What is TVL in DeFi?

Decentralized finance (DeFi) has grown exponentially in recent years, and the Cosmos ecosystem has emerged as one of the leading DeFi platforms. If you use DeFi dashboards like DefiLlama, you are familiar with how DeFi projects are often ranked using TVL. TVL (Total Value Locked) is one of the key metrics used to measure the success and popularity of DeFi projects. In this blog post, we will explain what TVL is, why it is important, and how it is calculated in the Cosmos ecosystem.

What is TVL?

Total Value Locked is a metric used to measure the total amount of cryptocurrency that is currently being held in a particular DeFi protocol. It represents the total amount of money deposited by users into a specific protocol. The popularity of the protocol is often measured by TVL. 

Importance of TVL

TVL is a crucial metric in the DeFi ecosystem as it gives investors and users an idea of the popularity and success of a particular DeFi protocol. If a protocol has a high TVL, it means that there is a significant amount of cryptocurrency being held in the protocol, and that there is a strong user base. High TVL is indicative of a project's ability to attract users, as well as its ability to retain them over time. This is commonly used by researchers and crypto users to evaluate the strength and potential of a project.

(TVL Pie Chart of Cosmos Ecosystem. Source: DefiLlama)

How is TVL calculated in the Cosmos ecosystem?

TVL in the Cosmos ecosystem is calculated in the same way as in other DeFi protocols. It is the sum of all the cryptocurrency held in a particular protocol's smart contracts. The Cosmos ecosystem includes various protocols such as Umee that offer different DeFi solutions, such as lending, borrowing, trading, and more. 

The TVL of a DeFi protocol can be calculated using the following formula:

TVL = ∑ (value of all assets locked in the protocol)

For example, if a DeFi platform allows users to lock up their ETH, DAI, and WBTC, the TVL would be calculated by adding up the total value of all these assets. Suppose the current value of the locked assets is:

10,000 ETH (worth $20 million)

50,000 DAI (worth $50,000)

1,000 WBTC (worth $60 million)

The TVL of the platform would be:

TVL = $20,000,000 + $50,000 + $60,000,000 = $80,050,000

This means that the total value locked in this particular DeFi platform is $80.05M. 

It is important to note that TVL can fluctuate over time due to market volatility or other factors, such as the introduction of new features or products. 

Limitations of TVL

The total value locked can be a useful metric in assessing the popularity and usage of a particular DeFi platform, but it’s important for users to understand its limitations, including the following:

• TVL only measures the total value of assets that are locked or staked in a DeFi platform or project, but it doesn't take into account user activities. So, a platform with high TVL but low user activities may not show a strong sign of future growth.

• A platform with a high TVL doesn't necessarily mean its TVL will remain high over time. Sometimes DeFi projects give generous liquidity farming incentives to boost their TVL for a period of time. It's important to DYOR (Do Your Own Research) before interacting with a new platform.

• When using a third-party analytics platform to research TVLs, it's important to check how often the platform updates its TVL data to ensure the metric is up-to-date.

• There is also something called double counting when a platform’s TVL is highly inflated. Sometimes, DeFi platforms use various mechanisms to artificially inflate TVL to attract more users. This can make it difficult for users to accurately assess the true usage of a platform. In that case, having a deep understanding of how the platform works is always helpful to get a more accurate picture of the project.

Conclusion

Total Value Locked (TVL) is an essential metric for measuring the success and popularity of DeFi protocols within the DeFi ecosystem. By calculating the total value of cryptocurrency held in a protocol's smart contracts, users can gain insight into the stability and strength of a particular DeFi project. As the Cosmos ecosystem continues to grow and evolve, TVL will remain a critical metric for assessing the health and viability of these platforms. With the rise of DeFi, TVL will continue to be an important tool for users.