Why we think the total value lock (TVL) may mislead the financial performance of the agreement, and what indicators we think investors should pay attention to
What does Total Value Lock (TVL) measure?
It measures the value of idle funds in the protocol smart contract.
Let us use Uniswap, Compound and MakerDAO as examples to illustrate some of the shortcomings of TVL as a financial performance indicator.
Uniswap
For Uniswap, TVL is equal to the value of assets deposited by the liquidity provider (LP) in the trading pool.
This is because when a trader trades on Uniswap, it is equivalent to depositing another asset back into the pool.
I.e. TVL = Deposit
By adding Uniswap v2+v3 liquidity (deposits), we arrived at the above $7-8 billion figure.
In our opinion, a better way to measure Uniswap’s performance is to focus on:
a) Transaction volume
b) Transaction costs incurred
Compound
For Compound, TVL is equal to the difference between the deposited and borrowed assets.
This is because when users borrow other users’ assets on Compound, part of these deposits will be withdrawn from the market.
TVL = Deposited Assets-Borrowed Assets
By calculating the difference between the assets offered and borrowed, we came up with the above figure of $11 billion.
In our opinion, a better way to measure Compound’s performance is to focus on:
a) Borrowing amount (outstanding debt)
b) Interest paid
MakerDAO
For MakerDAO, TVL is equal to the value of the borrower’s assets deposited in the vault.
This is because these deposits will not be withdrawn from the vault, because the agreement creates DAI borrowed by users.
TVL = Deposit
By looking at the value of the deposited assets, we came up with the above figure of $15 billion.
In our opinion, a better way to measure the performance of MakerDAO is to focus on:
a) Borrowing amount (outstanding debt)
b) Interest paid
To sum up, although TVL is useful as a technical indicator to measure how much value is deposited into the smart contract of the agreement, it does not necessarily tell investors how the agreement’s financial performance is.
