With the DeFi space moving at breakneck speeds, it can be hard to make sense of the avalanche of new projects. Fundamental analysis seeks to determine whether a protocol is overvalued or undervalued, so that investors and traders can make better decisions on their positions.
Wondering how you can measure the "intrinsic" value of DeFi assets? Read on to learn about some of the strongest metrics for doing so.
Decentralized Finance (DeFi)
moves at such an accelerated pace that it can be quite difficult to keep up, let alone evaluate new projects in a timely manner. What makes it even more challenging is the lack of a standard approach – there are many different ways to measure and compare DeFi protocols.
Not to worry, though. We'll cover some commonly used indicators that can be good sources of information in DeFi. Since a considerable amount of data is publicly available on-chain, it's easy for any trader or investor to use these indicators. We were inspired by Spencer Noon's thread
to collect some of them in this article.
As the name would suggest, Total Value Locked (TVL) is the aggregate amount of funds locked into a DeFi protocol. You could think of TVL as all the liquidity
in the liquidity pools of a given money marketplace. For example, in Uniswap's
case, TVL means the amount of funds deposited by liquidity providers to the protocol.
TVL can be a useful data point that gives you an idea about the overall interest in DeFi. TVL can also be effective in comparing the "market share" of different DeFi protocols. This can be especially useful for investors who are looking for undervalued DeFi projects.
What's also worth noting is how TVL can be measured using different denominations. For example, the TVL locked in Ethereum
projects is typically measured in ETH or USD.
In the case of a more traditional business, the Price-to-Sales Ratio (P/S Ratio) compares the price of the company's stock to its revenues. This ratio is then used to determine whether the stock is undervalued or overvalued.
Since many DeFi protocols already generate revenue, a similar metric can be used for them as well. How can you use it? You'll need to divide the market capitalization
of the protocol by its revenue. The basic idea is that the lower the ratio is, the more undervalued the protocol may be.
Bear in mind that this isn't a definitive way to calculate valuation. But it can be helpful in giving you a general idea of how fairly the market may be valuing a project.
Another strategy involves tracking the token supply on cryptocurrency exchanges. When sellers want to sell their tokens, they usually do so on centralized exchanges (CEXs). That said, there are a growing number of options available to users on decentralized exchanges (DEXs) which don’t require trust in an intermediary. However, centralized venues tend to boast much stronger liquidity
. This is why it's important to pay attention to token supply on CEXs.
Here's a simple assumption about token supply. When there are a large number of tokens on exchanges, sell pressure may be higher. Since holders and whales
aren't holding their funds in their own wallets
, it could be likely that they are looking to sell them.
With that said, this isn't so straightforward. Many traders will use their holdings as collateral
for trading on margin
. So, sending a large balance to an exchange doesn't necessarily mean that a large sell-off is imminent. Still, this might be something you want to keep an eye on.
We already know that keeping an eye on token supply can be useful. But looking at only the token balances may not be enough. It can also be helpful to look at recent changes in those balances. Large token balance changes on exchanges can often signal an increase in volatility
For example, consider the opposite scenario of what we've just discussed about token balances. If large holdings are being withdrawn from CEXs, that may indicate that whales
are accumulating the token. If they were looking to sell soon, why would they withdraw to their own wallets? This is how monitoring token movements can be useful.
While it has its limitations, a steadily increasing amount of addresses holding a particular coin or token should point to increased usage. On the surface, it would appear that more addresses correlates with more users and growing adoption.
This is a gameable metric, though. It's easy for someone to create thousands of addresses and distribute funds across them, thus giving the impression of widespread use. As with any metric in fundamental analysis, you should contrast unique address count with other factors.
So you're eyeing up some emoji-based token that promises crazy returns, but does it actually do
anything? It might get the Charles Ponzi
seal of approval if its sole purpose is to appreciate in price, but it won't be sustainable for long.
Understanding what the token is used for is critical to figuring out its true value. Ideally, you would measure this by looking at the number of transactions that aren't carried out for the purposes of speculation. That can be difficult, but a good start would be to look at transfers that don't take place on decentralized or centralized exchanges. The aim here is to check that people are using the token.
Wow, a token with a small supply! That's a really good sign, right?
Not necessarily. Another vital metric to keep an eye on is the inflation rate. A small supply now doesn't guarantee a small supply forever, particularly if new tokens are continuously minted. A notable property of Bitcoin is a constantly diminishing inflation rate
, which should theoretically prevent debasement of existing units in the future.
That's not to say that every system should aspire to replicate Bitcoin's scarcity. Inflation in itself is not necessarily bad, but too much could reduce your slice of the pie. There's no standardized percentage considered "good" or "bad," so it's wise to take the number into account when considering other metrics.
If you're a veteran cryptocurrency trader, you'll note that a lot of these metrics are commonly used in fundamental analysis for "traditional" cryptocurrencies. If you're unfamiliar with those, we highly recommend you check out What is Fundamental Analysis (FA)?
to step up your FA game across the board.
As always, the markets are unpredictable, irrational, and prone to extreme volatility. Above all, doing your own research
is crucial to success.
Still got questions about DeFi and fundamental analysis? Check out our Q&A platform, Ask Academy
, where the Binance community will answer your questions.