower level of trust in the project. However, it could also be a potential investment opportunity.
Supplied & Supplied/TVL
Supplied/TVL is an indicator that measures the relationship between the supply volume and the total locked value. The supply volume typically refers to assets provided to DeFi protocols through liquidity provision or borrowing. A higher ratio may indicate a larger supply volume for the protocol, which could mean more liquidity and higher utilization. Conversely, if the Supplied/TVL ratio is lower, it indicates relatively fewer supplied assets, potentially lower liquidity and lower utilization for the protocol. However, this does not necessarily mean better or worse asset utilization.
- Moderate (10%~50%): The ratio of supply to TVL should be within a moderate range, as either too high or too low may indicate issues with the protocol.
- Excessive (greater than 50%): Excessive supply may lead to insufficient liquidity or underutilization of assets.
- Low (less than 10%): A low supply may indicate a lower utilization rate of the agreement.
Volume & VOL/TVL
Volume/TVL is an indicator used to measure the relationship between daily trading volume and total locked value. This ratio can help evaluate the activity level and liquidity of a DeFi protocol. Generally, a higher VOL/TVL ratio may indicate more frequent trading activity, higher liquidity, and greater participation in the protocol, while a lower ratio may indicate lower trading activity and liquidity, which could lead to inconvenience in trading or increased price volatility.
- Moderate (5%-20%): The ratio of trading volume to TVL should be within a reasonable range. A high ratio may indicate the activity level of the protocol, but it could also expose it to high risks.
- High (greater than 20%): A high ratio may indicate high liquidity of the agreement, but it may also mean greater volatility and risk.
Market Cap and Fully Diluted Valuation (FDV) & Mcap/FDV
Mcap/FDV is used to measure the ratio between the market value and the fully diluted valuation of a DeFi project. Market value and Fully Diluted Valuation consider the total token supply of the project, including tokens that have not been released. It can be used to measure the extent to which the market value of an asset or protocol compares to its potential maximum value.
A lower ratio may indicate that the market has not fully recognized the potential value of the asset, potentially presenting investment opportunities. Conversely, a higher ratio may indicate that the market has already thoroughly evaluated the potential value of the asset, possibly representing increased investment risk or decreased potential returns.
If there is a significant difference between the market value of an agreement and its FDV, it means that there are still a large number of tokens that have not entered circulation. Therefore, investors should be aware that with the introduction of these new tokens into the market, there may be considerable selling pressure, depending on the release method of the new tokens and the current market response.
- High (greater than 1): A high ratio may indicate that the market is overvalued, suggesting that the market has already fully evaluated the potential value of the assets. This could mean increased investment risk or reduced potential returns, so caution is needed.
- Low (less than 1): A low ratio may indicate that the market has not fully recognized the potential value of the asset, undervalued by the market, and could be a potential investment opportunity.
Inflation Rate
Inflation Rate refers to the rate at which the supply of a token is increasing. In DeFi, understanding the inflation rate is crucial for evaluating the value and potential of a project. A lower inflation rate is typically seen as stable and sustainable, but considering the individual token’s economy and distribution model, a high inflation rate may not necessarily have negative effects.
- Low (less than 5%): Considered to contribute to the stability of token value, having a positive impact on the value of the token.
- High (above 5%): may lead to a devaluation of the token’s value, causing a negative impact on the token’s value.
CEX Reserve/Supply
CEX Reserves/Supply refers to the ratio between the reserves (usually in fiat currency) and the supply of a Centralized Exchange. This indicator can be used to measure the liquidity and stability of a centralized exchange, with 10% to 50% being ideal.
In general, the higher the reserve/supply ratio, the higher the reserve level of centralized exchanges, which means the exchange may be better able to meet users’ withdrawal needs and maintain good liquidity. Conversely, if the reserve/supply ratio is lower, it may indicate that the exchange’s reserve level is insufficient, leading to withdrawal delays or inadequate liquidity, especially during market volatility or high withdrawal volumes. This could result in a liquidity crisis for the exchange, causing losses to users. You can use Defillama CEX Transparency to calculate this.
Protocol Yield
Protocol Yield refers to the earnings obtained by users through participating in DeFi protocols. This may include interest, transaction fees, or governance rewards, among others. Understanding protocol yield can help evaluate the attractiveness and sustainability of a DeFi project. DeFi protocols with an Annual Percentage Yield (APY) of over 10% are considered to have high protocol yield, which may attract more users and investors, but it is important to ensure the sustainability and reliability of such earnings. On the other hand, not every protocol distributes cash flow to tokens, for example, Uniswap, although a leader in the DeFi space, uses $UNI solely as a governance token, detached from Uniswap’s performance. This means that regardless of how much trading volume Uniswap generates or how much transaction fees it earns, that money will only be distributed to liquidity providers.
