Total value locked (TVL) is a useful metric for traders and investors to evaluate the performance of DeFi projects. It is now a mainstay in the Web3 investing space.

Read on to understand what total value locked means, how it is calculated, and why it is an important metric in DeFi.

What is Total Value Locked?

Total value locked (TVL) is a simple measure of the total monetary value deposited and available in a smart contract application. It refers to the total value of cryptocurrency, typically measured in USD or cryptocurrency, that users have staked or locked within a particular DeFi platform. 

This metric offers insights into a platform’s overall activity and attractiveness, comprising the combined worth of assets used as collateral, the liquidity provided for trading purposes, and funds engaged in various DeFi protocols on a platform.

TVL plays a vital role in determining a platform’s success and widespread user adoption. A higher TVL often signifies greater trust and confidence from users, showcasing the platform’s ability to draw in liquidity and assets for activities like staking, lending, and borrowing. 

How is TVL Calculated?

Calculating TVL in DeFi involves adding up the total value of various assets held within a platform at a time. These assets may include stablecoins or other digital assets used in different activities on the platform.

The TVL figure changes continuously and is updated in real-time as users interact with the platform, deposit or withdraw assets. As users move assets in and out of the platform, the TVL reflects the current total value of the assets held within it. 

If you would like to determine the latest TVL of a platform, you can use DeFi analytics tools like Token Terminal or DeFiLama that monitor the activities of the protocol on the blockchain and automatically calculates the value.

Why Does TVL in DeFi Matter?

A DeFi protocol’s TVL matters because it can give insights into the health and popularity of its platform. For example, a higher TVL means more capital is available for borrowing and lending in a DeFi lending protocol.

Some other reasons why TVL in Defi matters include:

  • Trust Indicator: A high TVL can mean that people believe in the security and reliability of a protocol, as users are willing to commit money to use it. However, this could be a misleading signal as it’s possible for only a few people close to the founding team to deposit large funds and drive up TVL amount. To get a better picture of the reliability of a platform, you should also use other factors like the number of users and other activity data on the platform as a complimentary indicator of trust.
  • Protocol Growth: A steady upward trend in TVL could signify the growth of a DeFi protocol. As more users participate and lock their assets, they strengthen the network effect and attract even more users, creating a positive feedback loop for the protocol’s expansion.
  • Investor Interest: TVL can be used to gauge investor interest in the DeFi space. A high TVL can attract more traditional investors and institutions, bringing further legitimacy and mainstream attention to the space.
  • Risk Assessment: TVL can serve as an indicator of risk for investors and current users. A protocol with a very high TVL might be seen as safer, as many others have trusted it with their assets. On the other hand, a low TVL might suggest that a platform is less established or untested and, thus, is riskier to use.

TVL vs. Market Cap: What’s the Difference?

TVL and market cap are two popular metrics used in different contexts to evaluate the success of a cryptocurrency project. 

Market cap is a measure of total value market based on the number of tokens multiplied by the price of the token. The higher a cryptocurrency’s market capitalization, the more valuable it’s generally perceived by the market. On the other hand, TVL offers an assessment of the protocol’s adoption in real time. It shows how well the protocol fulfills its intended purpose and how much trust and interest it has garnered from users actively participating in its ecosystem.

You should use TVL if you are more interested in understanding a protocol’s present usage and its effectiveness in providing valuable services within the DeFi ecosystem. Conversely, market capitalization could be a better metric for evaluating investment performance.

However, it’s essential to remember that both TVL and market cap can fluctuate significantly due to market sentiment, making it vital to consider these metrics alongside other factors when making any investment decision. Finally, always remember to do conduct extensive research before committing any capital in the DeFi or broader crypto markets.