It is necessary to evaluate the risks associated with investing in DeFi. Similar to events in the traditional financial market, unexpected events may occur and turn the tide of expected events. These may lead to tremendous interest, up to 10x, or crucial losses that could destabilize traders.

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DeFi projects can be analyzed using the following metrics.

Total Value Locked (TVL)

Total Value Locked (TVL) is the total value of locked aggregate funds in a DeFi project. The TVL of a project can be used to assess the value, stability, and liquidity of the project, and determine its long-term trajectory in the market. A project that “locks” more value than others tends to improve over time and thus attracts more investors.

24-hour volume

This is the total monetary value of trades that occur within a particular DeFi protocol over 24 hours. A valid DeFi project ought to have a high 24-hour volume, as this would indicate it has high trading activities, a vibrant ecosystem, and liquidity. If these are low, traders have no interest in the protocol, and would likely not trade there. Blockchain provides a heatmap of DeFi prices and daily volumes.

Tokenomics, Token Supply, and Token Distribution

Tokens represent digital assets of significant value in a DeFi project. Tokenomics involves the creation and design of tokens, especially native tokens, and the economics that govern them. It also decides what incentives the tokens bear which benefit investors, and the token’s unique contribution to the web3 ecosystem.

Token distribution involves token allocation of varying percentages to the stakeholders of a DeFi project. These stakeholders include the users, developer team, validators, and investors.

Token supply refers to the rate at which a DeFi project disperses tokens based on response to market conditions. A DeFi protocol’s supposed maximum token supply is bound to reel in investors.

The tokenomics, distribution, and supply of tokens are very crucial for making long-term investments. Proper tokenomics ensures that there are constant incentives for users and investors. This in turn affects the decisions made by the stakeholders containing long-term investment.

Market Capitalization

Otherwise known as market cap, this is the total value of tokens a DeFi protocol has in circulation. It can be assessed with this simple equation stated below.

Market capitalization = current price of tokens x number of tokens in circulation

The sum of this calculation provides insight into DeFi’s net value, its strength compared to competitors, and its usefulness.

Security Assessment

A good DeFi project ought to conduct regular internal security audits, given the number of scams reported daily. These audits can also be carried out by third-party providers - security firms that assess their smart contracts and identify vulnerabilities and potential threats.

Bug bounty programs are another means to aid a project’s transparency and promote security awareness. A DeFi project can organize these programs with specific requirements, criteria, and rewards for participants.

Bug hunters that discover vulnerabilities provide detailed reports concerning the bug and its possible impact on their technology, often presented as documents, to the project.

This shows the project is pro-security, community-inclusive, and willing to undertake measures to keep investors' funds safe.

Price-to-sales Ratio

The price-to-sales ratio is used to evaluate stocks in the traditional finance market. In this context, it is used to compare the relative values of DeFi protocols in the blockchain system.

It is obtained by dividing the fully diluted market capitalization of a DeFi protocol by its annual revenue. It shows the value of the project. If the ratio is low, it indicates the protocol may be undervalued, conversely, if the ratio is high it shows the protocol is overvalued.

Unique Wallet Count

The total amount of registered wallet addresses can be used as a metric for gauging the growth of DeFi projects. This cannot relied on as a user can create multiple wallets and use them on a particular protocol for transactions.

Large numbers of signed-in wallet addresses show the use of the project, and vice versa. However, measuring the number of daily active wallets can prove to be a sustainable alternative.

Developer Team Evaluation

A DeFi project ought to have a whitepaper, an official website, a roadmap, relevant documentation, and an active community with an associated social media presence. These metrics will house primary information about the developer team, their objective concerning the project, their work history, and expertise.

The developers must have a transparent track record of successful projects they’ve built or participated in. They also need to have active social media profiles on Twitter, Linked In, GitHub, Reddit, and others. These can show their achievements, endorsements, and awards.

The developer team needs to shed more light on their roadmap, milestones, and development process. These can be found on their blogs, social media platforms, and interactive sessions.

Consider their current and possible collaborations with other DeFi projects, and their willingness to accept criticisms and make changes.

If a DeFi project does not offer these, it is wise to conduct more investigation before considering an investment.

Community Growth

Community growth is a gradual process that is hastened by a protocol’s robustness. This can be assessed by their public community platforms, on Discord, Reddit, and Twitter. Continuous, proactive conversations about the project show an active community.

When a DeFi project is built on a trusted technology and blockchain platform, Ethereum for instance, it insinuates the project has a strong backing. This will prompt new stakeholders to consider investing. Like that, multiple investments will occur and increase the project’s market value and liquidity. Users flock to projects that have large liquidity holdings.

DeFi projects that do not possess these metrics make it hard for stakeholders to make investments, as they do not show promise of providing interest.

Final Thoughts

DeFi plays a pivotal role in the blockchain space, as it provides permissionless alternatives to conduct financial transactions without intermediaries. Investments can be made with large returns. However, it is important to analyze DeFi projects using the essential metrics to make proper decisions.