DeFi provides investors with a plethora of opportunities, but it also comes with hazards. The following are three indicators that investors use to evaluate decentralized finance tokens and protocols.
Many “digital landmines” exist in the cryptocurrency ecosystem, such as rug pulls and protocol hacks, which can give novice users the feeling of being stranded at sea, much to the anger of cryptocurrency proponents who urge for immediate broad adoption of blockchain technology.
Technical analysis and gut sentiments are not the only factors to consider while investing. A handful of blockchain research platforms have introduced dashboards with analytics that can provide more insight into the fundamentals of sustaining — or not supporting — a cryptocurrency project in the last year, 2020.
When determining if an altcoin or decentralized finance (DeFi) project is a good investment, there are three main factors to examine.
1. Examine the project’s developer and community activity
Looking at the statistics that demonstrate the level of activity from the platform’s user base and development community is one of the most fundamental ways to get a read on a project.
Many of the industry’s best protocols provide analytics that tracks the number of active users over time. On-chain dashboards like Dune Analytics provide additional precise insights into this measure, such as the figure below, which shows the daily new Olympus protocol users.
The average number of active wallets on a daily, weekly, and monthly basis are other important data points to examine when measuring community engagement. Investors can also consider the protocol’s transaction volume and the number of transactions, as well as social media data like Twitter mentions, which can help gauge investor attitude regarding a project.
GitHub has been the go-to location for learning about planned upgrades, integrations, and where the project is in its roadmap when it comes to project development and developer activity.
If a protocol boasts about “soon to be released” features but has minimal active work or commits, it’s probably best to stay off until the activity matches the claims.
Finding an under-the-radar project with consistent development activity and a loyal user community, on the other hand, could be a good indicator.
2. Consistent increases in total value locks are expected
The sum of all assets placed on the protocol, also known as the total value locked, is a second measure to consider when evaluating a project’s total strength (TVL).
For instance, according to data from Defi Llama, the total value locked on the DeFi protocol DeFiChain (DFI) has been climbing recently as a result of a major protocol upgrade, with the TVL hitting new all-time highs on many days thus far in December. This indicates that the project’s momentum and interest are growing.
Users can look at statistics for different blockchain networks, such as the TVL on the Ethereum Network or the Binance Smart Chain, as well as specific projects like Curve and Trader Joe, using DeFi aggregators like Defi Llama and DappRadar.
Protocols with a higher TVL are seen to be more secure and trustworthy by the community, whereas initiatives with a lower TVL are considered to be riskier and have fewer active communities.
3. Determine who holds the majority of the tokens
The rewards that token holders gain for holding and being involved in the community are also aspects to consider. Investors should also look at how the token was launched and who the most powerful token holders are right now.
Because of its revenue-sharing concept and multichain trading features, people prefer to own SUSHI.
On the other hand, extreme yields for low liquidity, anonymously-run protocols with minimal community participation should be avoided because this can be the perfect condition for catastrophic losses. Rug pulls are a type of DeFi attack that often occurs after a big sum of money is transferred into smart contracts managed by a single anonymous party.
Examining the protocol’s token distribution, as well as the percentage of tokens assigned to the developers and founders vs. the tokens held by the community, might provide some useful insight into whether a platform is vulnerable to a rug pull or the vagaries of mercenary capital.
If the creators and backers hold the majority of the available supply, there is always the possibility that these tokens will be sold at market rate if or when early investors decide to abandon their position.