Footprint | DeFi Pitfall Guide: How to Find Worthy Investment Projects from Data

With the development and increasing popularity of the cryptocurrency market, more and more DeFi projects are entering the field, attracting a large number of investors. The development of DeFi in 2021 can be described as rapid, with the Total Value Locked (TVL) increasing by 860.42% from the beginning of the year to $21.4 billion before the publication deadline; the number of on-chain DeFi projects has also grown from 174 at the beginning of the year to 554, a growth rate of 218.39%. The prosperity of the DeFi market not only allows investors to earn higher returns than traditional financial investments but also boosts confidence.

Due to the decentralized nature of DeFi, a new project can be launched without the need for approval from relevant authorities, resulting in low costs. However, projects that engage in various forms of deception are common, and a slight oversight can lead to falling into the trap of fraudulent platforms. With so many projects available, avoiding pitfalls and discovering projects with investment value is essential for individual investors looking to participate in DeFi investments.

Total Value Locked (TVL)

For those involved in DeFi investments, the TVL indicator is not unfamiliar, as it can be obtained on major data platforms such as DeFi Llama, CoinGecko, and CoinMarketCap). TVL refers to the total value of assets deposited and locked in the protocol. A higher TVL indicates more assets aggregated by the project, higher user trust in the project, and a greater willingness to deposit assets into the platform for various economic activities such as providing liquidity and collateral. The more users gathered, the more popular the platform becomes.

As seen from the chart, among the top ten platforms by TVL, besides having a volume exceeding $5 billion, the TVL has been showing a monthly growth trend, demonstrating that the projects are maintaining their vitality and strength.

Market Cap

Market cap reflects the market value of a project in the DeFi industry, and this indicator is calculated similarly to traditional stock markets, primarily influenced by coin price and the quantity of tokens in circulation.

As shown in the chart, due to the influence of circulation and supply and demand on token quantity, the coin price fluctuates, affecting market cap changes. However, the market cap's increase or decrease has been maintained within a reasonable range of about 20%, without extreme spikes or cliff-like plunges.

After understanding the basic indicators, let's explore how to evaluate projects and discover potential and worthwhile investments.

It is advisable not to choose projects ranked too low in TVL. Select projects from the mid-range and above in the rankings.

From the scatter plot above, there are over five hundred current DeFi projects, among which many are newly emerging with small TVL volumes. Platforms with a TVL below $5 million account for as high as 33%. How to select suitable investment projects from numerous options? For safety reasons and to prevent risks of small-scale projects running away with funds, individual investors should select projects for investment from the mid-range and above in TVL rankings (around $20 million).

For DeFi projects, projects with a value between $1 million and $10 million are suitable for institutional seed investments and not for individual investors, as the future development positioning and strategic direction of such projects are not clear.

Projects with a value between $10 million and $20 million have found suitable development strategies, and investors can obtain data on such projects. However, due to stability considerations, these projects may face growth constraints. Once growth momentum falters, there is a high risk of stagnation or decline.

Projects with a value between $20 million and $50 million have to some extent found clear product mechanisms and growth points. The community and technical support are gradually improving. If you want to achieve returns higher than leading platforms, these platforms are a good choice.

For those with lower risk tolerance and less demand for returns, selecting projects from leading platforms based on their preferred DeFi project categories (such as providing liquidity for DEX or lending for Lending) for investment is advisable.

Token Price Stability and Reasonable Token Distribution Mechanism

After selecting suitable candidate projects through the TVL indicator, further screening is required based on the project's token situation. Evaluations should be made based on the token price variations of leading platforms, as shown in the chart above, primarily focusing on two aspects:

Firstly, whether the token price maintains a relatively stable trend of fluctuations (monthly increases or decreases should not exceed 20%). A stable token price indicates stable liquidity, reducing the likelihood of significant damage to the project caused by large token sales by individual investors.

Secondly, whether the token distribution mechanism is reasonable. For instance, whether the team/foundation's token holding ratio is too high. If it is excessively high, the project becomes more profit-driven. Additionally, if the token release rate is too rapid, it may lead to severe dilution of the token price, increasing the likelihood of token sales, which is not conducive to the sustainable development of the token price.

Confirming Asset Suitability for Long-Term Holding with MC/FDV Ratio

Leading platform market cap/fully diluted valuation ratio. Data Source: Footprint Analytics:

Comparison of leading platform market cap/fully diluted valuation ratio, price, token circulation, and total token supply. Data Source: Footprint Analytics:

Fully diluted valuation refers to the product of token price and the maximum token supply. When all tokens are released, market cap and fully diluted valuation are equal. If the "MC/FDV" ratio, which is the ratio of market cap to fully diluted valuation, is too small, it indicates that a large number of tokens are yet to be released. Investors should consider carefully, focusing on the project's duration of operation, token supply schedule, and whether token price growth is overheated.

For individual investors with a long-term investment demand, evaluating the "MC/FDV" ratio of projects is essential. As new tokens are released and gradually enter the market, when the supply of tokens exceeds actual demand, the valuation becomes unreasonable. As the market adjusts, the token price decreases, leading to greater selling pressure for long-term holders, making the held tokens almost worthless.

For example, for projects with a "MC/FDV" ratio exceeding 60%, the platform's tokens are more suitable for long-term holding, offering security, but the downside is the high entry price. Comparatively, platforms with a lower ratio, like CurveCRV, although not high, have token prices within a reasonable range and are worth considering. In contrast, Lido has an "MC/FDV" ratio lower than Curve at 6.32%, but the token price is higher than Curve at 43.75%, indicating a high market value estimation and currently unsuitable for long-term holding, as the token price may decline with market self-adjustment.

Evaluating Project Worthiness for Investment with MC/TVL Ratio

According to data provided by Footprint, the current top ten projects by TVL have an "MC/TVL" ratio (market cap to TVL ratio) generally below 1. This indicates that the projects are undervalued and worth investing in, especially with InstaDapp having a ratio of only 0.65%. Economically, the higher the TVL of a project, the higher the MC should be, as a high TVL implies the project is promising, bringing greater economic utility to the project and increasing the market value to match the TVL.

Therefore, when searching for investment-worthy projects, investors can evaluate the investability of projects from the perspective of the "MC/TVL" ratio. A ratio greater than 1 indicates that the valuation may be too high, with lower investability. If the ratio is less than 1, it signifies that the project is undervalued, potentially yielding higher returns. Additionally, investors can compare the ratio of projects they intend to invest in with that of leading platforms in the same category to see where the differences lie.

Conclusion

Readers can use the evaluation indicators in this article to assess their investment projects, summarized as follows:

• TVL ranking in the mid-range and above, approximately above $20 million
• Relatively stable token price: monthly fluctuations should not exceed 20%
• Reasonable token distribution mechanism: team token holdings and token release speed should be reasonable
• MC/FDV ratio less than 5%, tokens of projects are not suitable for long-term holding
• MC/TVL ratio less than 1, projects are suitable for investment

For the above-mentioned calculation-related indicators, readers can directly obtain them from the Footprint Dashboard without additional calculations.

After analyzing with the above indicators, it is evident that DeFi, as a new investment market, creates more investment possibilities compared to traditional finance due to its novelty and inclusiveness. With a wide variety of options, many worthwhile investment projects are known and understood, while many potential projects are yet to be discovered.

However, opportunities and risks coexist. We cannot solely rely on the above indicators to conclude whether a project is worth investing in or has development potential. Due to the unpredictable and rapidly evolving nature of the DeFi market, indicators may also fail at times. To minimize the risk of pitfalls, it is necessary to conduct more research and understanding on project backgrounds, operational models, etc., before investing, and avoid blind following.

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