The Secret Weapon of Evaluating DeFi Projects — TVL
What is Total Value Locked (TVL) and How you can find alpha early without Discord/Twitter/Influencers.
Seeking alpha on Twitter/Discord/TG is exhaustive and full of noises. With this single & simple metric, I go about a different way and got ahead of the CTs a few times.
It also tells me when to buy, sell, and hodl with an incredible win rate.
All you need is a simple metric
If you are looking to evaluate a DeFi project, no matter it’s buying in, selling out, or just hodling, you can’t get away without assessing the following:
- Is the price healthy
- Is the project popular?
- Does it have true demand of the protocol services? Or people are just swing trading
- How does it compared to others?
All the answers are covered by this single & simple metric, Total Value Locked (TVL).
What is TVL?
Total Value Locked is a core metric evaluating the health of a DeFi protocol. In general, all DeFi protocols share a similar theme.
“Give me some money, and I will use it to make you more money”.
The money you “give” is normally your TVL in a protocol.
Let’s see some example protocols:
Staking protocols
These protocols ask you to lock up your tokens and in return, they give you more tokens (rewards). Auto-staking protocols are a great example, promising the investors a 102,483% APY (Annual Percentage Yield) of rewards.
In staking protocols, the value of the staked tokens is the TVL.
Lending protocols
Similar but different to staking protocols. In both, you end up locking up your tokens in order to earn the rewards. The difference is that lending protocols make use of the locked-up tokens for lending/borrowing services.
Normally you need to provide collaterals in order to borrow money from these protocols.
The money investors provide (i.e. lock up / collateralize) is the TVL.
Liquidity farming
When you make a contribution to a liquidity pool on Dexes, you earn a proportion of the transaction fees from people who swap tokens from the pool.
Furthermore, to incentivize people to contribute to liquidity pools, many protocols offer rewards on top of the transaction fees (usually the APY field you see on their website).
The LP tokens from the contribution to a liquidity pool are the TVL.
“Node” Protocols
These protocols are inspired by the validator node model, where investors purchase a “node” in order to earn perpetual rewards. Note that these “nodes” are conceptual.
The money people spend to create nodes is the TVL.
The TVL formula
Now we know what TVL means. It is the sum of money investors put into the DeFi protocol/ecosystem. The formula below brings up the two key drivers.
TVL = Total locked tokens × Price of the token
As you can see, the two key factors determining the TVL are
- The number of locked-up tokens
- The price
Let’s see what we can do with this formula.
How to use TVL to evaluate a protocol?
First of all, I need to be clear.
- Any investment metric should be used in a relative way, i.e. compare it with 1) Time 2) and Others. Simply staring at a $100M figure doesn’t help.
- The TVL chart is incredible for mid-term signals.
- Combine the TVL chart with the price chart gives you a better read.
Now, let’s start the juicy part!!!
Because both the locked tokens and price determine the TVL, it is important to understand which one is the underlying driver. Below shows the different scenarios:
Which scenario is the best indicator for investing, hodling, and escaping?
TL; DR
Best buy
- Scenario 2 —Locked Tokens: Up + Price: Flat
Best hodl & DCA
- Scenario 3 — Locked Tokens: Up + Price: Down
Best time to de-risk
- Scenario 7 — Locked Tokens: Down + Price Up
- Scenario 8 — Locked Tokens: Down + Price: Flat
Run!
- Scenario 9 — Locked Tokens: Down + Price: Down
Note that these are the “Bests” investment action imo. Do read on for the corresponding action for each scenario, and why:
Scenario 1 — TVL is Up driven by Locked Tokens: Up + Price: Up
When you see this, the DeFi protocol is already trending up. People are buying and locking up the tokens for the provided DeFi service. Demand looks great.
This usually happens at launch hitting major bullish news. It is a good sign for the protocol, but may not be the best time to buy. Chasing the pump is risky.
Scenario 2 — TVL is Up driven by Locked Tokens: Up + Price: Flat
Not much is happening to the price because people are locking up the tokens they already own into the protocol.
If you ask any DeFi project, the best thing they want to see is not just the skyrocketing price but people are actually using their service. This is the more sustainable picture.
When people are quietly locking up the tokens, it usually means right now only the inner circle knows how good it is. And what happens next is that these people will spread the word, then more new people will come on board buying the tokens & using the service.
In short, this could be the early sign that the protocol will receive mass adoption in the near future.
Scenario 3 — Locked Tokens: Up + Price: Down
TVL can go in any direction in this scenario. Although the price is going down, money is still flowing into the protocol. It’s a healthy sign, meaning people have a strong belief in the project.
This normally happens when the broader crypto market or the specific DeFi sector is down. People are taking advantage of this and DCA’ing.
Safest action when seeing this is to hodl. But if the overall TVL is Up or Flat, DCA by allocating a small amount that you don’t mind losing is a good play. Risk still exists here as no one can tell when the price drop would stop, while the upside is this could be a great entry point for a promising project.
Scenario 4 — TVL is Up driven by Locked Tokens: Flat + Price: Up
Not much going on with the underlying service while people are buying the tokens.
It is likely that the broader market is bullish and the project is riding with it. Or, people see good potential on a high level but don’t bother using the service itself as it is not that interesting atm.
Remember the best thing for a DeFi project is to see people using the service. So in either situation, this is not the best time (maybe good time tho) to buy. Better invest with the macro condition in mind.
Scenario 5 — TVL is Flat driven by Locked Tokens: Flat + Price: Flat
Quiet. Don’t move.
Scenario 6 — TVL is Down driven by Locked Tokens: Flat + Price: Down
Despite the fact that the price is going down, people are not taking out the locked money & sell.
Likely the broader market is down and the project is taking a hit by the macro effect.
What to do? Stay safe by hodling. If you are in a profitable position, definitely consider sell some to de-risk. Better invest with the macro condition in mind.
Scenario 7 — Locked Tokens: Down + Price: Up
TVL can go any direction but one thing for sure is that the protocol is losing customers.
But why the price is going up? Likely thanks to the broader bullish market condition, OR people realize the best play is not to interact with the service bu to swing strade. This happened to “Node” protocols.
De-risk by selling some rewards.
Scenario 8 — TVL is Down driven by Locked Tokens: Down + Price: Flat
Many people are withdrawing, however the price remains flat. People are speculating an upcoming event.
It is a special scenario, because some people believe the upcoming news could break out, some think it may become a disaster, some have no idea.
For example, when StrongBlock had the migration to $STRNGR, the price of the previous token, $STRONG, was hovering at the near $125 for a week because everyone just don’t know how this migration would turn out.
In this scenario, we need more info to choose the right move. The best play here is to sell some, hold some, and buy a tiny if you don’t have much extra info.
Scenario 9 — TVL is Down driven by Locked Tokens Down + Price Down
The protocol is losing both existing customers and the traction from the new. Right now, it is riskier to hodl and hope things would turn around.
Run.
In summary
Note: The actions are NFA. They are what I’ve been doing and will keep doing. Sometimes, there can be complications like blackswan, rugs, unexplainable broader market behaviour. For some protocols you can’t even withdraw the tokens which makes this So make sure to DYOR and get educated more on how to analyse these complications.
Let’s use TVL on some real projects
Now, let’s have some fun with what we just learnt.
Terra $LUNA
If we head to DeFiLlama and check out the TVL for Terra ecosystem.
Over time, the TVL for Terra is going up. Looking awesome. However this is in the $USD value. Remember the TVL can be driven by the locked tokens and/or the price. To tell which one has been driving it, click on the LUNA tab where it shows the locked token view.
During summer last year (the DeFi Summer), people who knew Terra early realized how good it will be. So they locked in a massive number of the tokens. What happened at that time? Anchor protocol was born! No wonder.
Now let’s look at the price of $LUNA.
Despite the up & downs, the overall trend is going up.
Combining all these info together, you get these conclusions:
- The TVL in USD is mostly driven by the uptrending price of $LUNA rather the locked tokens.
- Back in summer last year, TVL is in Scenario 3 with TVL moving up driven by Locked Tokens: Up + Price: Down. DCA was the best move.
- When Anchor protocol was introduced, only the inner cirle realized how good it is. Despite that the price of $LUNA was down, they took a good advantage of it by DCAing and being earlier than others.
Should I invest in $LUNA now?
If we look at the recent weeks at a very high level, it is the Scenario 1: TVL is up driven by Locked Tokens: Up + Price: Up. The ecosystem keeps gaining popularity and more people are buying in. Certainly it is a healthy sign for Terra, however unless you have a strong long term belief in it, this is actually NOT the best time to jump in. It’s too popular. When things get too popular, most likely the next thing is it will either slow down, or do a pull back.
Thorchain $RUNE
The USD value goes up and down. There was an outbreak on early March, with a relatively flat pattern recently (slight uptrend).
Interestly, the number of locked $RUNE has been growing steadily. We see a very healthy accumulation just prior to March. This was a great sign at the time that people were secretly using Thorchain ecosystem just before the bull run.
Price goes up and down similar to the TVL USD chart. Recently it’s experiencing a reversal mostly due to the massive bull run just before & the current broader market condition.
Notice that before the breakout, price in Feb was quite flat.
To sum it up, the March bull run was totally predictable thanks to the TVL. It shows that money were flowing into Thorchain behind the scene while not many people noticed this (look at the flat price). When the broader market recovered, boom.
I captured this opportunity thanks to alpha brought by TVL.
What about the recent pattern? It is scenario 3 where the price is pulling back while the locked tokens have been accumulating steadily. The price was mostly affected by the broader market condition. It’s a bullish sign. Once we Bitcoin recovered, $RUNE is likely to shoot to the moon.
However, the risk is when will we see a recovery. Therefore, the safer play is hodling if you have some bags in $RUNE, and doing DCA with a small allocation.
Summary
- Total Value Locked (TVL) is the total money locked within a DeFi protocol. It can be by staking, lending, farming, noding or other forms.
- TVL is driven by both the locked tokens & price. When you see TVL going up, it’s not necessarily a good sign.
- The best signal (to me) is when the TVL is going up mainly due top the locked in tokens.
- The TVL trick perfectly explained the massive $LUNA run followed after the Summer 2021. Right now it is too popular.
- $RUNE is showing a healthy sign (Scenario 3) right now.
Congratulations, my secret weapon is yours now. Use it and evaluate more DeFi projects. Let’s share what signals you have found.
