Marketcap

We're all probably pretty familiar with market capitalization, it's the second indicator that draws our attention after the price column on popular sites that we use in the space such as coinmarketcap or coingecko.

Most of us are also familliar with with it's simple formula that goes something like this:

MarketCap = Price per Coin× Total Circulating Supply

If you want to be more fancy you can try the fully dilluted marketcap formula that basically replaces the total circulating supply with the maximum supply that will be available.

Although it looks like a reliable indicator, marketcap alone can misleading because:

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1. It doesn't say much about liquidity. Thus sometimes cryptocurrencies with small trading volume can still have a bigger marketcap.
2. Volatility is also not taken into account. Prices in this space are extremely volatile, and this reflect s in the marketcap, inflating it very fast, only for it to burst shortly after.
3. Tokenomics are also disregarded by the marketcap. Today we have a lot of projects in the top 100 that don't have half of the tokens distributed yet, and people often don't take that into account when deciding where to invest their money.

Total value locked

TVL it's a more recent term that we've seen often lately. It became popular along with the DeFi sector and it basically measures the amount of assets that are being staked ( this includes both the normal tokens and the LP tokens ) or lent ( aka "locked" ). One could argue that it tells more about the trust in the project that the marketcap alone. A big disclaimer it's that the TVL cannot be calculated for Bitcoin or other cryptocurrencies that do not have a DeFi platform, unless of course you want to count the wrapped Bitcoin on the ETH or other networks that are being staked.

Today according to DefiLlama the TVL across all significant protocols is around $48.4 billion.

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source: DefiLlama.com

Although its better than marketcap when it comes to measuring the trust and liquidty with a bit more fidelity, TVL alone has problems of it's own such as:

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1. It still doesn't say much about volatility. Even "locked" tokens are often times harder to sell because they require a period of unlocking or unstaking they still don't make an asset significantly less volatile.
2. The way value locked is calculated. As I previously stated, platforms sometimes count the LP tokens twice. Once when you provide liquidity and another time when you stake the LP ( while yield farming for instance ).

MarketCap/TVL ratio

This ratio provides a more nuanced understanding of a project. Here's why

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1. It standardizes the analysis, thus making it easier to compare projects of different scales and stages of development. It balances the scales if you will, and allows for a more "apples to apples analysis"
2. The ratio can indicate how efficiently a project is creating value relative to the amount of capital it has attracted. A lower MarketCap/TVL ratio might indicate that a protocol is generating more value or usage per unit of market capitalization.
3. Changes in the MarketCap/TVL ratio over time can serve as early indicators of a project's changing fundamentals, either improving or deteriorating, before these changes are reflected in the market cap or TVL alone.

But that is not to say that everything is perfect with this ratio, as it can still be misleading in a few scenarios.

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1. Especially if either the marketcap or TVL is temporarily inflated or deflated due to external factors, market makers, or transient FOMO or FUD.
2. The accuracy of the MarketCap/TVL ratio heavily depends on the accuracy of the underlying data. Inaccurate or outdated data for either market cap or TVL can lead to incorrect calculated ratios.
3. The MarketCap/TVL ratio does not account for a project's ability to generate revenue. Projects may have similar MarketCap/TVL ratios but vastly different revenue generation capabilities, which could significantly affect their long-term viability and investor returns.

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Looking into the MarketCap/TVL ratio, I came to the conclusion that it can be a cool tool when diving into the DeFi world. It helps compare different projects, hinting at how efficiently they're running and how investors feel about them.

But like everything in this space it has to be taken with a grain of salt. The ratio can get thrown off by short-term market changes, it can overlook how much money a project is actually making, and might miss other key stuff like how solid the tech is. Plus, it can be misleading if the market is going wild or if the data isn’t spot on.

So, while the MarketCap/TVL ratio can offer some useful hints, it’s not a golden standard for sizing up a DeFi project. Like with any other tool, it’s better when used as part of a bigger toolkit rather than a one tool too rule them all type stuff.

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