DeFi presents plenty of opportunities for investors, but there are also risks. Here are three metrics that investors use to analyze decentralized finance tokens and their associated protocols.
To the chagrin of crypto advocates, who call for immediate mass adoption of blockchain technology, there are many “digital landmines” that exist in the crypto ecosystem like Rug Pull. and protocol hacks can give new users a bad experience.
There’s more to investing than just technical analysis. Over the past year, many of blockchain analytics platforms have launched dashboards with metrics that help provide insight into the fundamentals supporting — or the lack thereof, of a cryptocurrency project.
Here are 3 key factors to consider when evaluating whether an altcoin or decentralized finance (DeFi) project is a sound investment.
CHECK THE PROJECT’S COMMUNITY AND DEVELOPER’S ACTIVITIES
One of the main ways to read a project is to see statistics that show activity levels from the platform’s user base and developer community.
Many of the top protocols in the space provide analytics that track growth in active users over time. Online dashboards like Dune Analytics provide more detailed information on this metric, such as the following chart showing daily new users on the Olympus protocol.
Olympus Daily New User. Source: Dune Analytics
Other pertinent data points to consider when evaluating community activity include the average number of active wallets on a daily, weekly, and monthly basis. Investors should also consider trading volume and volume on the protocol, and social media metrics like Twitter mentions that can help gauge investor sentiment about a particular project.
In terms of project development and developer activity, GitHub is the right place to learn about upcoming upgrades, integrations, and where the project is in its roadmap.
If a protocol is bragging about “coming soon” features but shows little ongoing development or commits being submitted, that can be a clear sign of improper behavior.
Otherwise, a project with stable development activities and a committed user base can be a positive sign.
FIND A STABLE INCREASES IN TOTAL VALUE LOCKED
The second metric to consider when assessing the overall strength of a project is the sum of all assets deposited on the protocol, also called total value locked (TVL).
For example, data from Defi Llama shows that the total value locked on the DeFi DeFiChain (DFI) protocol has recently increased following a major protocol upgrade, with TVL hitting an all-time high in the days up to now in December. This signals that momentum and interest in the project is growing.
Total value locked on DeFiChain. Source: Defi Llama
DeFi aggregators like Defi Llama and DappRadar allow users to dig deeper into data and look at stats for various blockchain networks like TVL on the Ethereum Network or Binance Smart Chain, as well as individual projects individually like Curve and Trader Joe.
Protocols with higher TVL tend to be more secure and trusted by the community, while projects that rank lower on the list typically carry more risk and tend to have fewer active communities.
IDENTIFY WHO THE MAJORITY TOKEN HOLDERS ARE
Other factors to consider are the benefits token sellers get from holding and being active in the community. Investors should also consider how the token was launched and who the dominant token holders currently are.
For example, SushiSwap allows users to stake native tokens SUSHI on the platform to receive a portion of the exchange fees generated, while Uniswap, the leading decentralized exchange (DEX) in DeFi, currently does not offer this feature.
While other factors such as trading volume and daily users have made Uniswap a legitimate investment for many holders, some traders prefer to hold SUSHI because of its revenue sharing model and its multichain trading capabilities.
On the other hand, it is prudent to offer excessively yields due to low liquidity, anonymous protocols running with little community activity as this can be the perfect setup for catastrophic losses. In DeFi, these are known as Rug Pulls and occur after large amounts of money have been deposited into smart contracts controlled by a single anonymous party.
Examining token distribution for the protocol, and tracking the proportion of tokens allocated to developers and founders relative to tokens held by the community can give some useful signals about whether a platform can fall victim to a Rug Pull.
If most of the available supply is held by creators and backers, there is the possibility that these tokens will later be sold at market rates if or when early investors choose to exit their positions.