While we keep working away on FlipMetrics, here's my take on TVL, a topic of frequent debate. I hope you enjoy it. If you do, please tell your friends to subscribe to the newsletter :) We'll have fun stuff every week.
Total Value Locked (TVL) is a common measurement for Defi project adoption. Should we care? What do we really learn from it? What is included in TVL? Is this even actionable or help determine network value in any real way?
That’s what we will cover in today’s newsletter.
At its core, TVL is the total value of assets engaged in a protocol, via staking, LP, lend/borrow, or other interactions. This typically excludes the protocol's own tokens, but we'll get to that.
DefiPulse categorizes TVL amongst five categories: Lending, dexes, derivatives, payments, and “assets”.
First off, “locked” is quite a deceptive term. Most protocols don’t keep assets locked in a real sense (though some do!), and most of the time, all it takes is a transaction or two to “unlock” or remove tokens from a protocol.
Some projects have bonus reward tiers for locking tokens longer — a quality ponzinomics scheme. In the meantime, the tokens given back to the user can be used in governance, or even carry value themselves.
Let’s provide three examples of locking. Don’t worry, these aren’t the only TVL mechanisms, because in Defi people have variations on variations of everything.
Aave, Compound, and other lending protocols create soft-locked TVL. If I deposit 100 ETH and borrow $50,000 USDC, I’ve “locked” that 100 ETH into the lending protocol. Of course, I simply repay that $50,000 USDC to unlock it, and it’s all done.
Now, what’s fun is I can also take that $50k and go lock it up some more. We’re locking on locking on locking because what could possibly go wrong? Keep in mind, any time you borrow against collateral, it's now leveraged and in market turmoil, your margin ratio may need some new collateral to protect the initial.
A fun newer example of creative TVL is Alchemix. Alchemix loans “repay themselves over time.” :: deep breaths :: notaponzinotaponzinotaponzi :: deep breaths :: (Okay, it's not a ponzi, it just sounds like one).
By depositing our $50k (say, of Dai) we borrowed from Aave (this may be a bad idea!), we can mint (and borrow) up to $25k of alUSD without liquidation risk. Our initial $50k will now earn yield through various strategies and the rewards of that yield will go toward paying off the $25k borrow so that we can forget it was ever a thing. And now we can go have fun with the $25k! Maybe roll the snowball of debt further or do some other yield farming. We are heavily incentivized to leave our deposit… forever? Or at least until we can withdraw it without paying them back.
That is some Grade-A time-locked TVL. Alchemix gets to count our full $50k of DAI deposits toward their TVL and it’ll be pretty sticky.
Cream had a good example of a more pedestrian time-locked TVL last Defi Summer. I’m too lazy to check how they do it now. Basically, you earned better APY if you agreed to keep your lending or LP tokens locked up in their staking contracts for a longer period of time. It helped stabilize the pool liquidity and rewarded people who agreed to lock for longer. TVL secured.
Many protocols use similar tiered reward mechanisms for staking their own governance tokens, as it helps prevent farm-and-dumps. However, tokens of the base protocol that get staked and timelocked for extra rewards aren’t typically considered as TVL (enter Sovryn drama stage right) because they are all native protocol assets rather than assets from the broader Defi ecosystem being utilized within the current protocol.
Black hole locked
The most fun example of TVL is where it’s a legitimate black hole. Curve is the most interesting example, and the recently launched Convex Finance version is the most fun. Curve rewards CRV to protocol participants. When a user locks their CRV for four years they get the full rewards of veCRV.
Convex Finance is an additional protocol that brings liquidity to this rewards mechanism. One can take CRV, convert it to cvxCRV, and on the backend Convex locks that CRV as veCRV and tokenizes the cvxCRV to the user, which when staked or utilized within the system will reward the veCRV rewards.
So, you get veCRV like rewards inside of Convex, without sacrificing liquidity. And all those CRV that get converted to cvxCRV go down the veCRV black hole (a four year lock) and are perpetually renewed by Convex.
That’s a black hole.
What counts as TVL
In this scenario, CRV that gets staked on Curve isn’t proper TVL (as it’s their own governance token). Whereas CRV that gets converted and staked on Convex does count as TVL for Convex, because it’s someone else’s token staked on their system.
Thus we now have some understanding of TVL, right? No? Here’s the smell test.
Does a protocol have a bunch of other protocols’ tokens locked in its smart contracts? Stables, ETH, altcoins? That’s TVL. Does a protocol have a bunch of its own token locked on its platform for governance and staking rewards? That doesn’t really pass the TVL smell test.
Does TVL matter?
The thing of utmost interest in Defi protocols is utilization in my opinion, and whether that utilization can turn into protocol profits. TVL is indication that a protocol is utilized, whether by raw activity (transaction counts) or value of assets engaged.
Is TVL perfect? No, far from it. Is it worthless? No, it gives a snapshot of utilization. How well a protocol monetizes that utilization is a different story. Whether that utilization is sticky (will people still use this protocol when the yield farming free money dries up?) is very, very important. TVL won’t tell you that story all by itself.
TVL is a nice thing to know. Just like total protocol revenue is nice to know. And several other metrics. It is not an end-all-be-all, and it does not indicate the true value of a protocol all by itself. It’s a piece of the puzzle for valuing Defi projects.