In the fast-paced world of DeFi, it can be overwhelming to keep up with the influx of new projects. To aid in decision-making, investors and traders can turn to fundamental analysis. This approach helps determine if a protocol is overvalued or undervalued. By assessing these values, stakeholders can make more informed decisions regarding their investments.
Basics
The rapid pace of Decentralized Finance (DeFi) can make it challenging to keep up with new projects and assess them on time. This task is further complicated by the absence of a standardized evaluation method, as there are numerous ways to compare and measure DeFi protocols.
Fortunately, some widely used indicators can serve as valuable sources of information in DeFi. These indicators are easily accessible to any investor or trader since a significant amount of on-chain data is publicly available.
Total Value Locked (TVL)
The Total Value Locked in a DeFi protocol is the collective amount of funds that have been locked into it. It can be likened to the liquidity in a money market's liquidity pools. In Uniswap's case, TVL represents the sum of funds deposited by liquidity providers to the protocol.
TVL serves as a valuable metric to determine the overall interest in DeFi and compare the market share of various DeFi protocols. Investors searching for undervalued DeFi projects can particularly benefit from this metric. Notably, TVL can be measured using different denominations. In Ethereum projects, it is commonly measured in ETH or USD.
Price-to-Sales Ratio (P/S Ratio)
When evaluating a traditional business, investors may use the Price-to-Sales Ratio (P/S Ratio) to compare its stock price to revenues and assess whether it's overvalued or undervalued. A similar approach can also be used for DeFi protocols, given that many of them generate revenue.
To calculate this metric, you need to divide the protocol's market capitalization by its revenue. The lower the resulting ratio, the more undervalued the protocol may be. However, it's important to note that this method isn't a definitive way to determine valuation. It can, however, offer investors a general idea of how the market is valuing a project.
Token Supply on Exchanges
A strategy for evaluating DeFi projects involves monitoring the token supply on cryptocurrency exchanges. While decentralized exchanges (DEXs) offer non-custodial options for users, centralized exchanges (CEXs) tend to have stronger liquidity. Therefore, it's essential to track the token supply on CEXs to gauge sell pressure. If there are a large number of tokens on exchanges, holders and whales may be looking to sell them. However, this isn't always straightforward as traders may use their holdings as collateral for margin or futures trading. Nonetheless, keeping an eye on token supply can provide a general idea of potential sell-offs.
Token Balance Changes
To gain a better understanding of the market, it's important to monitor changes in token supply on exchanges. Tracking recent changes can provide insight into the volatility of the market. Large movements in token balances on exchanges may indicate increased volatility. However, it's not just the size of the important balances. It's also useful to observe if there are any significant changes in those balances. For example, if large amounts of tokens are being withdrawn from CEXs, this could signal that whales are accumulating the token. If the intent was to sell soon, they would not withdraw to their own wallets. This highlights the importance of tracking token movements to gain insights into market dynamics.
Unique Address Count
A higher number of addresses holding a specific coin or token is often seen as an indication of increased adoption and usage. However, this metric can be manipulated. Someone can create multiple addresses and distribute funds across them, which can create a false impression of wider use. Therefore, it's important to consider other factors in addition to the number of unique addresses to gain a more accurate understanding of adoption and usage.
Non-Speculative Usage
If you're considering investing in a token that's based on emojis, it's important to understand what the token actually does. If its sole purpose is to increase in value, it's not a sustainable investment. To determine the token's true value, it's essential to look at how it's used. You can begin by examining the number of transactions that aren't carried out for speculative purposes. To do this, check for transfers that don't take place on centralized or decentralized exchanges. This helps ensure that the token is being used.
Inflation Rate
Keeping track of the inflation rate is another important metric when assessing cryptocurrencies. A small token supply at present doesn't necessarily mean a small supply in the future, particularly if new tokens are constantly being created. A unique feature of Bitcoin is its continuously decreasing inflation rate, which is intended to prevent the dilution of existing tokens over time. However, it's important to note that not every system should aim for Bitcoin's level of scarcity. While inflation is not necessarily negative, excessive inflation could result in a smaller slice of the pie for investors. As there is no standard "good" or "bad" percentage, it's essential to consider the inflation rate in conjunction with other metrics.
Conclusion
For those experienced in cryptocurrency trading, the metrics discussed for analyzing tokens are likely familiar. However, for those who are new to fundamental analysis, it's recommended to read up on the topic to improve their understanding. It's important to note that the cryptocurrency markets are highly unpredictable, irrational, and volatile. Therefore, conducting thorough research is essential for success.