TLDR; For better or worse, the crypto industry has fixated on Total Value Locked (TVL) in DeFi protocols as the unit of measure to benchmark the traction / adoption of this nascent industry. In this post, we make the case that it’s neither and the metric tracks factors irrelevant to traction/adoption. The entirety of this metric depends on the ETH-USD market.
Total Value Locked (TVL) is akin to Assets Under Management (AUM) – a common metric in finance that measures the size and “success” of an investment management firm. Investment firms generally charge a fee as a percentage of AUM, so there’s a tendency to bloat your AUM.
In the case of DeFi, it functions as a rallying cry for Ethereum fans to showcase DeFi adoption. If Ethereum were a startup, a chart that goes up and to the right is exactly what investors and the press want to see.
But as the title alludes to, this metric has its nuances.
Simply put, the entirety of this metric depends on the ETH-USD market.
Let me explain.
Case 1: The price of ETH goes down
If the price of ETH were to go down, the ETH-as-collateral loans are at the risk of being liquidated. Borrowers will have to go back to the lending platforms and top up their collaterals to bring their loans back to safety.
As we saw in a previous research piece of ours on dYdX liquidations, there’s a lot of profits to be had by liquidating loans.
DeFi is all lending right now and Maker has over 50% market share. ETH is currently the only realistic backing collateral. Yes, I know BAT can be used as a collateral as well in multi-collateral DAI, but it isn’t being used as a collateral in any significant way yet.
Case 2: The price of ETH goes up
This is easy to reason about. The total value locked in USD goes up with no meaningful change in traction or adoption. This is no reason to celebrate.
What’s a better metric?
What are your thoughts? Can someone from the DeFi community come up with a better metric? Would love your thoughts!