Despite the overall crypto market experiencing a bit of a down trend for the past few months, the total value locked in DeFi continues to grow. As we see the market building more trust in decentralized ecosystems, I can see more institutional investors becoming open to DeFi exposure. 

Currently, the majority of the market is narrative-driven. Investors mainly consider qualitative aspects of protocols like their development teams, roadmaps for new products, and the sentiment of Twitter, Discord, and Telegram communities. Traditional valuation methods are generally not reflective of the way the crypto markets are pricing assets.  However, there are some fundamental metrics that can help indicate when the market is overextended or undervalued.

I did some research and took some notes on basic KPIs for DeFi Protocols to help me get a better grasp of how to evaluate these projects. 

Key Performance Indicators for DeFi Protocols

TVL (Total Value Locked)

Total value that has been locked in a DeFi protocol via smart contracts. This includes funds dedicated as collateral for loans as well as funds locked in a liquidity pool.

TVL Ratio = Market Cap/TVL

*Smaller TVL Ratio could indicate that a project is undervalued

TVL itself is a great measure of a protocol’s popularity, however, considering this alone could lead you to overlook smaller projects with promising potential. Dividing the market cap of a token by the TVL could uncover smaller projects that are undervalued and primed for investment.

Total Revenue

Total fees paid by users of a protocol to supply-side actors. For a DEX (decentralized exchange) such as Uniswap, revenue would be earned in transaction fees. For a lending protocol like Compound, revenue is determined by interest paid by borrowers. Lastly, for a yield generating protocol like Aave, revenue is determined by yield generated from providing liquidity to a liquidity pool.

Price to Sales Ratio = Market Cap/Revenue

*market is willing to pay $X for every $1 generated in revenue

Revenue to Value Locked Ratio = Revenue/TVL

*the protocol is able to generate $X for every $1 locked in it

*the closer “X” is to 1, the more effective the protocol is at generating revenue from the underlying capital

Total Earnings

Amount of revenue that accrues to the protocol’s token holders. Because most DeFi protocols are in early stages not all of them offer direct cash flows to token holders, similar to how early-stage startups often do not pay dividends to stockholders because it may not be the most efficient allocation of capital for a developing company. However, some protocols like Sushiswap, PancakeSwap, MakerDAO, etc. already reward their token holders.

Price to Earnings Ratio = Market Cap/Earnings

*will become more relevant as the DeFi space matures and more protocols start directing cash flows to token holders

Sector Specific KPIs

DEXs

Trading Volume

Volume of transactions that a protocol facilitates per day. Higher volumes mean more cash flows for liquidity providers and token holders.

Price to Volume Ratio = Market Cap/Daily Volume

*indicates how the market is valuing the protocol based on the amount of volume the exchange facilitates. Market values the protocol at $X per $1 in trade volume/day.

Lending Protocols

Total Outstanding Debt

Outstanding Debt and Daily Net Borrow indicate the demand to borrow from the protocol.

Higher demand to borrow à Better rates for depositors -→ More liquidity from depositors -→ increases protocol’s capacity for borrowing demand

Insurance

Active Cover

Show demand for the protocol’s insurance policies. The higher the active cover means that more people are buying insurance policies and therefore, the protocol is collecting more premiums.

In the case of Nexus Mutual, the NXM token is bonded to curve driven by the amount in the protocol’s capital pool.

              *More active covers -→ more premiums accumulated by the capital pool -→ upward pressure on NXM token price