How to Evaluate a Defi Project
How do successful investors know which DeFi project to invest in? While no investors can predict the future, they can identify signs of a promising protocol. In this guide to evaluating a DeFi project, we cover everything from the fundamentals to key crypto metrics. By the end, you’ll be ready to do a deep dive into DeFi.
Firstly, what exactly is DeFi?
DeFi is short for “Decentralised Finance.” It’s a term that refers to financial-like products built on blockchains like Ethereum, Avalanche, and Cosmos. Being decentralised means that anyone can use or build on the projects, making it easier to serve the underbanked populations across the world.
What is a DeFi protocol used for?
DeFi is rebuilding many old tools from traditional finance inside the digital economy, as well as creating entirely new financial primitives.
Popular DeFi protocols include:
- Decentralised loans protocols like Aave
- Stablecoins like USD Coin
- Synthetic assets from Synthetix
- Decentralised exchanges like Uniswap
Start with the fundamentals of a good DeFi project
Before investors dive into the metrics, they typically get an overview of the project. Only if the fundamentals look solid will they do a deep dive into the project’s metrics.
The fundamental features of a good DeFi project can include:
- Whitepaper - Why will it attract users?
- Community - Does it have a thriving community?
- Team - Is the team qualified?
- Network effects -Is it set to grow?
For more information on researching the fundamentals, make sure you check out our article on how to do your own research.
9 Popular Crypto Metrics to Help You Evaluate a DeFi Protocol
1. Total Value Locked (TVL)
Total Value Locked (TVL) is the overall value of digital assets within a DeFi protocol. It’s one of the most popular indicators in the crypto ecosystem and is a common way for investors to compare competing projects.
In September 2020, the TVL of the entire DeFi space was ~AU$868 million. Impressively, more than half of that TVL was in a single protocol—Maker. This indicated that Maker had found product-market fit in the crypto space and was a promising project. Indeed, by the end of 2021, the TVL in Maker grew to ~AU$332 billion and the price increased from ~AU$700 to ~AU$3,500.
- Liquidity pools
To find the TVL of a DeFi project, visit a site like DeFi Llama. They track the main DeFi projects and make it easy for you to compare protocols.
2. Unique address count
The number of unique addresses is a reasonable proxy for seeing how many people are using a particular DeFi protocol. Checking the trend in unique address counts is a common tactic for investors. An increase in the number of unique addresses can indicate that more users are using the network and either buying or spending the token. Similarly, a decline in the unique address count can indicate the project is losing traction.
It’s important to consider that a single person can create multiple addresses on a DeFi protocol, giving the impression that it’s more widely used than it actually is.
3. Market cap
Arguably the most important metric for any crypto project, the market capitalisation is the total market value of the network, determined by multiplying the token price by the number of tokens outstanding. It’s a popular metric across both crypto and traditional finance.
The market cap can also be a milestone moment for cryptocurrencies, such as when bitcoin’s market cap passed the trillion-dollar mark.
4. Volume 24hr
The volume shows us how many people are actively buying and selling a specific cryptocurrency. A consistent volume that grows over time can be the sign of a promising DeFi project, however, a day of unusually high volume may occur after positive (or negative) news is released for a protocol.
5. Network Value to Transaction (NVT)
Using the market cap and volume, many crypto investors check the Network Value to Transaction (TVT) metric. Designed to mimic the price to earnings ratio used in traditional finance, it can be used to compare the fees generated on a protocol to the current value of that protocol.
6. Inflation rate
The inflation rate is how quickly the number of tokens in existence is expanding. For example, protocols can continually print new tokens to reward stakers. While inflation isn’t necessarily a negative signal, and can be a healthy part of a crypto ecosystem, it’s important to ensure that the inflation isn’t at an unsustainable level.
7. Circulating supply
Circulating supply is the number of tokens currently that are active in the crypto ecosystem. While there may be more tokens printed in the future, the circulating supply doesn’t account for these. That means it can be a useful measurement to compare to the current revenue of a project.
8. Max supply
The max supply of a token is important when making long-term investment decisions. If a protocol's max supply is set to dramatically increase over time, you want to be sure that the tokens you purchase would retain their value.
It seems almost too obvious to mention, but the top investors always pay attention to the price—even when all of the other metrics look fantastic. The price is the most important metric, as you don’t want to overpay for a token.
Making smarter decisions with the right trading tools
Now you know how to identify a promising DeFi project when you find one, you may benefit from these crypto research tools. They can help you identify emerging projects and find hidden gems. Then when you’re ready to trade, you can identify a good time to buy with our advanced trading charts and set auto-trades and price alerts. At Cointree, we’re not only here to give you access to the top cryptocurrencies, we’re here to help you trade smarter.
Disclaimer:\ Information provided is for educational purposes and does not constitute financial advice or investment strategy. You should obtain independent advice from an Australian financial services licensee before making any financial decisions.