One of the most often used metrics in the decentralized finance (DeFi) industry, total value locked (TVL), is “a deceptively complicated metric hiding under a benign name,” according to crypto intelligence firm Coin Metrics.
What this metric should be measuring is the total size of a levered market, and that figure “can be misleading as it is inflated by a leverage multiplier, carries high price sensitivity, and is far from holistic,” the analysts at the firm said.
According to them, due to the very broad scope of DeFi applications, measuring the adoption of the DeFi theme as a whole is not an easy task, which is why the industry “has converged” on TVL.
TVL of any protocol is taken as the sum dollar valuation of all collateral deposited in that specific decentralized application, so it can be compared to any other dapp (decentralized application) regardless of their functionalities.
At 11:27 UTC, DeFi Pulse shows the TVL to currently be USD 66.55bn, while, according to Defi Llama, it’s USD 111bn, and DappRadar claims it’s USD 98bn.
In either case, Coin Metrics identified three challenges standing in the way of computing a robust TVL metric.
1. The myth of ‘total’
What ‘total’ means is tracking all the versions of a protocol, its versions on multiple chains (Ethereum (ETH), Binance Smart Chain (BSC)), as well as second layers like Polygon (Matic) or Fantom (FTM).
Because protocol clones launch so often, it has become “nearly impossible to perfectly track all collateral allocated to a blockchain in real-time,” as observers like Coin Metrics need to pick which protocols to individually track TVL for. To accurately calculate TVL for a platform like Ethereum, providers need to constantly re-evaluate past measurements to reflect new protocols and collateral types.
“The frequency of new protocol launches leads to a natural underestimation of the total value used as collateral across all DeFi applications by all data providers,” they said.
Another complicating factor is that existing protocols can also mutate, so new versions and contract deployments must also be constantly monitored.
2. The myth of ‘value’
‘Value’ means finding a robust price for each asset that can be used as collateral, and DeFi protocols support a near-infinite variety of such assets. “The sheer scale of collateral types complicates the value estimations,” the analysts said.
Additionally, all these assets can be traded across multiple venues, including centralized, off-chain, on-chain, etc. The collection of pricing data from all venues is “a herculean task,” and yet, it must be done so that the asset used as collateral can be priced correctly via an index value that accounts for each venue.
But what further complicates the issue is that “even if a data provider were to have the bandwidth to produce index values from all possible trading venues, it is hard to take all data collected at face value.” Pricing data in DeFi liquidity pools can be manipulated, undermining value measurements.
3. The myth of ‘locked’
“Locked” is a misnomer, says Coin Metrics, as most protocols liquidity can be added or removed quickly. It also involves untangling the links between each asset to avoid double or triple counting.
One might assume each unit of value deposited as collateral is being used within that protocol only – that the assets are ‘locked and strictly being used in the context of the application. “However, due to how DeFi money markets are designed, this assumption is wrong,” per the the firm.
DeFi enables the creation of asset derivatives that rehypothecate collateral, meaning that the collateral used in one application can be used in another, then in another, and so forth.
“In brief, some assets used as collateral in DeFI applications are derivatives that represent existing claims on other collateral,” said Coin Metrics. “This results in a multiplier factor that can drastically increase TVL estimates since both real and rehypothecated collateral are being counted.”
As reported, the metric has been questioned by many in the crypto industry. Speaking to Cryptonews.com, industry figures agreed that there is a risk of double-counts inflating data on TVL. They also warned that much of the increase in TVL comes from yield farming activities that may create dangerous levels of systemic risk.
Besides double counts, other problems include counting in synthetic and governance tokens used to represent another cryptoasset deposited as collateral, and TVL increasing simply because crypto prices have increased relative to the USD.