Table of Contents
The list of new decentralized finance (DeFi) blockchain projects is constantly expanding. In this sea of options, which projects will be the stars of tomorrow, and which are worth investing in? In this article, we take an in-depth look at a comprehensive list of performance metrics used to assess the investment potential of a DeFi project.
Some of these indicators overlap with the metrics you would look at when evaluating traditional stocks. However, because of the very different nature of crypto investments, many of these indicators are more relevant to the crypto world. In fact, these indicators are particularly applicable to the DeFi project lexemes rather than other types of blockchain projects.
Price to sales ratio
The price/sales ratio (P/S ratio) is the fundamental KPI in the DeFi world. It is calculated by dividing the fully diluted market capitalization of a token by its 12-month revenue. In the case of DeFi, the revenue is derived from transaction fees and includes the fees retained by the protocol as well as the fees received by token holders and liquidity pool providers.
In traditional stock investing, a P/S ratio of 1: 2 is considered good, and a ratio of less than 1 is considered excellent. Given the young and rapidly evolving nature of the DeFi industry, these traditional rules may not be very applicable. Instead, it is best to use the P / S ratio to estimate the number of DeFi tokens by this metric for benchmarking.
In a comparative approach, you can use revenue for periods other than the 12-month period normally used. For example, you can use the last 6 months of revenue for the compared tokens in the denominator ratio. This is useful because many new DeFi projects are less than a year old. However, shorter periods may not be as reliable as the standard 12-month period and are often just a compensating measure because of the need to evaluate new tokens.
Total blocked value
The total blocked amount (TVL) refers to the total amount of all funds allocated as collateral for the DeFi project. It includes funds locked in liquidity pools as well as loan guarantees. TVL should not be confused with the market capitalization of the protocol.
Market value is the total amount of currency multiplied by its current price. TVL, on the other hand, refers to the value fixed in smart contracts on the platform. For example, in the case of the Maker DAO (MKR), one of the largest DeFi protocols, TVL refers to the amount of funds held as collateral for a loan in the platform’s vaults.
In the case of distributed exchanges (DEX), TVL usually refers to the total amount blocked in the liquidity pools. Higher TVL values indicate a more actively used protocol.
TVL reason
The TVL itself is an excellent indicator of the popularity of the protocol. However, by focusing only on this metric, you may miss out on smaller but still promising DeFi projects. The TVL ratio is an indicator obtained by dividing the market capitalization of a token by its TVL. This indicator helps identify small DeFi platforms that perform well and are potentially promising from an investment perspective.
As a rule, a smaller TVL ratio is preferred. Indicates a protocol that may be undervalued and worth investing in.
Annual rate of return
Liquidity pool betting on DeFi platforms can be a viable way to generate investment income. DeFi protocols can vary greatly depending on the returns they provide. An important metric to track is the return generated by Staking LPs.
Given the volatility of many DeFi protocols, it is better to look at annual returns rather than short-term returns. Naturally, as the popularity of the protocol increases, returns tend to decrease. The best returns are often achieved on smaller projects with reliable growth.
Consequently, annualized returns can be a great way to identify promising and currently undervalued DeFi tokens.
Supply of 5 tokens on centralized exchanges
While DeFi tokens are designed to be decentralized, attention to full token provisioning on centralized exchanges (CEX) is useful for investment analysis. The large number of tokens stored on CEX could indicate a potential large-scale sale.
These sales often lead to token destabilization. Thus, understanding these signs is an important due diligence step in your analysis. It should be emphasized that a large amount of CEX is not necessarily a guaranteed whale action waiting to happen. Using token provisioning as an indicator should only be part of your token research, along with the other indicators discussed in this article.
Token moves on centralized exchanges
In addition to information on token provisioning, it is worth examining recent token balance changes on CEX. This metric can provide additional information about the potential actions of a whale in the process of becoming a whale.
Token balances alone may not reveal a recent large-scale wave of FX portfolio withdrawals. Observing recent token moves may reveal significant withdrawals aimed at holding large amounts of tokens. These large-scale actions could also indicate future whale actions that could negatively impact token stability or delivery.
While token balances and movement are useful metrics, it is important to keep them in perspective. Frequent movement of tokens from trading accounts to personal wallets and vice versa is normal practice in the crypto world. Only very significant and highly atypical movements can indicate a period of future instability for a token.
The growth rate of unique addresses
Another useful indicator is the rate of change in the number of unique addresses for a token. If the number of unique addresses shows signs of rapid growth, it may indicate a rapid increase in the popularity of the project.
Of course, it should be kept in mind that this metric can be manipulated. A small group of people can create a large number of addresses in a short period of time to create an impression about the popularity of the project. Therefore, use this metric only in conjunction with others to evaluate a potential DeFi project.
Inflation rate
Many DeFi protocols impose rules to ensure that providing your token will not lead to inflation and devaluation of the token. However, not all tokens are protected from devaluation by platform rules. In some cases, the mechanism for maintaining a limited number of tokens is unclear or not even structurally defined.
When researching the DeFi protocol, it is important to note the increase in the supply token and the inflation rate. It may be better to avoid tokens that have tended to show high inflation rates in the past.
Completeness of project documentation
Perhaps because of the generally unregulated nature of DeFi, many projects were released with poorly documented details of their protocols. However, this has not stopped many people from investing in these projects.
When evaluating a DeFi project, a key indicator is the level of detail of the protocol provided to the public and potential investors. At a minimum, the project should have a technical document that explains the processes and tokenomics of the protocol in detail. The governance mechanism and voting rights granted to token holders should also be clearly described.
For example, what happens if your funds are lost to protocol because of a security breach? Are you rewarded? Will you have to wait for platform users to vote on possible compensation for you? Pay attention to these important details as you review the project white paper, website, and social media announcements.
While the integrity of project documentation is not a financial or operational indicator, it is a vital metric to consider.
Conclusion
Researching a DeFi project worth investing in can involve an analysis of many factors. However, the indicators described in this article should serve as a basic set on which you can focus.
Among the indicators considered are the P/S ratio, TVL and TVL. However, ignoring the other indicators and focusing only on these three can lead to a loss of important information. For example, even the best P / S and TVL ratios will not indicate possible whale actions that could destabilize the token. You can get an idea of such a scenario just by looking at token delivery and token balance movement on CEX.
In addition to financial and operational metrics, consider the clarity of the DeFi project and the completeness of the documentation. Even the most efficient protocol may not be worth the risk to invest if your rights as a token holder are not clearly defined or if you are unsure of the process for obtaining LP participation.
