Through the first 30 days of the year, Ethereum (ETH -0.59%) is up a surprising 37.53%, and now trades close to $1,700. Heading into the year, though, many traders expected Ethereum to consolidate its gains after The Merge and trade sideways in early 2023. Some even thought Ethereum might drop below $1,000. As a result, many investors are now asking: Is Ethereum's 2023 bull run sustainable?
The answer to that question can be found using one single metric: total value locked (TVL). This metric is useful as a shorthand way of tracking how much activity is happening on a blockchain. Generally speaking, the higher the number, the better it is for a blockchain. Let's take a deep dive into this metric and see what it tells us about Ethereum's future prospects.
What is TVL and why should I care?
Total value locked, as might be guessed by its name, refers to how much of a cryptocurrency is "locked" on a blockchain. There are various ways of "locking" your cryptocurrency, such as by choosing to participate in a crypto staking program. With staking, you agree to "lock up" your crypto to earn rewards for a certain amount of time, during which you can not trade it. Thus, blockchains that have successful staking programs also typically rank very high when it comes to total value locked.
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From a long-term investment perspective, you can think of TVL as a way of measuring trust in the future potential of a particular blockchain. At the very least, you need to trust that the blockchain is going to return your crypto funds after the "lock up" period is over.
How to use TVL to value Ethereum
By simply examining a table of blockchains ranked by TVL, you can immediately see which blockchains are having success in getting investors to "lock up" their crypto funds. According to this metric, Ethereum ranks No. 1 in the world, with $29.39 billion in TVL. And it's not even close. The No. 2 blockchain is Tron, with $5.35 billion in TVL. Taking a big-picture view, Ethereum is responsible for close to 60% of all blockchain TVL. That's a very compelling argument in Ethereum's favor, since it means Ethereum is having a lot of success in encouraging investors to "lock up" their funds and trust the blockchain.
But that's just the start. You can also use TVL with another popular metric -- total market capitalization -- to arrive at a much more nuanced view of which cryptocurrencies are overvalued and which cryptocurrencies are undervalued. For example, many investors like to divide total market capitalization by TVL to arrive at the crypto market's version of the price-to-book ratio. This ratio should be familiar to stock market investors, since it is often used to spot stocks that are trading very low compared to their overall intrinsic value.
So, for example, you can divide Ethereum's total market capitalization ($204.837 billion) by its TVL ($29.39 billion), to arrive at a very rough approximation of a price-to-book ratio for Ethereum. When you compare Ethereum's price-to-book ratio to that of its direct peers, you can see immediately how Ethereum is doing on a relative basis. For example, Ethereum has a 6.97 price-to-book ratio, compared to 34.36 for Solana, which is up more than 100% in 2023. Again, this is a very encouraging number for Ethereum, since it lets investors know that Ethereum may still have some room to run as part of its bull market rally, while the market might be getting too frothy and speculative for Solana.
Developing an investment thesis for Ethereum
The final step in using TVL to evaluate Ethereum is to come up with an investment thesis based on where funds are moving on the Ethereum blockchain. Using a website like DeFi Llama, it's possible to see exactly which decentralized finance (DeFi) protocols are attracting the most action. For example, the top DeFi protocol for Ethereum involves staking. This makes sense, since Ethereum instituted staking as part of The Merge last year.
You can also see one of the top staking protocols involves Coinbase Global. This, too, makes sense. It appears that Coinbase is having relative success at getting its clients to stake Ethereum directly on its platform. Taken as a whole, Ethereum's success with staking should be a net positive for its long-term growth potential.
As a long-term investor in Ethereum, you might decide to track TVL over an extended period of time, to see which areas are growing. This can alert you to developments that are still under the radar for many investors.
TVL is useful, but not perfect
TVL can be a very useful metric. It can help you spot when a cryptocurrency is undervalued, and can let you see how a particular blockchain compares to its peers. And, finally, it can let you put actual numbers to some of the hype and speculation you might see in the media. For example, before The Merge, many analysts were hyping the importance of staking for Ethereum. Well, several months later, it looks like they were right. Looking at TVL, it appears staking is very important to Ethereum.
Admittedly, TVL is not a perfect metric, and there are plenty of analysts who claim the number really needs to be cleaned and scrubbed before it can be used with any accuracy. However, based on my own analysis of TVL, I remain bullish on Ethereum long-term.
