DeFi (decentralized finance) could boast of only USD 1bn in total value locked in as recently as the beginning of June. This rose by a whopping 860% in the three months to September 2, hitting USD 9.6bn.
These figures haven’t escaped their fair share of scrutiny, however. Collected by DeFi Pulse, they’ve been questioned by people within the crypto industry, who suspect that much of the total value locked in is being double-counted (or even “double, triple, quadruple-counted underlying capital”).
Speaking to Cryptonews.com, industry figures agreed that there is a risk of double-counts inflating data on total value locked (TVL) in, regardless of whether data is compiled by DeFi Pulse, another aggregator, or a DeFi platform itself. They also warn that much of the increase in TVL comes from yield farming activities that may create dangerous levels of systemic risk, given the amount of interdependency and leverage involved.
TVL doesn’t always mean the same thing in DeFi
Here’s how DeFi Pulse unpacks what total valued locked in actually means:
“DeFi Pulse monitors each protocol’s underlying smart contracts on the Ethereum blockchain. Every hour, we refresh our charts by pulling the total balance of Ether (ETH) and ERC-20 tokens held by these smart contracts. TVL (USD) is calculated by taking these balances and multiplying them by their price in USD.”
Sounds simple, right? Well, there are a number of complicating factors that mean TVL might not be a transparent measure of the amount of money that has really been put into the DeFi ecosystem.
The first problem involves double counts, as explained to Cryptonews.com by DappRadar’s Project Manager Ilya Abugov.
“Effectively, if a user deposits some ETH in dapp X, gets xETH token back and goes to deposit xETH in dapp Y, both X and Y will have his/her ETH count towards their TVL. Yet, the user only deposited the one amount of ETH,” he said.
The Chief Blockchain Scientist at eToro, Dr Omri Ross, said that there’s also a risk that TVL will include synthetic tokens used to represent another cryptoasset deposited as collateral. The same danger may also apply to governance tokens.
“This can be the case for Compound’s cTokens but may also apply to the distribution of governance tokens to users depositing assets in a smart contract,” he said. “Until a governance token balance is claimed, it is typically retained by the protocol and may thus be counted towards the aggregate TVL, depending on the methodology used.”
Meanwhile, Scott Lewis, Founder of DeFi Pulse, claims that the company works "really hard to remove double counted assets from [DeFi Pulse] exactly to avoid this problem."
DeFi is changing very fast, and clarifying the TVL edge cases is something that we take very seriously at @defipulse. We will continue to maintain the best definition of TVL we can as DeFi grows, and eventually fully ossify when that is appropriate
— scott lewis🌾 (@scott_lew_is) August 16, 2020
DeFi Pulse may have received most of the criticism in recent weeks, but in many cases it would seem that it offers a more conservative estimate of total value locked in, at least compared to DeFi platforms themselves.
“Teams favor methodologies in which compounding yields, governance tokens staked in voting protocols, and other assets of relative or secondary importance to the main utility of the protocol are included in the count, whereas data aggregators tend to include only the assets locked towards the main utility of the platform,” said Ross.
According to him, the differences in TVL metrics frequently range between 10%-50% for major platforms, indicating considerable differences in methodology.
“For example: Earlier this week, the Compound protocol website advertised USD 1,277,766,218 of assets earning interest across 9 markets, while DeFi Pulse lists Compound as holding USD 595.8m,” he added.
Dollar value versus total number of assets
It also needs to be remembered that total value locked in can increase simply because crypto prices have increased relative to the US dollar.
“Over the summer we have seen TVL become almost synonymous with the growth of DeFi and become a chief measure of growth,” said Ilya Abugov.
“However, that is not very accurate. It is possible, for example, to envision a scenario when the amount of assets on smart contracts decreases, but the price of those assets increases enough so that TVL increases.”
This certainly contributed to the growth of TVL as ETH rose by around 100% between June and September, while the number of ETH locked in DeFi also more than doubled in the same time.
Short-termism may crash the system
Regardless of just how big it is exactly, DeFi’s growth appears to be driven by more high-powered, experienced users.
“Broadly speaking – DeFi users are not big institutions, but rather individuals or small groups. We call them ‘retail decentralized financial users’,” said Igor Lilic, the Principal Technical Lead at ConsenSys.
Lilic added that “small” is a relative term in this context. “Some of these projects have billions of dollars of assets under management,” he said.
For Illya Abugov, the DeFi ecosystem is dominated mostly by “whale liquidity farmers.”
“For now, a lot of activity is focused on short-term gains rather than the actual functionality/utility of the projects,” he noted.
But due to the interconnectivity of the whole ecosystem, and the way users can withdraw tokens from one platform and deposit them with another, such short-term profit-seeking may be dangerous.
## The Defi ouroboros is quickly becoming a systematic risk. locking up aggregated yield made with leverage in a M… https://t.co/gR22EOselm
— Ma/ya Zehavi (@mayazi)
@feindura This is a weak take. Any investment opp. not tied to a physical commodity or product looks like a ponzi s… https://t.co/pa12lXDqUd
— Pomp (in reality) ⟠ (@APompethiano)
“Financial integration can result in an increasing degree of contagion, the direct transmission of shocks from a single system to connected systems,” said Omri Ross.
“As such, the shock produced by an exploit or flash-crash initiating forced liquidations of overexposed vaults, would ripple through the system.”
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