Decentralized Finance (DeFi) is advancing at such a rapid pace that it can be difficult to keep up. What makes the process even more challenging is the lack of a standard approach, as there are many different ways to evaluate and compare DeFi protocols.
In this article we’re going to talk about some of the indicators we should understand since they can be good sources of information for DeFi investors. There is a considerable amount of publicly available data, so it is easy for any investor to use these indicators. The inspiration came from a Spencer Noon Twitter thread.
DeFi: 7 Essential Indicators
1. Total Value Locked (TVL)
As the name suggests, Total Value Locked (TVL), or Total Value Locked, is the aggregated value of funds locked in a DeFi protocol. We can imagine that the TVL represents all the liquidity in the pools
of liquidity of a given financial market. For example, in the case of Uniswap, TVL represents the amount of funds deposited into the protocol by liquidity providers.
TVL can be a useful piece of data, as it gives us a general idea about degree of interest in the DeFi sector. Furthermore, it can also be effective in comparing the “market share” of different DeFi protocols, which can be especially useful for investors looking for undervalued DeFi projects. Note that TVL can be measured using different denominations – for example, TVL in Ethereum projects is usually measured in ETH or USD.
two. Price-to-sales ratio (P/S ratio)
In the case of a more traditional business, the relationship between price and sale – Price -to-Sales Ratio (P/S Ratio) – compares the price of a company’s shares with its turnover, which is used to determine whether the shares are undervalued or overvalued.
Like many protocols DeFi already generate revenue, we can also use with them a similar metric. Like? Dividing the market capitalization value of the protocol by its revenue. The idea is that the smaller the proportion, the more undervalued the protocol. Note that this is not
a definitive way to calculate the value of a protocol; however, it can give us a general idea of how (un)fair the market’s assessment of a project is.
3. Supply of tokens in brokers
Another strategy involves following the supply of tokens in cryptocurrency brokers. When sellers want to sell their tokens, they usually do so at centralized brokerages/exchanges
(CEXs) . There are more and more options available to users on decentralized brokerages/
exchanges (DEXs) that do not require trust in an intermediary. However, centralized platforms tend to have much more liquidity. That’s why it’s important to pay attention to the supply of tokens from CEXs.
For example, when there is a large number of tokens on the trading platforms, the pressure to sell can be greater. As the holders
(holders) and whales are not keeping their funds in their personal wallets, this could be an indicator that they intend to sell them. Of course, in practice, it’s not that simple. Many traders
use their assets as collateral for margin or futures trading. This means that sending large amounts to a exchange
does not necessarily mean that a large sale is imminent. Anyway, it can be a data that is worth observing.
4. Token Balance Variations at Brokerages
We already know that monitoring token supply can be useful. But watching just the balances
of tokens may not be enough; it might also be a good idea to examine the recent variations
of these balances. Large variations in the balance of tokens on exchanges
may indicate an increase in volatility.
Consider, for example, the opposite scenario to the one we just discussed about token balances. If large holding values are being withdrawn from CEXs, this may indicate that the whales
are accumulating tokens. If they intended to sell them, why would they send the tokens to their own wallets? This is the basic idea about the usefulness of monitoring token movements.
5. Unique Address Count
Although this indicator has its limitations, an increasing amount of addresses containing a specific currency or token must indicate a increase in its use. That is, to suggest that an increase in the number of addresses is related to an increase in the number of users and, consequently, to a growing adoption.
However, this is a malleable metric, once someone it can create thousands of addresses and distribute funds among them, thus giving the impression that usage has greatly increased. As with any metric in fundamental analysis, we must compare the unique address count with other factors.
6. Non-Speculative Usage
Let’s imagine we’re considering an emoji-based token that promises incredible returns. But is this token really good for anything? It can get the Charles Ponzi seal of approval if its sole purpose is price appreciation, but it won’t be sustainable for long.
Understanding the function of the token is critical to discovering its true value . Ideally, this is measurable by looking at the number of transactions that are not
carried out for speculative purposes. Of course this can be a difficult task, but a good starting point would be to look at transfers that do not occur at decentralized or centralized brokers. The purpose is to check whether people are using the token in question.
7. Inflation rate
Wow, a token with little supply! That’s a good sign, isn’t it? Well… Not necessarily. Another key metric to watch out for is the inflation rate. A smaller supply now
does not guarantee that it will be like this
forever
, especially if new tokens are continually minted/issued. A notable property of Bitcoin is a constantly decreasing inflation rate, which theoretically should prevent the devaluation of existing units in the future.
This is not to say that all systems should replicate the Bitcoin method. Inflation itself is not necessarily a bad thing, but too much can be very harmful. There is no standardized percentage considered to be good
or bad
, so it is advisable to consider this number when evaluating other metrics.
Final Thoughts
Experienced cryptocurrency traders know that many of these metrics are already used in fundamental analysis of “traditional” cryptocurrencies. In the next article we will talk about “Fundamental Analysis” (FA) where we will discuss how to optimize the available analysis tools.
As always (and this is not specific to the world of cryptocurrency), markets are unpredictable, irrational and subject to high volatility. Doing our own research is critical to success.
Article adapted from Binance Academy
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