Total Value Locked (TVL) is the total value of assets locked in a DeFi protocol like staking, yield farming, and lending collaterals. TVL has been used to assess how useful and popular the entire DeFi ecosystem or a specific project is. It can also be used as an indicator for general DeFi market circumstances. This post will explain what TVL is, why it is essential, and how to apply this helpful indicator.
What is TVL?
To begin, the decentralised finance (DeFi) ecosystem is built on the blockchain network, which has no central authority. This signifies that the system's contributors are part of a decentralised network. Contributors lock their assets in a liquidity pool in order to establish a functioning decentralised financial system. The liquidity pool may comprise funds staked, farmed, or used as loan collateral. The entire value of these locked assets is measured by TVL.
So how is TVL determined? It is a rather simple mathematical method. TVL is computed by multiplying the assets locked up as collateral in an ecosystem by their current value. In a short, we may say:
Total Value Locked = invested assets * the asset's price.
Why is TVL important?
New projects are offered on a regular basis as investor interest in DeFi rises. With so many new ideas popping up, hearing about scam projects is unsurprising. To guarantee that a project is trustworthy and healthy, various signs must be checked. When investing in a DeFi enterprise, consider market capitalisation and transaction volume.
Yet, TVL is another component that has a unique relevance in the world of DeFi. The higher the TVL, the more dependable and healthy the project. Furthermore, it may be utilised as a signal for the overall DeFi market circumstances.
In addition, some investors use TVL to see if the project they intend to invest in is overvalued or undervalued. This can be done by calculating the TVL ratio. Three factors are critical for calculating the TVL ratio:
project’s supply
maximum circulating supply
current price
To get the TVL ratio of a DeFi project, do the following two steps:
Multiply the project’s supply by its current price. This gives you the total market capitalization of that project.
Divide the market cap by the maximum circulating supply.
If the final amount is less than one, the project is undervalued and hence appealing to investors. But, if it is more than one, the market is likely overpriced and less appealing for investment.
Conclusion
TVL is the entire asset value that is locked in the universe of DeFi. TVL can serve as a benchmark for the general state of the DeFi ecosystem and particular initiatives. Moreover, TVL is a reference measure for a DeFi protocol's utilisation, value, and legitimacy.
-Alok S K
