Decentralized protocols that aspire to replace the traditional financial system and their problems. How to distinguish the most valuable DeFi applications that are expected to prevail.
The collapse of IRON Titanium Token, from nearly $2 billion to zero, caused a sensation in the area of decentralized finance (DeFi).
The incident is not exclusively about Titan and Iron (the company’s partially secured stablecoin). It highlighted the problems that may arise in other decentralized protocols, which have not been able to ‘mature’.
So, how do we distinguish the most valuable applications that will prevail in the future?
It’s not easy.
DeFi is moving at such an accelerated pace that it becomes quite difficult to evaluate new applications in a timely manner. What makes it even more difficult is the lack of a formal approach. There are many different ways to measure and compare DeFi protocols. Today we present to you the main.
Total Value Locked(TVL)
Total Value Locked (TVL), as the name indicates, refers to the total amount of money committed to a DeFi protocol.
For example, in the case of Aave, TVL stands at $10 billion. It’s probably the most important size because it shows how attractive the app is to DeFi stakeholders. TVL also serves to compare similar protocols.
Price-to-sales ratio (P/S)
In the case of a traditional business, the price-to-sale ratio compares the value of a company’s capitalization with its revenues. This ratio serves to understand whether the value of the stock is undervalued or overvalued, especially in relation to other companies in the same industry.
Since many DeFi protocols are already generating revenue, a similar metric helps evaluate their rating. The lower the ratio, the more underrated the protocol is. This measurement alone, of course, is not reliable.
There may be a good reason why some protocols are cheaper than others
Currencies on Exchanges
As with all cryptocurrencies, the higher the percentage of total circulation found in exchanges and the smaller the private wallets, the more cautious we should be about the short-term trajectory of the price of the currency.
Of course here, by itself, this indication does not prove anything.
Many traders use their holdings as cover for leveraged trading. Sending a large quantity of a particular cryptocurrency to the exchanges does not necessarily mean that there is an intention to liquidate them immediately.
It is certainly something that needs to be taken into account.
TIP: You can follow Twitter accounts like Whale Alert that notify of huge transfers from and to exchanges/private wallets.
Unique number of addresses
The steadily increasing amount of addresses held by a particular cryptocurrency is a clear indication that interest from users is increasing.
Most addresses logically mean more users and wider adoption, which is certainly a good thing.
However, attention is needed. A user can have several addresses. So some deft people deliberately create new ones and distribute money to them, thus giving the impression of increasing acceptance.
Remuneration to holders
Several protocols, in order to entice the holders of their coins not to sell them directly, reward them by offering them a significant “staking” earnings.
For example, as long as they keep them and not sell them, they earn 12% a year in new currencies.
That in itself sounds tempting, but it hides some pitfalls.
For example, your cryptocurrency holdings may indeed increase by 12%, but if the exchange rate against the dollar declines, e.g. 15%, then, in fact, you have lost.
Yield farming is a method that can exploit dormant tokens. Who borrows them? One example is the decentralized exchanges.
If you deposit your tokens there, they offer as a reward their own currencies (which are directly exchangeable on the market for dollars) and part of the receipts they earn.
This brings us to the next criterion, which the investor should pay attention to the inflation rate. The new coins that are issued.
The small rate of production or the specified and strictly limited quantity reinforces the rarity, but it is not necessarily good in a new currency. They should circulate enough to facilitate its use and operation.
DeFi protocols aspire to replace the traditional financial system. Accept and receive loans, manage mortgage debts, take over insurance, finance, investment services.
They replace the banking bureaucracy and its people with smart contracts, removing intermediaries, employees, administrations, shareholders, buildings.
Bitcoin for many is considered the first DeFi protocol. It proved that no government or banking institution is needed to transfer money.
The rest of the DeFi who came out later is seeking to prove that no regulator is required to lend or borrow money.
Are they going to make it? Only the future can tell us. However, the bet is too big, as is the reward, for anyone who manages to pick out the winners.