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What is Total Value Locked (TVL) in Crypto and Why Does It Matter?

The total value locked represents the total assets deposited in decentralized finance (DeFi) protocols, which include rewards, interest, new coins and tokens, fixed income, etc.

Blockchain services are developed on peer-to-peer networks, so there is no central authority to govern, build or improve the ecosystem. Therefore, users and investors help to improve the performance of a network in decentralized finance or DeFi by locking their cryptocurrencies.

TVL is an important measure of the overall DeFi market, which is calculated based on smart contracts and funds locked on the platform. Currently, the index of total value locked in the cryptocurrency market globally has reached a staggering amount, with Ethereum deposits taking the largest share.

 

How the TVL index is created

TVL calculations in the digital currency market started in 2017 with the launch of the first DeFi projects, and at the end of 2017, the total locked value of the digital industry was only $120 million.

 

The financial market of digital currencies has experienced rapid growth since 2018. By the end of that year, TVL had grown to $6.5 billion, an annual increase of 54,000%. However, with the development of the decentralized DiFi industry, the annual increase became very small. By the end of 2019, this measure was about 8.5 billion dollars, which has increased by 31% annually. In 2020, the TVL industry grew 188% year on year to a total of $24.5 billion. Currently, at the end of September 2021, the total value locked up is almost $83 billion.

 

How is Total Value Locked (TVL) calculated?

Let’s say an investor connects his wallet to a DeFi platform and buys $1,000 worth of cryptocurrency to receive credit through transactions on the blockchain. Next, he lends another $1,000 as interest on the same platform. On the other hand, he deposits another $1,000 to fund a pool and earns a trading commission. Thus, if this were the only business of the hypothetical DeFi platform, its TVL would be $3,000.

The exact calculation of TVL depends on the nature of a DeFi application. Among the top DeFi projects by TVL, there are several distinctions. The three main types are:

 

Loan and borrowing protocols

The main function of these protocols is to use liquidity sources to lend crypto funds to users and allow users to borrow from pools. Famous examples of these protocols are Maker (MKR), AAVE (AAVE), etc.

 

Decentralized exchange platform for digital currencies (DeXs)

Decentralized exchanges (Dex) allow users to trade cryptocurrencies using an automated market maker (AMM). Users do not directly transact with each other when exchanging crypto assets on these platforms. Instead, they trade with liquidity that has the required currency pair. Prominent examples of these protocols include UniSwap (UNI) and SushiSwap (SUSHI). In these platforms, TVL refers to the total value available in all currency pairs of the protocol.

 

Performance optimization protocols

These programs use algorithms that optimize users’ investments in loan and borrowing platforms. Users of the platform deposit their funds into the protocol and the algorithm allocates the funds to the pools with the best-expected return through the yield farming process. The largest of these protocols are currently Yuen Finance (YFI) and Balancer (BAL). In these protocols, TVL typically refers to the value lent by users to the application for performance optimization.

 

Why is the measure of locked-in capital important?

TVL is the clearest indicator of DeFi project popularity among active users. This is a good measure of the value and credibility of a project.

 

The amount of capital locked in this market shows the desire of people for this project. These investors are the same cryptocurrency traders who invest in the token and expect the project to progress and succeed. They may not necessarily use the protocol itself in any consistent way.

 

These users help to increase the market value by buying platform tokens in the hope of increasing the price, and compared to traditional financial sources, they can be considered “shareholders” of the protocol.

 

If you decide to research the future potential of a DeFi project, you should check the statistics, but if you want to check how people currently think about the project, you should read the TVL figures.

 

Conclusion

Checking the index of the total volume locked in the market is a critical measure for the performance of DeFi projects and their analysis. Additionally, you can gain more insight into your favorite DeFi projects by using the TVL ratio, an indicator that combines TVL and market capitalization. When analyzing the TVL statistics of various DeFi platforms, note that due to its nature, the volume number locked in the market can change drastically in a matter of hours or days.

Source: Cointelegraph

 

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