DeFi is the abbreviation commonly used for “decentralized finance” systems. It is an upcoming technology that works on distributed ledgers just like in cryptocurrencies. Decentralized financing challenges the traditional financial system
by giving individuals more control over their transactions.
Using decentralized financing can easily avoid service fees that financial entities like banks charge. DeFi is accessible to anyone who has an internet connection. Funds are instantly transferred and can be stored in digital wallets personalized for users.
Three main components comprise DeFi systems; hardware, software, and stablecoins. The involvement of a centralized financing institution or a third party is eliminated by decentralized finance. There is no set-out book of rules and regulations that control DeFi. It is a system in continuous development.
With the ease of making cheaper and quicker transactions comes a cost to pay, and the customers have to be responsible for the transactions. The risks and benefits must be weighed out before getting into a DeFi project.
A best practice for DeFi investments is to look for market indicators that can give an idea about the performance of the DeFi project. There are numerous key performance indicators (KPI) that can give a good recommendation regarding possible investment opportunities in DeFi projects.
## 1. Total Value Locked (TVL)
In a decentralized financing project, the total number of DeFi tokens or the money stored as security is referred to as the “total value locked.” The TVL aids in the assessment of market shares of different decentralized finance protocols.
The TVL is considered to be the beginning point to assess the worth of a DeFi project. TVL indicates whether the asset is overvalued or undervalued. TVL represents the liquidity of a marketplace that can familiarize you with the interest rates on a wide scope in decentralized finance. A DeFi Investor can pinpoint undervalued decentralized finance projects through Total Value Locked.
Usually, the total value locked is calculated in US dollars or Ethereum, which itself is a stablecoin. The main advantages of the TVL can be summed up as follows:
- TVL represents the liquid money accessible for transactions in all decentralized finance protocols.
- TVL controls the gains from decentralized finance applications.
- TVL gives an idea to investors about worthy protocols.
- If the total value locked for a project is high, this means that it is a valuable project
The total value locked holds a high position in the key indicators for a DeFi protocol. Investors are urged not to miss out on considering the TVL before finalizing a project for investing.
## 2. Annual Staking Yield
Staking in DeFi refers to the passive income that a DeFi investor can earn by holding a legitimate cryptocurrency in a certain amount. The staked currency has to be stored on a decentralized finance platform. Liquidity pool staking can present profitable opportunities to investors on DeFi platforms.
Nodes are used to validate the staked block after the investors enter their DeFi tokens in a staking pool. Node allocation is done randomly by the system. However, the blocks with larger amounts of tokens to be staked will have a greater chance of being selected.
An annual yield refers to yearly profits rather than short-term returns. Annual yield is much more reliable than the one obtained from a shorter time period. Viewing the annual performances makes it very simple and easy for a DeFi investor to note undervalued assets.
Returns from a DeFi project can differ from project to project. One project might have a favorable return in a month, whereas another protocol might give favorable output after a longer time period. Hence the annual yield will provide a more reliable and clearer picture of the performance of an asset.
## 3. Price-to-sales ratio (P/S ratio)
This ratio compares the market capitalization of an asset with its revenue. As DeFi projects also generate revenue, the P/S ratio can be used to evaluate them . The value of a stock is determined using the ratio of its price to its sales. In decentralized financing protocols, the P/S ratio is calculated by dividing the protocol’s capitalization by its total generated revenue.
It is believed that an undervalued protocol will have a low p/s ratio, which means that it is a good investment opportunity. Similarly, a protocol with a higher price-to-sales ratio will indicate that it is overvalued. This ratio can be better used for the evaluation of protocols that are in their early stages.
These protocols usually have a lower revenue because most of it is reinvested to help the protocol grow. The P/S ratio indicator can prove to help make informed decisions but should not be treated as a DeFinitive measure.
## 4. Token supply on exchanges
Tokens are sold and bought on two types of exchanges: centralized and decentralized. The difference between them is that in a decentralized exchange, an intermediary entity is not required to build trust. If the token holders do not store their funds in crypto wallets, a large number of tokens to be sold is available. Sellers become under pressure to sell tokens leading to an unstable token.
Keeping an eye out on the token supply in these exchanges. A token with high liquidity can present a good front for investment. It is often observed that DeFi whales flush the market with a huge amount of tokens. This sudden increase in the token supply gives an immediate boost to the popularity of that asset. This increase in popularity also increases the overall demand for the token.
Although token supply on exchanges is a very useful indicator, it is better to look for other key indicators that can help the investor in DeFi trading and earn money. Every DeFi investor must conduct thorough research on multiple factors before finalizing a platform for investment.
## 5. Token balance changes on exchanges
Keeping an eye out for token supply may be an important tactic to understand the DeFi market and invest wisely. However, the significant and recent alterations in the token balance of a DeFi exchange platform should also be monitored.
Token volatility can be observed by keeping a check on the balance of the token in exchange. A probable increase or downfall in the demand and popularity of a token can be indicated by the changes in the token balance. It is often an indication for investors that DeFi whales are storing tokens when massive withdrawals are observed in centralized exchanges. Similarly, large deposits could suggest that the DeFi giants are trying to get rid of certain tokens.
## 6. Inflation Rate
The above mentioned key indicators suggested that a smaller DeFi token supply may be a positive sign for investors. This is not always the case, if most DeFi protocols show a small token supply for now, there is no guarantee that it will remain the same. A high inflation rate devalues a decentralized finance token.
The DeFi protocols, which have specific rules to prevent inflation, are usually considered a good fit for investing. However, there are protocols that either do not have any mechanism for inflation control or the rules are not so efficient. This makes the supply of tokens difficult to manage. As mentioned earlier, the supply rate of a DeFi token is one of the key performance indicators (KPI).
It is always recommendable to research the supply rate as well as the inflation rate of the tokens. If high inflation is evident from a token in the past, avoiding it can be a perfect decision. The DeFi markets are of very unpredictable nature and extremely volatile. Thorough research always proves to be vital to generate revenue from an investment.
## 7. Unique addresses growth rate
The unique address growth rate indicates the popularity of a project in the DeFi market. A DeFi project is said to be popular, given the increase in the number of unique addresses. Bear in mind that this indicator is very easily manipulated, and decisions based on it can lead to losses. Unique addresses refer to the individual crypto wallets associated with DeFi.
Positive growth of an address in DeFi protocol will indicate that the investors are generating revenue. It is very easy and simple to create addresses quickly. If some people decide to generate many addresses and a hoax of popularity, naive investors can easily get entrapped.
Therefore, to avoid such mishaps, it is better to not solely rely on this indicator and make a decision by the country verifying your findings from all available DeFi indicators.
## 8. Documentation Completeness
One major disadvantage of decentralized finance being an unregulated platform is that many protocols are either launched with incomplete documentation, or the documentation is done very poorly. A huge number of new gullible investors have fallen into these traps. This has led to people losing their hard-earned money to such projects.
Some details that must be checked before signing up for a project are: what will be the course of action in case of a security breach? Who will be liable to compensate for any funds lost? Do the platform users vote for compensation to be provided? These kinds of details are often looked over by new investors, which leads them into such pitfalls that they are often unable to recover from. A project’s website announcements and whitepaper must be reviewed thoroughly before investing.
## 9. Non-speculative usage
An investor mostly has two concerts regarding a protocol. One, what are the risks involved with this investment, and second whether he will get a decent profit on the investment or not. High risk means that investments will be lost, and the return on those investments will be negative. Many assets often promise very good returns, but after investing in them, they don't deliver those promises.
So knowing why one should invest in an asset and where it is used is very important to determine the real worth of an asset. The customer is urged to look for projects that have legitimate uses. The transactions in a protocol performed for speculative use should alert the investor to be careful in investing in this protocol.
The number of transactions carried out for an asset can provide information about the real worth of that asset. The investor can know about the usage of a potential asset by reviewing its number of transactions.
## 10. Social Community Size
Social media has made it easy for everyone to connect, inquire about something, and even keep looking for DeFi projects. Social media platforms can provide a good idea about the trends in the popularity of an asset.
Keywords play a vital role in determining these trends, the keyword of the kind “how to invest in J tokens.” And “what is a J token“indicates an increase in the demand for a token. If some known influencers start mentioning a certain asset on social media, their viewers tend to react to that asset positively. This pushes the popularity and demand for that asset beyond limits.
One recent example of such an increase in popularity was seen with DogeCoin. The demand and popularity of DogeCoin skyrocketed after some notable individuals wrote about the coin. To sum up, we could say that if most of the social community is discussing a certain project, the project will likely grow exponentially.
## Closing thoughts
DeFi markets present a very attractive front for investments. It is up to the investor to identify and pick an asset that shows promise in the future. Sole responsibility comes on the shoulders of investors. One can predict an asset's potential by studying certain DeFi indicators' characteristics. These key indicators guide one in the right direction as to where one should put his investments.
On one hand, the DeFi system's unregulated nature has benefits like not being dependent on any mediary entity. On the other hand, it also directly puts all responsibility on the investor. Proper research about the asset will ensure a certain level of return from the investment.