Aave, Maker, Compound: this is the right way to assess their value

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TVL or Total Locked-In Value is a technical metric that has been used as a primary yardstick to measure the performance of DeFi lending platforms. Simply put, it measures the cumulative amount of assets that are staked on a particular protocol. The conventional argument is that the higher the value stuck in a particular DeFi platform, the better.

By simply displaying the total underlying offer secured by a platform, TVL does not evaluate the whole picture in any way. Different protocols use each locked token unit in different ways. On some protocols, each token pair requires individual ETH pools, while other networks may inherently provide liquidity to multiple tokens in the same ETH pool.

In simpler terms, on protocols belonging to the latter type, 1 ETH would end up meeting the liquidity needs of 10 different ERC-20 tokens, while the former would require 10 ETH to serve those 10 tokens. Indeed, the latter network would require much less fixed assets than the former to provide the same amount of liquidity.

In addition, other intrinsic details such as the amount of outstanding loans are also eliminated from the TVL equation. So, overall, TVL is an asymmetric metric that only projects the one-dimensional view.

The right way

While weighing where each rig is, it becomes essential to look at a few other factors as well. One of these key metrics is the loan-to-value ratio. LTV measures the ratio of the loan to the value of a purchased asset. Ultimately, risk is assessed based on the likelihood that liquidity will be sufficient to cover the outstanding loan balance. Thus, the higher the LTV, the riskier it would be for users / lenders to provide liquidity to the protocol.

According to LTV data from Dune Analytics, the aforementioned ratio for Aave, Compound and MakerDAO was 15%, 39% and 92% respectively at the time of writing.

Source: Dune Analytics

As such, Aave and Compound together make up 90% of the total DeFi revenue generated, but the same doesn’t highlight how much protocols actually earn. [net value]. Only when the respective amounts of outstanding loans are deducted and basic accounting standards are followed, users would get a clear picture.

However, it’s critical to note here that Maker collects all fees charged, while Compound and Aave only take 10% of the borrowed rate paid and more of the pie goes to vendors. So if Maker started pulling cash or if Aave or Compound gave up, the base TVL metric would switch completely and favor Maker.

In addition, the outstanding debt of Aave and Compound is inflated by a factor of 3-4 times compared to the organic loans outstanding, mainly due to stable agriculture.

Overall, the simple ranking of DeFi protocols based on available liquidity is biased to say the least.

Footnote

DeFi tokens, as such, haven’t been in good shape lately. The three aforementioned tokens generated negative returns for their investors [AAVE: -22.81%, COMP: – 28.51 and MKR -38.44] in the past month. The risk-adjusted returns of all tokens have also been negative lately, making them an unfavorable investment option at the moment.


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