Nominal vs Adjusted TVL
With the DeFi sector driving the current boom in the crypto industry, TVL has become an almost iconic metric. News headlines glisten with awe-inspiring numbers: $4B, $6B, $7B. It feels like every week there is a new milestone or record broken.
The metric is used to highlight the growth in the DeFi sector, but it may be grossly overstating the pace. In a bull market, it exaggerates asset growth, while in bear markets their outflow. When the effect of price appreciation is taken out of the equation the real picture emerges.
Why skyrocketing prices are a problem for TVL
TVL, or total value locked, measures how much capital appears on a project’s smart contracts, and is akin to deposits and reserves in the traditional industries. It is measured as TVL = A * P, the number of tokens multiplied by the current price of those tokens.
As such we can easily imagine a case when the amount of tokens stays the same or even decreases, but TVL increases because of rising prices. This is why this metric can be so misleading.
Take for example ETH. It is accepted by a number of DeFi dapps as collateral and accounts for a large portion of their TVL. Over the past 90 days, Ethereum saw a dramatic increase in price.
This in turn has reflected in the TVL of the projects that accept it. So is the rise in TVL a result of increased activity or a reflection of surging prices?
Factoring out the price effect
In order to get a clearer picture, we can fix prices as of 90 days ago. That reveals the change in TVL solely dependent on the balance totals, which depicts a more realistic picture of the evolving dynamics.
Consider the difference between TVL and adjusted TVL. Yes, TVL still shows growth, but it is not nearly as steep. In fact, around 45% of TVL growth can be accounted for by the changing prices.
Of the top five dapps by TVL only Curve shows more or less similar values between its nominal and adjusted TVLs, and even then price changes account for nearly 15% of growth.
For Synthetix price movement accounts for over 80% of growth. The differences highlight how misleading the TVL metric is on its own.
Implications going forward
It is important to consider what adjusted TVL means for industry analysis. It uncovers real growth (or lack of it) and coupled with relevant metrics can present an accurate picture of activity in the ecosystem.
For example, as can be seen from the graph, UAW (unique active wallets) has been plateauing since mid-August. Coupled with a much slower pace of growth of TVL this presents a very different view of DeFi development.
Moreover, understanding the implications that price changes have on the project’s assets is imperative for risk analysis. For example, for projects like Uniswap TVL is composed of assets in the liquidity pools. During price spikes, this value can grow quickly and distort expectations of asset inflow and available liquidity.
The growing market has catalyzed development efforts. A number of projects have raised or are raising funds for their DeFi ideas. However, if expectations of market growth are being based on nominal TVL there may be a serious disconnect with realistic demand.
That is not to say that DeFi is not growing at an impressive rate. Adjusted TVL has posted 3x growth over the past 90 days. However, the distortion created by price changes in nominal TVL, on its own misrepresents the pace of growth and may help fuel a bubble.
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