Author: Patrick Scott | Dynamo DeFi
Compiled by: Deep Tide TechFlow
In the past, crypto asset analysis largely revolved around charts, hype cycles, and narratives. However, as the industry matures, actual performance becomes more important than empty promises. You need a filter to help you extract truly valuable signals from the overwhelming amount of information.
Fortunately, this filter already exists; it is called Onchain Fundamentals.
On-chain fundamentals provide DeFi (Decentralized Finance) with a structural advantage over traditional finance (TradFi). This is not only one of the many reasons why "DeFi will win," but also a core concept that anyone wanting to invest in this industry must understand.
For the past four years, I've been immersed in researching DeFi data metrics, initially as a researcher and later working with the DefiLlama team. This article summarizes some of the most useful analytical frameworks I've learned during this time, hoping to help you get started using these tools.
Why are DeFi metrics important?
On-chain data is not just a breakthrough in evaluating crypto assets, but a revolution in the entire financial data field.
Consider how traditional investors evaluate companies: they wait for quarterly financial reports. Now, some are even proposing to change the frequency of financial report releases from quarterly to semi-annually.
In contrast, financial data for DeFi protocols is available in real time. Websites like DefiLlama update relevant data daily or even hourly. If you want to track earnings by the minute, you can even directly query the blockchain data (although overly granular data may not be very meaningful, you do have this option).
This is undoubtedly a revolutionary breakthrough in transparency. When you buy stock in a publicly traded company, you rely on financial data released by management after auditing by accountants, which is often delayed by weeks or even months. But when you evaluate a DeFi protocol, you directly access transaction records that occur in real time on an immutable ledger.
Of course, not every crypto project has fundamental data worth tracking. For example, many "memecoins" and "air projects" with only a white paper and a Telegram group are not very helpful in terms of fundamental analysis (although other metrics such as the number of holders may provide some reference).
However, for protocols that generate fees, accumulate deposits, and distribute value to token holders, their operation leaves data traces that can be tracked and analyzed, often before the market narrative takes shape.
For example, Polymarket's liquidity has been growing for several years, a trend that began long before the prediction market became a hot topic.
The price of the HYPE token surged last summer due to its consistently high earnings performance.
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These indicators have already hinted at future trends; you just need to know where to look for them.
Analysis of core indicators
Let's start with the core metrics you need to understand when investing in DeFi.
TVL (Total Value Locked)
TVL measures the total value of assets stored in a smart contract of a protocol.
For lending platforms, TVL includes both collateral and the assets provided.
For decentralized exchanges (DEXs), TVL refers to deposits in the liquidity pool.
For a blockchain network, TVL is the total value locked across all protocols deployed on that network.
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In traditional finance (TradFi), TVL is similar to Assets Under Management (AUM). Hedge funds report AUM to show the total amount of money clients entrust to them. TVL serves a similar purpose; it reflects the total amount of funds users deposit into the protocol, indicating the level of trust users have in the protocol's smart contract.
However, TVL has been criticized over the years, and some of the criticisms are valid.
TVL does not measure activity. An agreement may hold billions of dollars in deposits but incur virtually no fees.
TVL is highly correlated with token price. If the price of ETH drops by 30%, the TVL of all protocols holding ETH will decrease proportionally, even if no actual withdrawals occur.
Since most DeFi deposits are in volatile tokens, TVL is highly susceptible to price fluctuations. Therefore, astute observers combine net USD inflows with TVL to distinguish between price changes and actual deposit activity. Net USD inflows are calculated by summing the change in balance for each asset over two consecutive days (multiplied by the price). For example, a protocol 100% locked in ETH will have its TVL decrease by 20% if the price of ETH drops by 20%, but its net USD inflow will be $0.
Nevertheless, TVL remains valuable when presented in both USD and token form and combined with activity or productivity metrics. TVL remains an important tool for measuring protocol trust and the overall scale of DeFi. Just don't mistake it for a complete evaluation metric.
Fees, income and income of currency holders
In DeFi, the definitions of these terms differ from those in traditional accounting, which can be confusing.
Fees: From a user's perspective, fees refer to the costs you pay when using a protocol. For example, when you trade on a DEX, you need to pay trading fees. These fees may go entirely to the liquidity provider or partly to the protocol. Fees represent the total amount paid by users, regardless of where it ultimately goes. In traditional finance, this is equivalent to Gross Revenue.
Revenue: Revenue refers to the protocol's share of profits. In other words, how much of all fees paid by users does the protocol actually retain? This revenue may flow to the protocol's treasury, the team, or token holders. Revenue excludes fees allocated to liquidity providers and can be considered the protocol's gross income.
Holders Revenue: This is a narrower definition, tracking only the portion of income distributed to token holders through buybacks, burn fees, or direct staking dividends. In traditional finance, this is similar to a combination of dividends and stock buybacks.
These distinctions are crucial in valuation. Some protocols may generate substantial fees, but because almost all of these fees are distributed to liquidity providers, the final revenue is meager.
DefiLlama has already released complete revenue statements for many protocols. These statements are automatically updated based on on-chain data, breaking down revenue into different items and redefining these metrics in standard accounting language.
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These revenue reports also include visualizations of fund flows, showing the entire process from user inflows into the agreement to redistribution among stakeholders. This information is invaluable if you want to gain a deeper understanding of the economic model of a specific project.
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Trading volume
Trading volume is used to track the size of trading activity.
DEX Trading Volume: Statistics on all trading pairs on decentralized exchanges (DEXs).
Perp Volume: Total trading volume across all perp trading platforms.
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Trading volume is a key metric for measuring overall participation in the crypto market. When people actively use digital assets, they trade. Surges in trading volume are typically associated with changes in market interest, whether it's a market frenzy or a panic sell-off.
Compared to previous cycles, perpetual contract trading volume has increased significantly. In 2021, the presence of perpetual contract exchanges was quite limited. Today, platforms like Hyperliquid, Aster, and Lighter handle billions of dollars in trading volume daily. Due to this rapid growth, comparisons with historical data are of limited value. For example, comparing current perpetual contract trading volume with 2021 data only indicates that the sector has expanded, without providing much other valuable information.
Within a particular category, market share trends are more important than absolute trading volume. For example, if a perpetual contract DEX's market share grows from 5% to 15%, even if its absolute trading volume decreases, it indicates an actual improvement in its market position. DefiLlama's library of custom dashboards offers many market share charts worth exploring.
Open Interest
Open interest refers to the total value of derivative contracts that are not yet closed or forced to close. For perpetual DEX contracts, open interest represents all positions that have not yet been closed or liquidated.
Open interest is an important metric for measuring liquidity on a derivatives platform. It reflects the total amount of capital deployed in currently active perpetual contract positions.
This metric can crash rapidly during periods of market volatility. A massive wave of forced liquidations can wipe out open contracts within hours. By tracking recovery after such events, one can observe whether a platform is able to regain liquidity or whether funds have permanently migrated to other platforms.
Stablecoin Market Cap
For a blockchain network, stablecoin market capitalization refers to the total value of all stablecoins deployed on that network.
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Stablecoin market capitalization is an important metric for measuring capital inflows. Unlike TVL, which is affected by token price fluctuations, stablecoins represent real US dollars (or equivalent US dollars) that users actually inject into the blockchain through cross-chain bridges. For example, when the market capitalization of stablecoins on a certain chain grows from $3 billion to $8 billion, it means that $5 billion of real capital has flowed into that ecosystem.
Since October 2023, approximately $180 billion has flowed into the crypto market in the form of stablecoins. A portion of this inevitably entered DeFi, driving TVL growth, increased trading volume, and fee generation. Stablecoin flows are analogous to capital inflows in a country's economy; an increase in stablecoin supply signifies the entry of new funds, while a decrease in supply indicates capital outflows.
App Revenue & App Fees
Application revenue and application fees are chain-level metrics that track the revenue and fees generated by all applications deployed on the chain, but exclude stablecoins, liquidity staking protocols, and gas fees.
I see it as the “GDP” of blockchain, which shows the scale of actual economic activity taking place in the ecosystem.
Revenue metrics are among the hardest to fake because they require users to actually spend money. This makes it a high-signal indicator of activity levels within the DeFi ecosystem.
It's important to note that you cannot value an asset based on app revenue, as valuing it based on revenue unrelated to the asset is meaningless. App revenue and app fees are better suited for diagnosing whether a chain is growing, rather than for assessing its value.
How can we effectively interpret these indicators?
Understanding individual metrics is the first step, but to use them effectively requires an analytical framework. I prefer to use the following three-step analytical approach:
Prioritize sustained and stable growth.
Simultaneously track both stock and flow indicators.
Consider the impact of token unlocking and incentive mechanisms.
1. Prioritize sustained and stable growth.
Protocols that show a brief surge in revenue followed by a rapid collapse fail to demonstrate sustainable value creation. I've seen countless protocols set revenue records in a single week, only to disappear a month later.
What truly matters is consistent, steady growth over a longer period. For example, an agreement whose monthly revenue gradually increases from $500,000 to $2 million over six months demonstrates sustainable growth. Conversely, an agreement whose revenue suddenly spikes to $5 million in a single week but then quickly drops to $300,000 is likely just a fleeting anomaly.
In the crypto industry, time passes much faster than in traditional markets. Here, a month of sustained growth is roughly equivalent to a quarter in a traditional market. If a protocol's revenue grows consistently over six months, it can be considered a company with six consecutive quarters of revenue growth. This kind of performance is noteworthy.
2. Simultaneously track both stock and flow indicators.
Stock metrics, such as TVL (Total Value Locked), Open Interest, stablecoin market capitalization, and treasury funds, tell you how much capital is deposited into the protocol.
Flow metrics, such as fees, revenue, and volume, tell you the actual amount of activity in the protocol.
Both are equally important.
Activity volume is easier to fake. For example, a protocol can artificially inflate trading volume through incentives or wash trading, and such temporary spikes are not uncommon. Liquidity, on the other hand, is much harder to create. For users to actually deposit funds and stay long-term, the protocol needs to have real utility or offer attractive returns.
When evaluating any agreement, at least one stock metric and one flow metric should be selected for analysis. For example:
For perpetual DEX contracts, you can select open interest and trading volume.
For lending agreements, you can choose TVL and fees.
For blockchain, you can choose stablecoin market capitalization and application revenue.
If both of these indicators show growth, it suggests that the agreement is indeed expanding. If only the activity indicator is growing, while liquidity remains stagnant, further analysis is needed, as there may be manipulation. If only liquidity is growing, while activity is stagnant, it may indicate that deposits are mainly coming from a few "whales."
3. Consider token unlocking and incentive measures.
Token unlocking creates selling pressure. A portion of the vested tokens released weekly by the protocol will always be sold. If there is no other source of demand to offset this selling, the token price will fall.
Before investing, please check the token's unlocking schedule. A protocol with 90% circulating supply has minimal future dilution pressure. However, a protocol with only 20% circulating supply and a large-scale unlocking planned in three months carries entirely different investment risks.
Similarly, high-revenue protocols may appear less impressive if they distribute more token incentives than they earn from users. DefiLlama tracks this through its "Earnings" metric, which deducts incentive costs from revenue. For example, a protocol might generate $10 million in revenue annually but distribute $15 million in token rewards.
While incentives are an effective strategy for driving protocol growth early on and are often necessary in the early stages of a protocol's lifecycle, they do create selling pressure that needs to be offset by other demands.
