It’s not uncommon for a project to generate hype, only to collapse weeks later. Therefore, it is especially important for retail DeFi investors to 1) have a framework for analyzing projects, and 2) apply this framework before jumping in.
The decentralized nature of DeFi allows anyone to participate. It’s surprising how little technical know-how or cash is needed to start a project or token. The results can be catastrophic for investors who decide to invest without doing due diligence.
Fortunately, the flip side of decentralization is that data is transparent and readily available. The data doesn’t lie, so this is where an intelligent investor should look first.
When researching a project, you can’t go wrong starting with 3 metrics and 5 charts.
Total Closed Value Chart 1: TVL Growth Chart 2: TVL Distribution Market Capital Chart 3: MC/FDV Ratio Chart 4: MC/TVL Ratio Token Price and Allocation Chart 5: Token Price Movement
1. Total Value Closed (TVL)
Make sure the project has stable TVL growth.
TVL refers to the total value of assets deposited by users and locked in a protocol. More assets locked into a project means users have more confidence in providing liquidity and collateral for the protocol’s economic activities. Both of these indicate the market’s confidence in the project.
As you can see, the top 10 protocols are both large values above $5 billion and stable TVL growth month-over-month. This indicates that a project continues to maintain its vitality and strength.
On the other hand, when looking at weaker, less reliable projects, the picture is different. Large TVL changes per day, with an unsustainable upward trend, usually followed by a significant drop the day after the rise.
Choose projects whose TVLs are “middle of the pack”.
As is clear from the spread chart below, projects are growing like crazy with an extremely uneven TVL spread. There are currently more than 500 DeFi projects, 33% of which have TVLs below $5 million.
This is one of the easiest ways to separate projects into 3 categories:
Already “priced” or overvalued/overvalued Completely new, unproven and risky Projects with potential
How should you balance risk with reward?
To be on the safe side and to avoid too small projects running away with their money, individual investors should try to choose projects in the mid-TVL range and above (around $20 million) when deciding who to invest in. invest.
Those in the range of $1 million to $10 million are eligible for seed rounds by investment institutions. Individual investors should avoid this because their future positioning and strategic direction is not clear.
While TVL projects in the range of $10 to 20 million have found a suitable growth strategy and investors have access to data on this segment, in terms of stability, there is a risk of stunted growth in these projects and a high risk of poor growth or decline. if growth is not sufficient.
TVL projects in the $20 million to $50 million range have to some extent found a clear fit in terms of product mechanics and growth, with the community and technical support gradually becoming more sophisticated, and are a good choice if you are higher want to achieve returns as the top protocols.
If your risk tolerance is low and your need for return is not too high, you can choose projects from the top protocols to invest in based on your preferred DeFi project category (eg DEX for providing liquidity, lending for lending, etc. .)
2. Market Capitalization (MC)
Market capitalization is the most accurate overall reflection of a project’s market value.
This measure is calculated similarly to shares in the traditional stock market, namely by multiplying the price of the token by the number of tokens in circulation and available for trading.
Since the number of tokens is affected by circulation and supply and demand, the price of the token can change rapidly. On the other hand, market capitalization tends to rise or fall within a 20% range, with no sharp rises followed by rapid crashes.
This stable quality makes the market capitalization a good underlying indicator to evaluate projects and identify potential and valuable investments.
Avoid low MC/FDV ratios when looking for long-term holdings.
Fully diluted valuation (FDV) refers to the maximum supply of tokens multiplied by token price. In other words, it is equal to the market capitalization when all tokens are released.
If the MC/FDV ratio of a project’s tokens is low, it means that a large number of tokens have not yet been released. This happens when 1) the protocol is newly live; 2) the total supply of the token is extremely large.
Investors should carefully consider FDV, focusing on the length of time the project has been online and the token supply schedule.
Some examples of projects with low ratios are:
Fruit: MC/FDV ratio is 0.002%StakedZEN: MC/FDV ratio is 0.077%Hanu Yokia: MC/FDV ratio is 0.17%
The MC/FDV ratio allows investors to determine whether a token price is overheated. This is because a low ratio indicates that the supply will eventually be higher than the actual demand once project owners release more tokens. With demand increasing rapidly, the price is likely to drop as the market adjusts.
Check out the chart below to see what top-rated projects looked like from an MC/FDV perspective.
Projects with a MC/FDV ratio higher than 60% are better for long-term holding with price certainty almost guaranteed.
On the other hand, projects with a high MC/FDV ratio are not without disadvantages. They usually have higher entry prices. Although this is not always the case, analyzing the data will allow you to make better investments based on your goals.
Curve (CRV), for example, has an MC/FDV of 11.86%. Lido, another lending project, has a lower MC/FDV at 5.54% AND a higher token price. So, comparing the two, we can see that those looking for long-term DeFi loan projects to invest in should consider Curve over Lido.
Keep an eye on projects with a low MC/TVL ratio.
The current MC/TVL ratios of the top 10 TVL projects are almost invariably less than 1. This means that these projects are undervalued and worth investing in. Here’s why:
From an economic perspective, the higher the TVL of a project, the higher the MC should be because a high TVL indicates that investors have a high degree of confidence in the project’s economic utility.
In other words, when investors include their tokens, it means they are using the project rather than speculating. More utilization relative to speculation is usually a good sign.
Therefore, investors should take a close look at the MC/TVL ratio. A ratio greater than 1 indicates that the valuation may be too high and investability is low, while a ratio less than 1 indicates that the project is undervalued and that the yield is poised to increase.
Remember to always compare projects within the same categories for valid comparisons, and especially compare lesser-known projects’ ratios to those of the top protocols.
2. Stable token price and reasonable token allocation mechanism
Choose projects whose tokens are stable.
Many people are doing DeFi investments backwards. They start by looking at token prices, then research the underlying project to justify their (often FOMO-driven) investment.
Instead, you should have already investigated suitable projects using the criteria and indicators explained above.
After you’ve shortlisted projects you’re interested in, screened for solid fundamentals, you can then look at the token prices.
In crypto, “stable” is a relative term.
At Footprint, we recommend being wary of price jumps and drops within 20%. Normally, the extreme price change indicates an unhealthy market reaction to some news that might just be a pump.
If the token price remains relatively stable, the liquidity of the token is also relatively stable. Therefore, the possibility of damage to the project caused by a large number of individual investors selling tokens is reduced.
As with other metrics, this rule of thumb is best applied when comparing different options on a visualization chart, as above.
The data suggests that InstaDApp and MakerDAO are more resistant to the negative effects of a sale than, for example, Curve.
Summary: 5 steps to assess the investability of a DeFi project
When looking for the next project to invest in, start with the basics. Use data to compare projects within the DeFi projects you feel strongly about in your thesis.
The takeaways:
Stable TVL growth Mid-range TVL ranking or higher, around $20M or higher MC/FDV ratio higher than 5% MC/TVL ratio less than 1 Stable token price with monthly fluctuations below +/- 20%
For the above metrics, readers can directly access them in this featured article: Footprint dashboard, titled “How to Discover Valuable Project”
Furthermore, the tokenomics and the team structure of a protocol are also key reasons to consider when investing. If the percentage of tokens held by the team or foundation is too high, there is a higher chance that the project is a money grab.
This can easily lead to a situation where a core group of people can quickly release tokens in an attempt to “cash out”, leading to a severe dilution of the token price and a greater possibility of the tokens being sold.
DeFi, as a new investment market, has created more investment possibilities than traditional finance, with many valuable projects that are quite slept on.
However, opportunity and risk go hand in hand. It is important to remember that the DeFi market is inherently unpredictable and that even the above indicators are no guarantees of long-term viability.
This post was brought to you by Footprint Analytics.
What is Footprint Analytics?
Footprint Analytics is an all-in-one analytics platform to visualize blockchain data and discover insights. It cleans and integrates chain data so users of any experience level can quickly start exploring tokens, projects, and protocols. With over a thousand dashboard templates plus a drag-and-drop interface, anyone can build their own custom charts in minutes. Uncover blockchain data and invest smarter with Footprint.
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Disclaimer for Uncirculars, with a Touch of Personality:
While we love diving into the exciting world of crypto here at Uncirculars, remember that this post, and all our content, is purely for your information and exploration. Think of it as your crypto compass, pointing you in the right direction to do your own research and make informed decisions.
No legal, tax, investment, or financial advice should be inferred from these pixels. We’re not fortune tellers or stockbrokers, just passionate crypto enthusiasts sharing our knowledge.
And just like that rollercoaster ride in your favorite DeFi protocol, past performance isn’t a guarantee of future thrills. The value of crypto assets can be as unpredictable as a moon landing, so buckle up and do your due diligence before taking the plunge.
Ultimately, any crypto adventure you embark on is yours alone. We’re just happy to be your crypto companion, cheering you on from the sidelines (and maybe sharing some snacks along the way). So research, explore, and remember, with a little knowledge and a lot of curiosity, you can navigate the crypto cosmos like a pro!
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