In this article, you will learn what is TVL and importance of TVL in defi. Since decentralized finance (DeFi) boomed in 2020, financial market experts have come to terms with a new type of investment and have looked at ways to measure its performance.
For DeFi platforms to function, they require capital to be deposited as loan collateral or liquidity in trading pools. And that value is called TVL.
What is TVL?
TVL is the total value locked. Other than market capitalization, trading volume and total and circulating supply, total value locked (TVL) is one crypto indicator that is popular among DeFi investors to assess the overall value of assets – in United States dollar or any fiat currency – deposited across all DeFi protocols or in a single DeFi project.
DeFi assets include rewards and interest, coming from typical services such as lending, staking and liquidity pools, provided in the form of smart contracts. TVL in staking, for example, is a particularly useful indicator for investors looking to support the DeFi platforms with the highest rewards. It is the total value locked in the DeFi staking protocols and represents the amount of assets deposited by the liquidity providers.
In 2022, TVL has reached nearly $2 billion globally, growing from $400 million in the previous two years. With the increasing popularity and value of DeFi in the cryptocurrency space, TVL has become an essential metric for investors who want to assess if the whole eco system or a single protocol is healthy and worth investing in.
While TVL is simply defined as the total value of cryptocurrency locked in a smart contract, there are underlying conditions that may affect the value of DeFi projects.
Various elements concur on TVL's worth other than deposits, withdrawals and the amount a protocol is actually holding. The TVL also changes with the value of the fiat currency or the native token. Some protocols' deposits may be denominated in the project's native token, so its TVL varies with its value. If a specific token grows in value, so does the protocol's TVL, too.
Importance of TVL in Defi
TVL matters because it indicates the capital's impact on DeFi applications' profits and usability for traders and investors.
When the TVL of a DeFi platform rises, it is followed by an increase of liquidity, popularity and usability. These factors contribute to the project's success. A higher TVL means more capital is locked in DeFi protocols, with participants enjoying more considerable benefits and proceeds A lower TVL implies lower availability of money, resulting in lower yields.
DeFi protocols' market share can be easily identified through analytics firms' platforms like DeFi Pulse and DefiLlama, which provide data on the amount of crypto assets locked in their respective smart contracts.
DeFi participants who track down TVL on DeFi Pulse must know that the platform monitors protocols' smart contract movements on the Ethereum blockchain only by extracting the total balance of Ether (ETH) and ERC-20 tokens. DefiLlama, on the other hand, calculates the TVL by extracting the total balance of all of the DeFi chains combined or each individual platform separately.
How to calculate TVL?
It is straightforward to calculate the crypto TVL. First, the market cap of an asset has to be found by multiplying the DeFi project's supply by the current price. Then, dividing the market cap by the maximum circulating supply, the TVL is revealed.
In 2022, Ethereum appeared as the largest network by DeFi TVL, accounting for over half of the total DeFi volume worldwide.
Bottom Line
Because of the nature of DeFi services, money can easily move around and be counted multiple times, thus miscalculating protocols' liquidity capacity. As with every indicator, TVL is only an estimate of the market's condition and because of its flaws and approximation, it should not determine an investor's strategy. But knowing what is TVL which is a basic knowledge of blockchain.
