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There are many articles that explain TVL in detail. Here I want to give a brief summary of what TVL is. Think of these as your reference notes.
The Total Locked Value is a number that represents the spot value (usually in fiat, i.e. USD) for all assets currently in use in a particular protocol. The assets can be:
- Used in simple yield logs that enable depositors to receive an equivalent representation of their deposited tokens.
- Stored in credit logs where the assets on deposit serve as collateral for the loans.
- In the liquidity pools of an AMM (Automated Market Maker) exchange.
- Act as the underlying asset for synthetic assets, futures and options.
- Liquidity for payment protocols that facilitate the transfer of assets from l2 (layer 2) to the ETH mainnet.
The TVL number for Defi would be the total value of the assets deployed in the entire Defi system. This value does not represent any leverage from the underlying assets. An analogy would be the funds that a bank holds in its deposits throughout the lending process.
The TVL is a metric used to measure the health of a defibrillator log. The TVL of an asset can be interpreted as the proportion of the asset’s capital in the entire defi ecosystem, which gives a rough idea of its usefulness. To make the metric for assets with different market capitalizations more comparable, a TVL ratio using what is defined as:
Total market capitalization of the locked asset / total value locked
The market capitalization here can be either the entire circulating supply or the total supply multiplied by the price of a single unit (token) of the asset. It is important to note this variability factor in the metric.
The above calculation is accurate in a simple scenario in which the value of the stored token is counted once. However, the complex nature of defi staking leads to scenarios where the value is counted twice. Suppose an investor puts 10 ETH in a protocol and then receives 10 SETH tokens (Staked Ethereum tokens) in return. These 10 SETH tokens confirm the investor’s initial stake in ETH and the SETH tokens can be accepted by another protocol that allows the investor to set their SETH tokens. While the investor has introduced 10 ETH value into the defi space when the total TVL is calculated or the TVL is calculated per protocol, the values are inflated due to this double counting. Such a scenario is common in Defi and therefore the TVL calculations should be given leeway.
If one looks at the TVL, measured by the market capitalization of the total circulating supply, then theoretically the following applies: the lower the TVL rate, the better, because the more saturated the staking pool, the lower the ROI (return on investment) per token. So the higher the TVL ratio, the lower the value of an asset should be.
Obviously, with Defi’s creativity, not every token is created equal, and more factors affect the price of a token than just the TVL. For example, the use of the token is important. If staking the token doesn’t generate a return, a TVL metric is almost worthless. Tokens with governance properties can request a premium.
While it’s not an all-encompassing metric for determining the value of a token, it’s still widely used and a good reference point for investors like the price-to-equity ratio of stocks. In fact, there is a Defi-Index after Defi-Impuls (the popularizer of the TVL metric) to balance its weights via the integrated tokens via the TVL metric.