Rethinking the validity of TVL
I’ve said it once and I’ll say it again: TVL (total value locked) is a terrible metric for derivatives trading.
The Nature of Leverage
The charm of leverage is that you can exchange $10 of purchasing power for $1 of margin. If the ratio of TVL to trading volume is too high, it means that the capital efficiency is not high, which deviates from the goal of perpetual contracts.
Why does anyone care about TVL?
In proof-of-stake (PoS) networks, such as Ethereum or Solana, it makes sense to assess the economic security of a network based on the amount of capital staked. The more dollars staked in Ethereum, the harder it is to attack the network.
However, when it comes to trading, we care about the efficiency of capital utilization. This is exactly why lending markets and margin trading are so powerful. We can lock up a small amount of collateral or margin and then cover the rest with loans, so the purchasing power is far greater than cash on hand.
The capital efficiency problem in DeFi
In decentralized finance (DeFi), no one has yet fully solved the problem of undercollateralized lending due to the risk of counterparty default. But this is exactly what drives both traditional and centralized financial markets. Why do you think market makers like their “lines of credit”?
Advantages of Derivatives
Derivatives, especially perpetual swaps, offer an excellent way to achieve efficient capital utilization. As a result, they have become the primary tool for crypto traders, accounting for more than 68% of all cryptocurrency trading volume (mainly perpetual swaps, crypto options are still insignificant).
Selection of success indicators
It’s no surprise that the metrics for success in derivatives trading revolve around volume (capital turnover) and open interest (the total value of open positions). Anyone touting TVL either doesn’t know what they’re talking about or is misleading you.
The evolution of DEX design
Furthermore, this is why the design of decentralized exchanges (DEXs) (spot and perpetual contracts) has moved towards order books and AMMs (automated market makers) with pooled liquidity. You want your LP (liquidity provider) capital to be fully utilized by counterparties, not sit idle in a corner with a constant product.
Practical application thinking
So think about it, do you want your perpetual swap to do the most trades with limited capital? Do you want your LP position to generate a lot of fees for every dollar you deposit? Or do you want it to be like a flashy vault with all the vanity TVL?
in conclusion
TVL is not a suitable metric to measure the success of DEX. What we need to focus on is capital efficiency and actual trading volume, which can truly drive the healthy development of the market. I hope that future DEX designs can pay more attention to these key factors, bringing higher returns and lower risks to investors and traders.
