Decentralized Finance moves at a blazingly fast speed, and because of that change, it can be hard to understand how to evaluate projects. I’d like to take a moment to go over some things that everyone in DeFi should know, that will help you learn how to better understand the health or status of a particular project.
Tokenomics
Tokenomics is short for token and economics, and in the cryptocurrency world, a token is a representation of something, such as value, voting rights etc., and economics we already know. The quality of the tokens economics will convince others to invest as well, so it is vital that you understand tokenomics, and apply it to your investing strategy. Because tokenomics refers to the quality of the economics of a particular token, it is extremely important when deciding whether you should invest in a project or not.
Some of the most important factors to understand are token supplies (inflationary? deflationary?), token emissions (are they going to mint a lot of tokens to reward users?), business models (is it sustainable? are they going to burn or buyback tokens? do they require any tokens to be held?), token distribution models (how did they or will they distribute their tokens?), real world utility (is this token even needed in their business model?) and many other factors.
“TVL” Total Value Locked
Total value locked describes the total aggregate of all funds that are locked into a protocol. Things like liquidity pools, and staking pools are considered “TVL”. TVL is a good indicator to help determine the health of a protocol, based on historical figures, and trajectory, you can better understand the direction a project is headed. TVL is also important to help determine a projects marketshare, and can even be used in some cases to determine if a tokens price is under or over valued.
Exchange token supplies and their changes
Traditionally when sellers wanted to sell large amount of tokens, they needed to use a centralized exchange for that, so they would send large amounts over to their preferred exchange. There are metrics that keep track of this flow of money, and can be a good indicator of when investors may be getting ready to sell. Because the tokens aren’t in the investors personal wallets, it can be assumed they are on the exchanges to prepare for liquidation. This isn’t a perfect indicator by any means though, because some investors will move large amount of assets to centralized exchanges to use as collateral or margin trading.
Wallet Address count
Each project on Binance Smart Chain has a corresponding BSCScan.com page for their contracts/tokens, that will show you how many wallets are currently holding their tokens. Using this number, can help you determine the speed of growth, or even the speed of contraction, of a given project. This indicator is also not perfect, because when users stake their assets, they get deposited into a wallet with everyone else’s staked tokens, so the wallet address count will end up getting skewed lower.
Valid Use Case
We’ve all seen the meme coins explode in value, and then proceed to crash towards the depths of hell. If a project doesn’t have a valid use case for its token, investors tend to dump them and move on to others. Most tokens add use cases to their tokens by allowing investors to stake them, use the tokens to accomplish a task, or simply hold the tokens to obtain membership etc.
Understanding the use case for the token is critical to figuring out its true value. The idea is to try and figure out how often people are actually using the token.
Inflation
Token supplies aren’t all created equal, some are fixed, some grow, and some even decline in size. Its important to understand how the supply will change over the life of your investment, as it directly effects the supply and demand of the asset. An example would be Bitcoin, Bitcoin started off with just the 1 genesis block that was mined, and inflated in size ever since. That however hasn’t been a problem for Bitcoin, as it has been able to utilize the network effect to increase its price regardless of a growing supply.
Some other tokens that inflate their supplies won’t be so lucky however, as it’s not guaranteed that the growth of unique wallet addresses, and investors, to the project will overcome the rising supply. Some new novel tokenomics concepts have recently grown in popularity, using deflationary tactics, through burn mechanisms, have been able to actually reduce the supply during normal operations of the protocol, therefore improving the supply and demand of an asset.
Price to Sales ratio
In the traditional finance world, it’s common to use the P/E ratio to determine the health of a particular company, that compares the companies Price-to-Earnings ratio of the companies stock to its revenue/earnings. Most DeFi protocols are generating revenue (and some even sharing it like Jetfuel Finance or Beefy Finance), so it is usually possible to use this equation to get a similar metric to determine the health of a crypto protocol as well. This can be done by dividing the projects market capitalization with the revenue that a protocol is generating. The lower the ratio is, the more undervalue a project may be.
In Closing
Keep in mind that none of these tools are perfect, and can not provide a definitive way to calculate a valuation for a project, however all of them in totality, when used correctly, can really help investors try and swing the odds into their favor.