5 charts to uncover your next long-term DeFi investment

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Posted by : Crypstarter Team

Category : Blog, news

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Decentralized finance assets, specifically crypto, are by far the best-performing investment class today. However, if you are not careful, you could lose all of your money.

It’s not uncommon for a project to generate a lot of attention, only to fizzle out a few weeks later. That is why it is critical for retail DeFi investors to 1) have a framework for analyzing projects and 2) apply this framework before investing.

DeFi’s decentralized nature allows anyone to participate. It’s amazing how little technical knowledge or capital is required to bootstrap a project or token. The consequences for investors who choose to invest without conducting due diligence can be disastrous.

Fortunately, the downside of decentralization is that data is transparent and easily accessible. Because data does not lie, this is the first place an astute investor should look.

When investigating a project, you can’t go wrong by starting with 3 metrics and 5 charts.

  1. Total locked value
    Chart 1: TVL Growth
    Chart 2: TVL Distribution
  2. Market cap
    Chart 3: MC/FDV Ratio
    Chart 4: MC/TVL Ratio
  3. Token price & allocation
    Chart 5: Token Price Movement
Monthly Total Number of DeFi Protocols (Data source: Footprint Analytics)
1. Total Value Locked (TVL)

Ascertain that the project’s TVL growth is consistent.
The total value of assets deposited by users and locked into a protocol is referred to as TVL. The presence of more assets locked in a project indicates that users are more confident in providing liquidity and collateral for the protocol’s economic activities. This reflects the market’s confidence in the project.

Top 10 Protocols TVL & Market Cap Comparison (Data source: Footprint Analytics)
Top 10 Protocols TVL & Market Cap Comparison (Data source: Footprint Analytics)

As you can see, the top 10 protocols have both huge values above $5 billion and consistent month-to-month TVL growth. This indicates that a project’s vitality and strength are still intact.

When it comes to weaker, less reputable projects, the picture is quite different. Massive TVL changes per day, with an unsustainable upward trend, usually followed by a significant drop the next day.

Unstable TVL Projects (Data source: Footprint Analytics)
Unstable TVL Projects (Data source: Footprint Analytics)

Pick projects whose TVLs are “middle-of-the-pack.”

The scatter chart below shows that projects are proliferating at an alarming rate, with an extremely uneven TVL distribution. There are currently over 500 DeFi projects, with 33% having TVLs of less than $5 million.

This is one of the simplest ways to divide projects into three categories:

  • Already “priced in” or overleveraged/overvalued
  • Completely new, unproven and risky
  • Projects with potential

How should you strike a balance between risk and reward?
Individual investors should try to select projects in the middle of the TVL range and above (around $20 million) when deciding who to invest in to be on the safe side and avoid the risk of too small projects running away with their money.

Seed rounds of $1 million to $10 million are appropriate for investment institutions. Individual investors should steer clear of these because their future positioning and strategic direction are unclear.

While TVL projects in the $10 to $20 million range have discovered a viable growth strategy and investors have access to data on this segment, there is a potential of stunted growth and a significant chance of poor or declining growth if growth is insufficient.

TVL projects in the $20 million to $50 million range have found a definite fit in terms of product mechanics and growth, with community and technical support becoming increasingly powerful, and are a suitable choice if you want to achieve larger returns than the top protocols.

If you have a low risk tolerance and a low demand for return, you can invest in projects from the top protocols based on your selected DeFi project category (e.g. DEX for providing liquidity, lending for lending, etc.)

2. Market Cap (MC)

The market capitalization of a project is the most accurate overall reflection of its market value.

This metric is calculated in the same way that stocks are calculated in the traditional equity market, by multiplying the token’s price by the number of tokens in circulation and available for trading.

Because the number of tokens is affected by circulation as well as supply and demand, the token’s price can fluctuate quickly. Market capitalization, on the other hand, tends to increase or decrease within a 20% range, with no sharp increases followed by precipitous drops.

Because of this consistency, the market capitalization is a good underlying indicator for evaluating projects and identifying potential and worthwhile investments.

Avoid low MC/FDV ratios when looking for long-term holds.

When looking for long-term investments, keep an eye out for low MC/FDV ratios.
The fully diluted valuation (FDV) is calculated by multiplying the maximum supply of tokens by the token price. In other words, when all tokens have been released, it equals the market cap.

If the MC/FDV ratio of a project’s tokens is low, it suggests that a big number of tokens have not yet been released. This occurs when 1) the protocol is brand new and 2) the token’s total quantity is extremely large.

Top Protocols Token MC/FDV Ratio (Data source: Footprint Analytics)
Top Protocols Token MC/FDV Ratio (Data source: Footprint Analytics)

Investors should consider FDV carefully, focusing on the length of time the project has been online and the token supply schedule.

Low Ratio of  MC/FDV  (Data source: Footprint Analytics)
Low Ratio of  MC/FDV  (Data source: Footprint Analytics)

Some examples of projects with low ratios are:

  • Fruit: MC/FDV Ratio is 0.002%
  • StakedZEN: MC/FDV Ratio is 0.077%
  • Hanu Yokia: MC/FDV Ratio is 0.17%

The MC/FDV ratio allows investors to assess whether a token price is overheated.

This is because a low ratio indicates that once project owners release more tokens, supply will eventually exceed demand. With demand rapidly increasing, the price will almost certainly fall as the market adjusts.

Look at the chart below to see how top-ranked projects looked in terms of MC/FDV.

Projects with an MC/FDV ratio greater than 60% are better for long-term holding because price stability is almost guaranteed.

Price of Top Protocols (Data source: Footprint Analytics)
Price of Top Protocols (Data source: Footprint Analytics)

Projects with a high MC/FDV ratio, on the other hand, are not without drawbacks. They typically have higher entry prices. Though this is not always the case, analyzing data will enable you to make better investments based on your objectives.

Curve (CRV), for example, has an MC/FDV ratio of 11.86%. Another lending project, Lido, has a lower MC/FDV of 5.54 percent as well as a higher token price. When the two are compared, we can see that those looking for long-term DeFi lending projects to invest in should consider Curve over Lido.

Keep an eye out for projects with a low MC/TVL ratio.

Top 10 Protocols MC/TVL Ratio (Data source: Footprint Analytics)
Top 10 Protocols MC/TVL Ratio (Data source: Footprint Analytics)

The current MC/TVL ratios of the top ten TVL projects are almost always less than one. This means that these projects are undervalued and should be pursued. This is why:

From an economic standpoint, the higher the TVL of a project, the higher the MC should be, because a high TVL indicates that investors are confident in the project’s economic utility.

In other words, when investors lock in their tokens, it means they are using the project rather than speculating on it. More utilization in comparison to speculation is usually a positive sign.

As a result, investors should pay close attention to the MC/TVL ratio. A ratio greater than one indicates that the valuation is possibly too high and that the project’s investability is low, whereas a ratio less than one indicates that the project is undervalued and that the returns are likely to rise.

Always compare projects within the same categories for valid comparisons, and especially compare the ratios of lesser-known projects to those of the top protocols.

2. Stable token price and reasonable token allocation mechanism

Choose projects whose tokens are stable.

Many people invest in DeFi reverse. They begin by examining token prices before conducting research on the underlying project to justify their (often FOMO-driven) investment.

Instead, you should have already researched appropriate projects using the metrics and indicators described above.

Top 5 Protocols Token Price Change (Data source: Footprint Analytics)
Top 5 Protocols Token Price Change (Data source: Footprint Analytics)

After you’ve created a shortlist of projects you are interested in, screened for solid fundamentals, you can then look at the token prices.

In crypto, “stable” is a relative term.

At Footprint, we recommend being wary of price jumps and drops within 20%. Normally, the extreme change of price indicates an unhealthy market reaction to some news that might just be a pump.

If the token price remains relatively stable, the liquidity of the token is relatively stable also. Therefore, the possibility of damage to the project caused by a large number of individual investors selling tokens is reduced.

As with other metrics, this rule is best applied when comparing your different options on a visualization chart, as above.

The data indicate that InstaDApp and MakerDAO are more resistant to the negative effects of a sell-off than Curve, for example.

Summary: 5 Steps to Assess The Investability of a DeFi Project

Start with the fundamentals when looking for your next investment opportunity. Comparing projects inside the DeFi projects you care about in your thesis with data is a good idea.

The takeaways:

  • Stable TVL growth
  • Mid-range TVL ranking or above, approximately $20M or higher
  • MC/FDV ratio higher than 5%
  • MC/TVL ratio less than 1
  • Stable token price with monthly fluctuations under +/- 20%

The following stats are available to readers directly in this featured article: Footprint dashboard, entitled “How to Discover Valuable Project”

Furthermore, a protocol’s tokenomics and team structure are important factors to consider while investing. If the team or foundation owns a large majority of the tokens, there’s a good likelihood the project is a money grab.

This can easily lead to a situation in which a small number of people releases tokens quickly in order to “cash-out,” resulting in a significant dilution of the token price and a higher likelihood of the tokens being sold off.

As a new investment market, DeFi has opened up more investment opportunities than traditional finance, including many worthy initiatives that have been overlooked.

However, opportunity and danger are inextricably linked. It’s vital to keep in mind that the DeFi market is fundamentally unpredictably volatile, and that even the above indicators are no guarantee of long-term success.

Source: Cryptoslate

Disclaimer: This article is for informational purposes only. It is not a direct offer or solicitation of an offer to buy or sell, or a recommendation or endorsement of any products, services, or companies. Crypstarter does not provide investment, tax, legal, or accounting advice. Neither the company nor the author is responsible, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with the use of or reliance on any content, goods or services mentioned in this article.

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