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Fundamental valuations seem a bit outdated at the moment when the market is driven by narratives, but it serves as a good intuition check.
Original title: “The Way of DeFi | Comprehensive Evaluation of Different DeFi Protocols with 12 Indicators “
Written by Lucas Campbell, Bankless Analyst Compilation: Free and Easy
The original author is Bankless analyst Lucas Campbell. In this article, the author summarizes 12 indicators for evaluating DeFi protocols, including 7 general indicators and 5 evaluation indicators specific to different fields.
We have said before that DeFi is rapidly accessing the achievements of traditional finance for thousands of years. We are relearning and reorganizing the old methods and applying them to this new paradigm.
We have learned a lot in the past few years. We now have a deeper understanding of how agreements work and how they generate value. More importantly, we now have tools to analyze their new (and old) valuation indicators.
Therefore, we will take some time today to review some of the general indicators and indicators specific to a certain field that currently exist in the industry, as well as several key ratios to be considered when studying new agreements.
Market value and fully diluted valuation (FDV)
We need to understand the difference between the market value of the agreement and its fully diluted valuation (FDV). If all tokens are in circulation, then the total market value of the agreement is very valuable for those who wish to hold an asset position for a long time.
If there is a huge difference between the market value of the agreement and FDV, it means that there are still a large number of tokens that have not yet entered circulation. Therefore, investors should realize that as these new tokens flow into the market, there may be considerable selling pressure.
This is especially important for newly introduced agreements, in which the circulating supply often only accounts for a small part of the total supply. For example, in the scene when Curve was first launched, the initial transaction price of its tokens was between 15-20 US dollars, and the FDV value of the agreement exceeded 50 billion US dollars, which was even higher than the market value of Ethereum at the time!
Recognizing this difference can help you save considerable money. Obviously, the valuation of the Curve token at the time was unreasonable. As a result, the market began to adjust itself, and valuations gradually became more reasonable. What is the key point? Understanding the supply plan of the underlying asset and how to convert it into the current valuation is very helpful for long-term positions (especially newly launched agreements)!
Total value locked value (TVL)
Total value lock (TVL) is one of the most widely known indicators in the DeFi field. It represents the total amount of assets held by each agreement. Some people can consider it as the agreement’s asset management value (AUM). Generally speaking, the more locked values in the protocol, the better.
This means that people are actually willing to lock their capital in the agreement and trust it to a certain extent in exchange for any utility it provides (such as earning income, providing liquidity, or acting as collateral).
However, we must realize that with the introduction of liquid mining, this indicator can be divided into “incentivized” TVL and “non-incentive” TVL. There are some subtle differences between the two. An agreement with a $1 billion non-incentive TVL may reflect the real demand for the service better than a $1 billion liquidity agreement with a high-yield incentive.
Uniswap and Sushiswap are a good example of comparison.
Currently, these two agreements have similar TVL values, of which Uniswap has a locked value of US$3.7 billion and Sushiswap has a locked value of US$3.4 billion. The key difference is that the assets locked in Uniswap are not motivated by tokens, so they are organic. On the other hand, a large part of the assets locked in Sushiswap are motivated by a large number of SUSHI tokens.
This does not mean which protocol is better, but it is worth emphasizing. Therefore, when you study TVL as a valuation indicator, you must realize how much of it is motivated, or not motivated at all.
The total value lock-in value of mainstream DeFi protocols, source The Block
The income of the agreement is equal to the total cost paid to the participants of the agreement supplier. For AMM, this may be the total fee paid to the liquidity provider (LP), while for interest rate agreements, this may be the amount of interest paid by the borrower. In general, the income indicator can actually be attributed to the amount that users are willing to pay for using the agreement. This is why we say that income is such a key indicator. We can literally translate it into services that people are willing to serve the agreement. The amount paid.
Revenue of mainstream DeFi protocols, sourced from Token Terminal
Revenue is the amount that users are willing to pay to the agreement, and these revenues are obtained by the supplier participants who provide basic services, and the agreement revenue refers to the amount of revenue actually obtained by the token. This actually represents the bottom value of the agreement, which is the profit margin.
In other words, just as early-stage startups and growth companies do not pay dividends to shareholders, not every agreement allocates cash flow to tokens.
Uniswap and Sushiswap are good examples that we like to use for comparison. Although Uniswap is a leader in DeFi revenue metrics, Uniswap’s cash flow has not yet accumulated to UNI token holders. In contrast, Sushiswap chose to allocate approximately 16% of the revenue generated by the transaction (0.05% of the 0.30% transaction fee) directly to the xSUSHI pledger.
Distribution of fees between LP (agreement fees) and token holders, source Dune Analytics
Market-to-sales ratio (P/S)
The market-to-sales ratio (P/S) is an indicator that compares the market value of an agreement with its revenue. For enthusiastic Bankless readers, many people may already be familiar with this indicator. It compares the market value to revenue (even if it is used) , This is a reliable measure. In traditional finance, the market-to-sales ratio (P/S) is a basic evaluation index that measures the market’s returns relative to assets and expectations for future growth.
The core of the market-to-sales ratio (P/S), the convertible market is willing to pay X dollars for every dollar of revenue. Interestingly, the market-to-sales ratio (P/S) may mean different things in the context of different agreements. Here are some examples:
- DEX: The market is willing to pay X USD for every USD 1 in transaction fees earned;
- Borrowing: The market is willing to pay X dollars for every dollar of interest paid by the borrower;
- Earnings mining: The market is willing to pay X dollars for every dollar that LP generates;
Therefore, the market-to-sales ratio (P/S) of different types of DeFi agreements cannot be directly compared because they may have some subtle differences. Of course, it is a very valuable indicator when comparing similar agreements!
Market-to-sales ratio (P/S) of mainstream DeFi protocols Source: Token Terminal
Price-to-earnings ratio (P/E)
Since many DeFi protocols are still in their early stages of development, token holders usually have no direct cash flow, which is similar to the traditional world. With this in mind, as the industry matures and more and more agreements distribute dividends to token holders, the price-to-earnings ratio (P/E) indicator will become more and more important.
In other words, some existing agreements, such as Maker, Sushiswap, Kyber, etc., provide direct cash flow for token holders. The following is the price-to-earnings ratio (P/E) data of the application protocol calculated by Token Terminal.
Revenue to value lock-in ratio
The fee-to-value lock-in (F/V) ratio can be used as an interesting indicator of how efficiently an agreement generates expenses from the capital it holds. For reference, we calculate this indicator by dividing the annual cost by the locked value.
Similar to the above ratio, the literal meaning of this indicator is “the agreement can generate X dollars for every dollar locked in.”
The closer the “x” value is to 1, the more effective the agreement is to earn fees from the underlying capital, and it may indicate that the agreement is a better investment choice than similar agreements. For example, the following is the cost to value lock-in (F/V) ratio of the top 5 DeFi protocols obtained by combining the data of Token Terminal and DeFi Pulse.
Uniswap is the leader in this indicator. The agreement can bring in revenue of $0.35 for each dollar locked in. Obviously, this efficiency is very high.
Evaluation indicators for specific areas
The indicators specific to a certain field are the basic metric used to judge whether the protocol is used for its intended purpose.
What is the trading volume of DEX? How much did the loan agreement borrow? Is anyone casting synthetic assets?
These are the key questions you should ask when studying the feasibility and usage of each protocol. Here are what you should know:
Obviously, one of the most basic indicators to measure the success of a liquidity agreement is the volume of transactions that it facilitates. The greater the transaction volume, the greater the cash flow of protocol participants (including liquidity providers and token holders).
DEX monthly trading volume, source: The Block
Volume to price ratio (P/V)
The volume-to-price ratio (P/V) is a valuation indicator specific to the DEX field, and it has similar properties to the P/S ratio.
The rationale behind this ratio is not to evaluate the value of these agreements based on the amount of fees incurred by these liquidity agreements. There may be subtle differences when studying agreements with different interest rates. The P/V ratio will run through everything. Determines how the market evaluates the value of the agreement based on the volume of transactions facilitated by the exchange.
P/V data of mainstream DEX, source Andrew Kang
Daily net borrowing
For other interest rate agreements such as Compound, Aave, and Cream, the total outstanding debt and utilization ratio represent the demand for borrowing from the agreement.
This is a key reason for the interest rate agreement: it activated the flywheel. The higher the borrowing demand, the better the interest rate for storage users, which drives people to have greater incentives to increase more liquidity, thereby increasing the borrowing demand capacity of the agreement.
Simply put, more demand for borrowing means higher interest rates for suppliers, which is crucial for attracting capital to join the agreement.
Net borrowing metrics of Aave, Compound and MakerDAO, source Dune Analytics
Total outstanding debt/derivatives
The outstanding debt or synthetic assets of derivatives agreements such as Synthetix and Maker are one of the key drivers behind revenue and agreement gains.
The more outstanding debt, the more capital available for monetization of the agreement, and the more cash flow that can be distributed to token holders. In short, the outstanding debt is actually a key indicator of the demand for agreed synthetic assets (ie Maker’s Dai, Synthetix’s Synths, etc.).
Dai’s total outstanding debt, source: Coinmetrics
Insurance amount (Active Cover)
Active Cover is the most basic indicator of insurance agreements such as Nexus Mutual and Cover.
Simply put, it shows the market’s demand for an agreement “insurance policy.” The higher the effective insurance amount, the more insurance policies sold, which means the more premiums (that is, income) charged by the agreement. This relationship is very direct with Nexus Mutual, because the pricing of the token NXM is based on a joint curve driven by the total capital in the pool. The more insured, the more premiums earned by the capital pool, and the more likely the joint curve will rise.
The total effective insurance amount of Nexus Mutual, source: Nexus Tracker
to sum up
Now we have many ways to analyze each DeFi protocol. Fortunately, this industry has developed into a diversified protocol ecosystem. You can compare each other and see what the result is when they are added together.
That being said, there are many factors that cannot be presented in numbers, but they are equally important, including the team’s capabilities, the new products being developed, and the most important narrative.
Like traditional finance, fundamental valuation indicators are basically outdated, value investing is outdated, and the entire market is now driven by narrative. The market no longer price assets based on income multiples or price-to-earnings ratios, but based on company Narratives (some people may call meme) to value assets.
This of course also applies to the encryption field. If NFT is very popular now, then the NFT token project will explode. It is that simple and does not require excessive analysis.
However, basic valuation metrics do serve as a good intuition check, especially when you delve into similar agreements. If a project is invested in the market with an FDV value of US$50 billion and exceeds the market value of its base layer, then this may not be a good time for investment, and the market’s expectations may be too high.
Therefore, in the final analysis, it is important to realize that the crypto market is still young, inefficient, and prone to crazy and irrational trends, and these trends are not necessarily in line with the fundamentals.
In any case, the basic valuation indicators outlined above can provide reliable data support for your investment theory.
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