How To Analyze DeFi Projects

Introduction

According to Statista, the DeFi economy has been anticipated to break the ice on an average revenue per user of US$1,378.0 by 2024 with a projected user base of 22.09 million users by 2028. Aggregating this prediction based on its current worth, the DeFi market is expected to achieve a revenue of US$26,170.0 million in 2024, resulting in a more robust financial economy.

To say the least, decentralized finance strides as one of the monumental innovations enabled by blockchain technology. Taking the reins with style, it offers a handful of solutions that have made the world of finance better and more accessible. The introduction of decentralized finance did not only change the process of finance, it birthed the digital economy which has given users access to a good number of financial services, and by extension, enhanced financial inclusion and freedom.

This innovative and groundbreaking shift has given rise to a two-way world of financial transactions and multiple access to financial products, subtly taking out control of some key roles from traditional gatekeepers like banks. DeFi projects have democratized financing, allowing anybody with an internet connection to borrow and lend as well as trade and execute yield farming.

Navigating a large number of projects is becoming increasingly important as the DeFi space expands rapidly. However, it would be good to answer this question: Is it safe to interact with any DeFi protocol or build on its ecosystem? The answer is a definite NO, thereby fostering the need to understand the Pros and Cons of how to analyze DeFi projects.

In this article, we’ll go over several essential indicators and metrics needed to assist you in assessing the potential and effectiveness of DeFi projects.

Understanding the Essentials of Decentralized Finance

Source: Savemyleads.com

Investors and individuals entering the DeFi space must have a basic knowledge and skill of analyzing projects properly as it becomes obvious that user rates in the DeFi industry have experienced a significant surge across notable projects like Ethereum, Solana, BNB Smart Chain, Avalanche, Injective, Metis, Polkadot, and a handful of others. This fact makes it more important to have an analytical mind.

To get things right from the start, substantial study is required, which includes knowing the project’s fundamentals as well as analyzing its community support and security measures. One of the attractive features of DeFi lies in its open and permissionless nature, where different individuals and teams contribute to the development of applications covering a multitude of use cases. This can range from empowering users with unprecedented control over their personal data to ensuring absolute ownership of their digital assets.

For those venturing into the DeFi landscape, a cautious and prudent approach is paramount. The limitless possibilities of this technology require newcomers to exercise due diligence and understand the risks and potential rewards associated with different projects.

Exploring Due Diligence in DeFi

Over time, some popular terminologies have evolved in the crypto space due to their volatile and speculative nature. These names include WAGMI/NGMI, diamond hands/paper hands, Rugpull, REKT, FUD, FOMO, DYOR, etc. The basic idea behind these terms is an offshoot from insecure activities that affected some individuals, leading to losses that should now be guided against.

For instance,

• It was reported that 120 million US dollars was lost on December 3, 2021, in the Badger DAO hack.
• Late 2021 in November, Crypto Briefing reported that consumers lost around 31 million US dollars on Ethereum and Polygon.
• CNBC, making reference to Elliptic, said that frauds and thefts have cost over $10 billion in 2021.
• Also, on November 3, 2021, The India Bureau of Business Insider made a report that 1.4bn US dollars were lost to DeFi hacks. Luckily, about half of the stolen funds were recovered.
• Furthermore, insecurities about DeFi extended to the UK. Reporting on October 18, 2021, Coindesk stated that, according to the City of London Police, approximately 146 million pounds didn’t see the light of the day due to fraud.

Consider due diligence as the compass guiding users through the complexities of decentralized finance. It empowers them to discover projects with genuine potential while also protecting them from unforeseen challenges that are prevalent. In the larger picture of DeFi investments, due diligence is more than a preventative step; it is a strategic need for anyone looking to confidently and gainfully navigate the decentralized frontier.

Moreover, the process of due diligence goes beyond risk minimization; it serves as the foundation for investors to connect their decisions with specified goals and risk tolerance.

How to Analyze DeFi Projects: Starting with Basic Analysis

Researching the team’s credibility, reviewing the project roadmap, and auditing the project’s smart contracts could be a good way to start basic analysis in DeFi. Users, especially newbies should take note of this fundamental approach to analyzing DeFi projects.

Research Team’s Credibility

Usually, a project’s ability to succeed depends on the caliber and strength of the team. A DeFi project led by an experienced team is more likely to thrive. Investors should carefully scrutinize the founders, developers, advisors, and key officials, considering their past records and industry prominence before investing.

Smart Contract Audits

Vulnerability with DeFi projects due to smart contracts usually comes off easily. To find and stop possible security breaches, it is essential to make sure a project is subjected to an independent, and trustworthy security audit.

Source: Morethandigital.info

Review Project’s Roadmap

Source: ICO Drops

Analyzing a DeFi project’s roadmap provides insight into its goals and how it plans to achieve them. A clear timeline of the project’s development and milestones instills confidence in investors regarding the project’s commitment to its objectives. Most often, these road maps are usually embedded in their official website. Some other times, a few projects could expound on it in their white papers. Solana seems to have a good road map and will most likely be among the top DeFi projects contending with Ethereum. Here’s a display of its ecosystem and how massive it’s becoming.

Source: Yashhsm.medium.com

Evaluate Community Strength

This is one of the basic indicators to also look out for. Of course, it may not always be a yardstick but it counts many times. A project’s community strength and support reflects its adoption rate, viability, and future growth. A strong and active community is indicative of a sustainable project, while poor community strength can be a red flag. Leveraging social media platforms helps gauge community sentiment.

Assess Governance and Decentralization Model

DeFi projects often have governance tokens for user participation. Evaluating decentralization levels and power distribution among token holders is vital. Projects with strong community governance tend to have a more sustainable future. Recently, users are more attracted to projects that give incentives to their community, such as airdrops. In some cases, users may be less likely to think that the project owners are frauds since they willingly share value from the project with them.

Source: Appinventiv.com

Deep Dive Analysis: Metrics and Indicators

Delving into the advanced analysis of DeFi projects requires meticulous research that spans days or weeks, unraveling intricate layers to gauge the project’s true potential. This intensive process involves scrutinizing details, evaluating intricate metrics, and deciphering the project’s long-term viability, offering a comprehensive understanding to discerning investors.

Total Value Locked (TVL)

Source: Cointelegraph

Speaking of DeFi analysis, Total Locked Value appears to be one of the first indices to consider. It is a key indicator for analyzing the interest users have in a DeFi protocol, reflecting the aggregate number of funds deposited by liquidity providers. TVL refers to the total amount of assets, typically in cryptocurrency, that users have staked, provided as collateral, or deposited into smart contracts within the DeFi protocol. The higher the TVL, the more assets are actively participating in the protocol. In essence, TVL is a key metric used to assess the overall scale and success of a DeFi protocol.

Most notably, as of February 2021, Uniswap’s TVL rose by more than $4 billion, demonstrating the level of trust of many users and their commitment to the platform. Additionally, the position of the project’s TVL can be used to make informed decisions and predictions about possible outcomes and success rates. Investors have however been found to have the habit of making multiple TVL comparisons among protocols with the aim of making sound conclusions and informed decisions regarding potential tractions on their choice project.

24-hour Volume

The 24-hour trading volume is a crucial metric when analyzing DeFi projects. It serves as a straightforward indicator, measuring the total trading activity within a specific protocol over 24 hours. This metric is valuable for both traders and investors as it reflects the level of interest in the project. A high 24-hour volume is indicative of active trading and increased liquidity, suggesting a vibrant and healthy ecosystem. This can attract more participants to the market, fostering a dynamic environment for buying and selling assets within the project.

Conversely, a lower 24-hour volume signals reduced market activity and liquidity levels. Such declines may result from a lack of interest or confidence among traders and investors. When participants hesitate to engage in transactions, it can lead to diminished liquidity, potentially impacting the project’s overall viability. Monitoring changes in 24-hour trading volumes provides valuable insights into the market sentiment, helping stakeholders make more informed decisions about the potential risks and returns associated with a particular DeFi project.

Market Capitalization

Unlike other DeFi analysis strategies, Market Capitalisation ranks among the few analysis processes that should be closely monitored. It is a metric used to ascertain the total value of a DeFi protocol’s circulating supply of tokens. To get the actual worth or value of the market cap of a given project, multiply the current price of the token by the total number of tokens in circulation.

To make a coherent analysis, while looking at the market cap, adding the competitive landscape, level of adoption, and protocol’s utility, makes it a more rounded approach to aid in having a comprehensive understanding of the overall potential and viability.

Network Value to Transactions (NVT)

Network Value to Transactions (NVT) is a simple metric that compares a cryptocurrency’s market capitalization to its daily transaction volume, allowing for a relative assessment of a network’s valuation based on usage frequency. A greater NVT indicates an overvalued network, whereas a lower NVT suggests undervaluation. For example, Litecoin (LTC) has a higher NVT than Bitcoin (BTC), which could indicate overvaluation relative to Bitcoin.

Also, Dogecoin (DOGE) may be regarded as undervalued relative to Bitcoin due to its NVT. While NVT has limitations, such as excluding off-chain transactions, spam assaults, and distinguishing between old and new addresses, it is a reasonable starting point for valuation research. However, a more thorough analysis is required to completely appreciate a cryptocurrency’s price.

Circulating Supply

It is notable that unmined bitcoins, such as those belonging to Satoshi Nakamoto, are included in Bitcoin’s circulating supply. In the world of cryptocurrencies, the word “circulating supply” refers to the number of tokens actively traded in the market at any particular moment. This indicator is critical in calculating a cryptocurrency’s market capitalization, which represents the digital asset’s overall economic value. The market capitalization is derived by multiplying the cryptocurrency’s unit price by the entire number of existing coins, including those lost or confiscated.

Inflation Rate

The inflation rate is also a significant metric in the analysis of DeFi protocols, representing the pace at which new tokens are generated. A lower inflation rate will likely imply a more controlled token scarcity over time, which benefits token holders by potentially enhancing long-term value.

Executing a holistic perspective on tokenomics is crucial before evaluating the inflation rate. In this regard, it’s therefore sound to strike a balance between incentivizing participants through higher inflation rates and maintaining token supply scarcity with lower inflation rates. Understanding the unique philosophy behind each protocol is key to assessing its intrinsic value and further making informed decisions as well.

Number of Addresses

The number of wallet addresses serves as a possible indicator measuring the quantity of the DeFi protocol participants, akin to user numbers in traditional Web2 applications. It is utilized to gauge user engagement, with an increase in address numbers being a positive sign of growing popularity and adoption. It’s noteworthy that this metric can be manipulated, particularly in scenarios such as airdrops where an investor may possess multiple addresses.

Source: Be[In]Crypto

Analyzing the Tokenomics of DeFi Projects

Project tokenomics are usually presented in percentages capturing token allocation for specific items

Tokenomics, or token economics, is another critical metric when analyzing DeFi projects. It involves understanding the principles and mechanisms governing a project’s token distribution. This knowledge is instrumental for making informed decisions about acquiring and holding specific tokens. By delving into tokenomics, investors gain insights into how tokens are allocated, circulated, and incentivized within the ecosystem.

For project developers, a solid understanding of tokenomics is crucial for designing sustainable and successful token economies. It allows them to establish mechanisms that align with the project’s goals and contribute to its long-term viability. It’s important to recognize that tokenomics can vary based on a project’s specific objectives. For example, tokens designed to encourage participation in decentralized applications may require different structures compared to those intended to function as stablecoins.

Examining a visual representation of tokenomics, such as the one for CAKE (PancakeSwap’s token), becomes a valuable tool for individuals evaluating a project. By considering factors like token distribution, incentives, and overall economic design, investors can assess whether PancakeSwap stands as a promising and well-structured project, aligning with their investment goals and preferences.

Source: COIN98

Tools for DeFi Research

As much as having a basic understanding of DeFi project analysis can help to ace amazing strides and make wealth, some tools will be indispensable in this approach. At present, over 211 DeFi tools exist that aid in exploring the DeFi space for different needs but the underlisted took the spotlight.

DappRadar

Source: DappRadar

DappRadar, founded in 2018, is one of the leading Web3 DApp distribution tools, methodically tracking over 12,000 decentralized applications (DApps) spanning 40+ blockchains. To say the least, DappRadar possesses a monthly user base of over half a million as of December 2022, offering a vast canvas for discovering and tracking dApps, NFTs, tokens, and DeFi initiatives.

The website’s user-friendly interface enables users to discover DApps based on their preferred blockchain or genre, such as gaming, DeFi, exchanges, social platforms, and others. Each DApp is elaborately detailed with data such as Unique Active Wallets (UAW). This data provides insights into user engagement, transaction volumes, token values, and total smart contract balances.

Dune Analytics

Source: Dune Analytics

Dune, formerly known as Dune Analytics, is a community-driven data powerhouse that offers customers the unique ability to query the blockchain with SQL. The portal provides free access to a wide range of popular dashboards, allowing users to research individual cryptocurrency projects, find trending efforts, and browse dashboards built by their favorite authors.

As with any tool, the ultimate strength rests in the user’s proficiency, highlighting the importance of dedicated practice. While Dune enables users to drill down into specific data, even individuals who are inexperienced with SQL can request specialized dashboards from data wizards for a fee. Exploring dashboards developed by the community’s top data scientists is a wonderful place to start on your Dune adventure, made easier by Dune’s star system, which ranks dashboards by popularity.

Coingecko

Source: Coingecko

CoinGecko goes beyond the scope of a simple cryptocurrency data aggregator tool, with a massive database containing tens of thousands of digital assets. Beyond its remarkable listings, CoinGecko has a user-friendly interface that allows for an in-depth examination of any crypto asset. Users may uncover facts such as the contract address with a single click, which is especially handy for people who utilize MetaMask for bespoke token imports.

Additionally, CoinGecko broadens its utility by providing extensive educational content about blockchain technology and has amazing features where users can evaluate the price of a cryptocurrency. This includes NFT Floor Price, which allows users to track the floor price of NFTs on Ethereum and Avalanche, with ambitions to include additional chains in the future.

CoinMarketCap

Source: CoinMarketCap

CoinMarketCap has remained a must-have tool that is frequently recommended to crypto beginners starting on their crypto trading journey due to its vast utility and significance. This website provides a full suite of features, including pricing information, cryptocurrency leaderboards, and market statistics. CoinMarketCap, known for its simple user interface, provides data on over 5,000 tokens, making it a go-to resource for anybody looking for insights into the volatile crypto scene.

Whether you want to quickly obtain information on the crypto market or go into extensive research of certain cryptocurrencies, CoinMarketCap meets these objectives admirably. Further, the platform groups coins and tokens into different categories, allowing users to get insights into their performance as well as uncover new projects.

IntoTheBlock

Source: IntoTheBlock

IntoTheBlock emerges as a top crypto data analytics organization that specializes in providing deep insights and analysis of the volatile cryptocurrency market. Using advanced machine learning algorithms, the company methodically monitors data from a variety of sources, including exchanges, social media, and on-chain transactions, to provide a comprehensive view of the market.

IntoTheBlock offers a variety of tools and services to help individuals and organizations navigate the cryptocurrency ecosystem, including market analytics, sentiment analysis, and portfolio management. Notably, the company uses its experience to provide customized solutions for businesses looking to smoothly integrate cryptocurrency data into their processes. One of IntoTheBlock’s distinguishing advantages is its ability to undertake extensive studies of certain cryptocurrencies and their underlying blockchain networks. This entails analyzing on-chain data, including transaction volumes, miner behavior, and network activity, as well as off-chain data like social media sentiment and prevailing market trends.

Nansen

Source: Nansen

Nansen has quickly established itself as a leading blockchain data analytics platform, separating itself from decentralized platforms such as Dune Analytics by employing its own team of professionals. Its experience has resulted in a range of advanced trading tools that are unique in the market.

Further, Nansen distinguishes itself by tracking over 70 million wallets, allowing for in-depth analysis of money flows and revealing insights and trends that might otherwise be overlooked with fewer data points. Take NFT Paradise, a Nansen dashboard that provides real-time floor price updates from OpenSea. It gives users a significant informational edge by tracking the wallets of NFT whales and using the Profit Leaderboard to analyze the most profitable wallets in the NFT sector.

Conclusion

Delving into the world of DeFi presents both potential rewards and inherent risks. While the innovations of decentralized finance offer exciting opportunities for financial inclusion and democratization, navigating this dynamic landscape requires a cautious and analytical approach.

This article has explored several key aspects of analyzing DeFi projects, equipping you with a solid foundation for making informed decisions and gaining a clearer understanding of a project’s potential and viability.

Remember, every investor’s risk tolerance and financial goals are unique. Always tailor your DeFi ventures to your own circumstances and ensure meticulous research, clear strategies, expert guidance, and robust risk management plans are in place. By exercising prudence and employing the analytical tools discussed here, you can navigate the DeFi space with confidence, increasing your chances of success in this rapidly evolving financial ecosystem.