Decentralized Finance (DeFi) ecosystem growth can be hard to keep up with, let alone analyze new projects that are emerging at a rapid pace. Fundamental analysis seeks to determine whether a protocol is overvalued or undervalued so that investors and traders can make better decisions on their positions.
Total Value Locked
As the name suggests, Total Value Locked or TVL refers to the number of tokens locked into a specific DeFi protocol. It is simply all the liquidity in the liquidity pool of specific marketplaces. In the example of Uniswap, a DeFi protocol used to exchange cryptocurrencies, TVL refers to all funds deposited to the protocol by the liquidity providers.
It is possible to measure TVL in various denominations. For example, one can measure TVL staked in Ethereum projects in ETH or USD.
TVL is one key indicator that offers knowledge on the overall interest in DeFi. As an investor, you can consider TVL as a data point to come across DeFi projects that are not valued highly enough. Additionally, TVL can also help you compare and assess the market share of various DeFi protocols.
Price-to-sales ratio (P/S ratio)
In simple terms, the price-to-sales ratio or P/S ratio is an indicator that helps investors calculate whether the stock is undervalued or overvalued by comparing its price to the company’s revenue. It can be achieved by having investors divide the protocol’s market cap by its revenue.
The lower the price-to-sales ratio in the calculation, the higher the odds the protocol is undervalued. Although it is not assertive and may not be a correct way of calculating valuation in the end, it still provides investors with a piece of crucial knowledge on how fairly the project is being valued in the market.
Token supply on exchanges
DeFi investors are advised to monitor token supply on exchanges. More often than not, sellers rely on centralized exchanges (CEX) to sell their tokens. Therefore, centralized exchanges tend to have higher liquidity than decentralized exchanges (DEX), which don’t need the trust of an intermediary.
When there are way too many tokens available to buy on centralized exchanges, the pressure to sell these tokens can be higher because of the possibility that holders are not storing funds in their wallets. Therefore, it is essential that DeFi investors monitor token supply on exchanges having higher liquidity.
Again, this strategy is not assertive and does not accurately predict an imminent sell-off in large volume since traders tend to have a large balance on these exchanges for trading on margin or futures. However, monitor token supply is still something every DeFi investor should consider.
Token balance changes on exchanges
In the earlier section, we discussed why it is important that you monitor token supply on exchanges. However, as an investor, only tracking token supply and balances on exchanges may not be enough. It is equally imperative that you also monitor recent changes in token balance on those exchanges.
The significant changes in token balance on exchanges can often indicate there may be an increase in volatility. Large amounts of funds being withdrawn from centralized exchanges could indicate whales are accumulating the token.
Unique address count
Monitoring an increasing number of addresses holding a particular asset could be a reliable strategy for investors to determine its relevance. There is a direct correlation. The steady growth in the number of addresses holding a particular asset can often indicate its growing popularity and adoption, thereby increasing buyers and usage of the token.
Remember that it is not difficult for someone to create many addresses and distribute funds across all of them, giving a false impression that the asset is widely used. Hence, investors should be a little cautious about considering unique address count as a reliable metric.
Some assets only promise great returns, while others deliver and live up to their promises. As an investor, you need to be careful before investing in assets that appreciate price but are unlikely to sustain for long. Therefore, it is critical to determine the actual value of any asset, what it can be used for, and why it is worth investing in.
Investors can do some research and measure the asset’s true worth by paying attention to the number of transactions pertaining to that particular asset. This primary yet effective indicator tells investors whether people are using the token or not.
Last but not least, the inflation rate is another significant indicator that every DeFi investor should pay attention to. Limited supply assets may not always guarantee good returns in the long run. Some assets initially have limited supply, but they may not necessarily remain that way for long periods.
If new tokens are regularly minted over a period of time, the chances are that the amount of supply will eventually increase. Inflation may not be a bad thing for investors, but too much inflation may not deliver promising returns on your investment. Therefore, it is also important to pay attention to the inflation rate when considering other metrics.
The Bottom Line
Whether you are an experienced investor or a newcomer, you should certainly have a basic understanding of some of the most commonly used DeFi indicators we discussed in this article. The market is sometimes unpredictable and prone to high volatility. Therefore, it is crucial to do more extensive research before investing in any project.