A comprehensive review of 12 indicators for DeFi valuation: Total locked value, revenue, and price-to-earnings ratio, etc

This article was published on Babit Information, original title: 《The Path of DeFi | A Comprehensive Assessment of Different DeFi Protocols Using 12 Metrics》，Author: Lucas Campbell, Bankless Analyst, Translated by: Sa Tuo Xi

The original author is Bankless analyst Lucas Campbell. In this article, the author summarizes 12 metrics for evaluating DeFi protocols, including 7 general metrics and 5 metrics specific to different domains.

We have previously mentioned that DeFi is rapidly integrating the achievements of traditional finance over thousands of years. We are relearning and reorganizing old methods and applying them to this new paradigm.

In recent years, we have learned a lot, and we now have a deeper understanding of how protocols operate and how they generate value. More importantly, we now have tools to analyze them using new (and old) valuation metrics.

Therefore, today we will take some time to review some of the general metrics and domain-specific metrics currently existing in the industry, as well as several key ratios to consider when researching new protocols.

General Metrics

Market Capitalization and Fully Diluted Valuation (FDV)

We need to understand the difference between a protocol's market capitalization and its fully diluted valuation (FDV). The total market capitalization of a protocol is very valuable for those who wish to hold asset positions long-term if all tokens are in circulation.

If there is a significant difference between the protocol's market capitalization and FDV, it means that a large number of tokens have yet to enter circulation. Therefore, investors should recognize that as these new tokens flow into the market, there may be considerable selling pressure.

This is especially important for newly launched protocols, where the circulating supply often represents only a small portion of the total supply. For example, when Curve was first launched, its token's initial trading price was between $15 and $20, and the protocol's FDV was over $50 billion, which was higher than Ethereum's market capitalization at that time!

Recognizing this difference can help you save a considerable amount of money. Clearly, the valuation of Curve tokens at that time was unreasonable. And what was the result? The market began to self-adjust, and valuations gradually became more reasonable. What’s the key point? Understanding the supply schedule of the underlying asset and how to translate it into current valuations is very helpful for long-term positions, especially for newly launched protocols!

Total Value Locked (TVL)

Total Value Locked (TVL) is one of the most well-known metrics in the DeFi space. It represents the total amount of assets held by each protocol, and some may view it as the protocol's Assets Under Management (AUM). Generally speaking, the more value locked in a protocol, the better.

This means that people are actually willing to lock their capital in the protocol, trusting it to some extent in exchange for any utility it provides (such as earning yields, providing liquidity, or acting as collateral).

However, we must recognize that with the introduction of liquidity mining, this metric can be divided into "incentivized" TVL and "non-incentivized" TVL, with some subtle differences between the two. A protocol with $1 billion in non-incentivized TVL may better reflect the true demand for that service than a protocol with $1 billion in liquidity with high yield incentives.

Uniswap and Sushiswap are great examples for comparison.

Currently, both protocols have similar TVL values, with Uniswap's locked value at $3.7 billion and Sushiswap's locked value at $3.4 billion. The key difference is that the assets locked in Uniswap are not incentivized by tokens, making it organic, while a significant portion of the assets locked in Sushiswap is incentivized by a large number of SUSHI tokens.

This does not mean that one protocol is better than the other, but it is worth emphasizing. Therefore, when you study TVL as a valuation metric, be sure to recognize how much of it is incentivized or completely non-incentivized.

Total Value Locked of Mainstream DeFi Protocols, Source: The Block

Revenue

The revenue of a protocol equals the total fees paid to the protocol's supply-side participants. For AMMs, this may be the total fees paid to liquidity providers (LPs), while for interest rate protocols, this may be the amount of interest paid by borrowers. Overall, the revenue metric can be summarized as the amount users are willing to pay for using the protocol, which is why we say revenue is such a critical metric. Literally, we can translate it as the amount people are willing to pay for the services of the protocol.

Revenue Situation of Mainstream DeFi Protocols, Source: Token Terminal

Protocol Profit

Revenue is the amount users are willing to pay to the protocol, and this revenue is earned by supply-side participants providing the underlying services. Protocol profit refers to the actual income amount received by the tokens. This essentially represents the bottom value of the protocol, i.e., the profit margin.

That is to say, just like early-stage startups and growth companies do not distribute dividends to shareholders, not every protocol will distribute cash flow to tokens.

Uniswap and Sushiswap are good examples for comparison. Although Uniswap leads in DeFi revenue metrics, its cash flow has not yet accumulated to UNI token holders. In contrast, Sushiswap chooses to directly allocate about 16% of the revenue generated from trading (0.05% of the 0.30% trading fee) to xSUSHI stakers.

Fee Distribution Between LPs (Protocol Fees) and Token Holders, Source: Dune Analytics

Price-to-Sales Ratio (P/S)

The Price-to-Sales Ratio (P/S) is a metric that compares a protocol's market capitalization to its revenue. For avid Bankless readers, many may already be familiar with this metric, which compares market capitalization to revenue (i.e., usage). It is a reliable measure. In traditional finance, the P/S ratio is a fundamental assessment metric that measures the market's valuation relative to the income generated by assets and expectations for future growth.

The essence of the P/S ratio can be translated into how much the market is willing to pay X dollars for every $1 of revenue. Interestingly, the P/S ratio may mean different things in the context of different protocols. Here are some examples:

• DEX: The market is willing to pay X dollars for every $1 earned in trading fees;

• Lending: The market is willing to pay X dollars for every $1 of interest paid by borrowers;

• Yield Farming: The market is willing to pay X dollars for every $1 of yield generated by LPs;

Therefore, the P/S ratios of different categories of DeFi protocols cannot be directly compared, as there may be some subtle differences. Of course, it is a valuable metric when comparing similar protocols!

P/S Ratios 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 typically do not have direct cash flow, similar to the traditional world. With this in mind, as the industry matures and more protocols distribute dividends to token holders, the P/E ratio will become increasingly important.

That said, some existing protocols, such as Maker, Sushiswap, and Kyber, provide direct cash flow to token holders. Below is the P/E data for application protocols compiled by Token Terminal.

Revenue-to-Value Locked Ratio

The Fees-to-Value Locked (F/V) ratio can serve as an interesting metric to understand the efficiency with which a protocol generates fees from its locked capital. As a reference, we calculate this metric by dividing annual fees by the locked value.

Similar to the ratios mentioned above, this metric literally means "the protocol can generate X dollars for every $1 locked."

The closer the "x" value is to 1, the more effective the protocol is at earning fees from the underlying capital, and it may indicate that the protocol is a better investment choice than similar protocols. For example, here are the top 5 DeFi protocols' F/V ratios derived from combining data from Token Terminal and DeFi Pulse.

Uniswap leads this metric, as the protocol can generate $0.35 in revenue for every dollar locked, which is clearly very efficient.

Domain-Specific Evaluation Metrics

Domain-specific metrics are fundamental measures used to determine whether a protocol is being used for its intended purpose.

What is the trading volume of the DEX? How much has the lending protocol lent out? Is anyone minting synthetic assets?

These are key questions you should ask when researching the feasibility and use of each protocol. Here’s what you should know:

DEX

Trading Volume

Clearly, one of the most basic metrics for measuring the success of a liquidity protocol is its trading volume. The higher the trading volume, the more cash flow there is for protocol participants (including liquidity providers and token holders).

Monthly Trading Volume of DEXs, Source: The Block

Volume-to-Price Ratio (P/V)

The Volume-to-Price Ratio (P/V) is a valuation metric specific to the DEX domain, similar in nature to the P/S ratio.

The rationale behind this ratio is to assess the value of these liquidity protocols based on the amount of fees generated by them. This may have subtle differences when studying protocols with different interest rates. The P/V ratio runs through everything and determines how the market assesses the value of protocols based on the trading volume facilitated by exchanges.

P/V Data of Mainstream DEXs, Source: Andrew Kang

Lending

Daily Net Borrowing

For other interest rate protocols like Compound, Aave, and Cream, total outstanding debt and utilization ratios indicate the demand for borrowing from the protocol.

This is a key reason for interest rate protocols: it starts the flywheel. The higher the borrowing demand, the better the storage user rates, which drives people to have a greater incentive to add more liquidity, thereby enhancing the protocol's borrowing capacity.

In simple terms, more borrowing demand means higher rates for suppliers, which is crucial for attracting capital to join the protocol.

Net Borrowing Metrics of Aave, Compound, and MakerDAO, Source: Dune Analytics

Derivatives

Outstanding Debt / Total Derivatives

Outstanding debt or synthetic assets of derivatives protocols like Synthetix and Maker are one of the key drivers behind revenue and protocol profit.

The more outstanding debt there is, the more capital is available for monetization by the protocol, and the more cash flow can be distributed to token holders. In short, outstanding debt is actually a key indicator of the demand for synthetic assets of the protocol (i.e., Maker's Dai, Synthetix's Synths, etc.).

Total Outstanding Debt of Dai, Source: Coinmetrics

Active Cover

Active Cover is the most basic metric for insurance protocols like Nexus Mutual and Cover.

Simply put, it shows the market's demand for the protocol's "insurance policies." The higher the effective insurance amount, the more policies sold, which means the more premiums (i.e., revenue) the protocol collects. This relationship is very direct with Nexus Mutual, as the pricing of the NXM token is based on the total capital in the pool driven by the joint curve. The more insurance there is, the more premiums the capital pool earns, and the more likely the joint curve is to rise.

Total Effective Insurance Amount of Nexus Mutual, Source: Nexus Tracker

Conclusion

Now we have many ways to dissect each DeFi protocol. Fortunately, this industry has developed into a diverse ecosystem of protocols, allowing you to compare them and see how their results stack up.

That said, there are many factors that cannot be presented in numbers, but they are equally important, including the capabilities of the team, new products being developed, and most importantly, the narrative.

Like traditional finance, fundamental valuation metrics have essentially become outdated; value investing is out of fashion, and the entire market is now narrative-driven. The market no longer prices assets based on revenue multiples or P/E ratios, but rather based on the narrative of the company (which some may call a meme).

This certainly applies to the crypto space as well. If NFTs are hot right now, NFT token projects will explode; it’s that simple, without excessive analysis.

However, fundamental valuation metrics do serve as a good intuitive check, especially when you delve into similar protocols. If a project enters the market with a $50 billion FDV and exceeds the market capitalization of its underlying layer, then it may not be a good time to invest, as market expectations may be too high.

Therefore, ultimately, it is important to recognize that the crypto market is still young, inefficient, and prone to wild, irrational movements that may not align with fundamentals.

Nonetheless, fundamental valuation metrics, as outlined above, can provide reliable data support for your investment thesis.