As part of decentralized finance or DeFi, Total Value Locked or TVL has positioned itself as a main metric to measure and evaluate the economic dynamics and growth of protocols within the sector.
Understanding what Total Value Locked is, how it is calculated, and its limitations is key to analyzing the state of the DeFi industry and its participants. In this article, we explore everything you need to know about TVL and its usefulness as a metric.
What is Total Value Locked in DeFi?
Total Value Locked in DeFi is a measure that represents the amount of crypto assets locked in a protocol, decentralized platform, or blockchain.
That is, TVL is basically the value, generally presented in US dollars, of the cryptocurrencies, tokens or stablecoins that users deposited within a particular DeFi application, such as decentralized exchanges (DEX), through their different services, such as lending, liquidity pools or staking and liquid staking, or also within the blockchain in general.
In this sense, protocols or decentralized applications (DApps) in the DeFi sector, such as Uniswap, AAVE or PancakeSwap, have their own TVL. While it is also possible to calculate it on public blockchains or Layer 2 networks, such as Ethereum, Solana, BNB Chain, Polygon, Arbitrum or Avalanche.
Of course, there is a generalized metric that seeks to estimate the total TVL of all DeFi protocols in the sector.
How is TVL calculated?
In general, TVL is calculated in real-time by adding up the dollar value of all tokens held in smart contracts of DeFi protocols.
This means that if a user deposits 100 tokens worth $100 each on Uniswap, $10,000 would be added to the total value locked. If they deposit 5,000 stablecoin tokens, worth $1 each, that would be $5,000 for the TVL.
This calculation includes funds generally deposited in the protocol’s smart contracts, then adding funds such as those from loans, pools, staking and other types of participation, although some derived assets are not considered.
Some specialized sites avoid adding assets that may inflate estimates of the overall TVL calculation, and that add-in duplicate.
Please note that TVL calculations may vary slightly depending on the protocol or DeFi platform in question, as well as the data aggregator, website, or tool that offers to track the metric.
Why does TVL in DeFi increase or decrease?
There are many reasons why TVL increases, but we can mainly associate growth during bullish market cycles, as well as due to an increase in investor participation, greater retail and institutional adoption, increased trading activity, increased token valuation, increased incentives and attractive returns.
Likewise, the opposite effect on each of these factors will mean a negative trend that could lead to a decrease or decline in TVL. Other elements such as a loss of confidence, hacking, scams or theft of funds, economic deficiencies, among others can also influence negative trends.
The Importance of Total Value Locked in DeFi
Total Value Locked is a relevant data for the DeFi sector, as it can offer a measure of the movement of users and investors, as well as the economic dynamics within the different decentralized applications.
TVL can serve as an indicator for certain trends and opportunities for investors, while for protocols it means a display of their growth, number of users, or liquidity.
TVL can also be seen as a way to compare different DeFi platforms and assess their relative popularity.
For its part, the general calculation of the global TVL allows illustrating the movement of assets within the DeFi sector as a whole. For blockchain infrastructures and networks, it offers a large-scale measure of the development and activity of its ecosystem of decentralized applications.
Limitations of Total Value Locked as a Metric
Despite being very popular, adopted and useful for decentralized finance, Total Value Locked also has limitations as a metric, for example:
- It tells us nothing about the quality of the protocols or the efficiency of their operations.
- It is subject to manipulation, as it can be artificially inflated by vendors transferring funds between their own wallets, creating worthless tokens, or through temporary or unsustainable economic incentives.
- TVL can also be very volatile as its calculation depends on the prices of digital assets.
- A high TVL does not imply that the protocols are secure or well-designed.
- Total Value Locked does not necessarily guarantee the security of funds within the protocol, let alone the long-term success of the protocol.
TVL should not be viewed as a metric capable of completely defining activity, growth and development within DeFi, but rather as data that encompasses an important part of the ecosystem in terms of interest, liquidity and economic movement.
More importantly, do not use Total Value Locked as a standard metric that fully defines the health of a decentralized protocol or project.
Therefore, it is crucial to consider TVL in conjunction with other metrics and conduct further research before making investment decisions.
Tools to visualize TVL in DeFi
We present some of the most popular specialized tools and pages to explore the Total Value Locked in DeFi. This with other data that will be of great help for your analysis, search for information, evaluation, or monitoring of decentralized finance.
Conclusion
Total Value Locked is a critical metric for understanding the DeFi sector, but it has limitations. While TVL provides insight into user activity, liquidity, and economic dynamics within DeFi applications, it should not be relied upon as the sole indicator of a protocol’s health or potential. Instead, use TVL in conjunction with other metrics and research to make more informed investment decisions.
