This value is called Total Value Locked or TVL. This value is then weighted against the market capitalization of an asset to obtain a ratio of market capitalization to TVL.
But how is this ratio calculated, how does the TVL report affect the value of a decentralized service
, and how can you use the TVL report to determine whether a decentralized financial service is undervalued or overvalued? We will answer all these questions in this edition of Ask CryptoVantage.
How the TVL ratio is calculated
There are three main factors to consider when calculating and looking at the TVL market capitalization ratio of a decentralized financial service: circulating supply, maximum bid, and current price.
Let’s use Uniswap as an example, as it is one of the most well-known DeFi providers. Uniswap currently has a circulating supply of about half a billion UNI, with a maximum supply of 1 billion UNI.
To obtain Uniswap’s current market capitalization, simply multiply the circulating supply by the current price of UNI. So to get the TVL report you take that market cap number and divide it by the service TVL and you get the TVL report.
For Uniswap it is above 2, which means that there is only about half of the value locked in the platform as the platform is valued. When the maximum supply is taken into account, the TVL ratio becomes even higher at over 4.
How does the TVL report affect value (in theory)?
From a purely theoretical point of view, the higher the TVL ratio, the lower the value of an asset should be, this is not always the case in reality (as with Uniswap), but there are more factors that not only TVL affect the price of a DeFi token such as the number of services available and the usefulness of the token. In any case, theoretically you should want the price to be closer to 1 or less than 1, because the more saturated the pool, the lower your returns.
How can you use the TVL report to determine if a DeFi asset is undervalued or overvalued?
One of the easiest ways to use the TVL report to help determine if a DeFi asset is undervalued or overvalued, is by simply looking at the report. In general, if it is less than 1, it is probably underestimated. But there are warnings here. Venus (XVS) for example has a very low TVL ratio of less than 0.2, in theory this should mean that XVS is undervalued, but if you actually dig into XVS and its role in the platform, it doesn’t have much use, and this helps explain the price of the asset. Conversely, if it is well over 1, it may be overrated.
The key thing here is to research the DeFi asset you’re interested in and then also use TVL as a tool to help you decide what might be undervalued (since you don’t want to buy anything overvalued). See how it is used on the platform, how it is distributed and only the general tokenomics of the asset.
