Why DeFi Pulse's Key Metric Is So Simple It's Confusing

The Takeaway:

Sometimes ideas can be so simple they are hard to understand.

This is especially true in the decentralized finance (DeFi) era of cryptocurrency, where entrepreneurs are building borrowing, saving and hedging facilities on the world computer, Ethereum.

One website, DeFi Pulse, has become the standard by which everyone checks the state of the industry. Built by Concourse Open Community, the data site has found something that almost all the projects in this space have in common: collateral. It then invented a common measurement: total value locked (TVL).

Yet just how TVL works has been somewhat confusing to those in the space.

"There are assets that are locked into a smart contract, and it's kind of that simple," Concourse Open Community co-founder Scott Lewis told CoinDesk.

Here's an illustration of why this is confusing. 

For simplicity's sake, let's say DeFi money market Compound let a user deposit ether (ETH) and also borrow ETH on deposited ETH collateral. So, for example, someone deposits 100 ETH and then borrows 40 ETH. But then they turn around and deposit that same 40 ETH into Compound.

In that case, Compound would report 140 ETH in deposits and 40 ETH in borrows. DeFi Pulse ignores obligations and just looks at what's actually there – that's it. So DeFi Pulse would see 100 ETH, and that's what it would report.

There are two upshots to this.

First, this helps explain why if a user goes to Compound's markets page, they would see $1.76 billion in total supply (as of this writing), but on DeFi Pulse it's at $818 million. A lot of users are depositing one asset, borrowing another, trading the borrowed asset for the deposited asset and then re-depositing. That's basic yield farming for the COMP governance token. So it increases the total supply but there isn't actually that much crypto there.

Read more: What Is Yield Farming? The Rocket Fuel of DeFi, Explained

Numbers get wild on the Compound markets page these days. Second, MakerDAO will always have an advantage on DeFi Pulse because depositors put in one asset (such as ETH, USDC, BAT, WBTC and others) and borrow another (DAI) that didn't exist before the loan was originated. So, whereas Compound and Aave let one user borrow from another user's deposits (reducing the total in the smart contract), on MakerDAO the loans don't reduce the amount of crypto in its smart contracts.

With complexity comes questions.

A recent analysis by Damir Bandalo, founder of Encode.Club, an organization for university-based crypto enthusiasts, argued that DeFi Pulse overstates TVL because, for example, if someone deposits on Compound and creates cTokens then deposits those cTokens in Balancer, one could argue that is a double count of the Compound deposit.

Bandalo's is really a philosophical question or at least an accounting question. If someone disagrees with the stance DeFi Pulse has taken, they can clearly create their own tool, but getting more fine-grained about it might also generate more confusing edge cases.

DeFi Pulse keeps it simple: It counts up all the actual assets seen in smart contracts and then multiplies that by the dollar value that asset could sell for in the spot market.

"If we're thinking about total value locked as how much people are locking in smart contracts, we think it makes sense to count everything," Lewis said.

On the other hand, Lewis acknowledges DeFi Pulse has to work hard to avoid double-counts that really are clearly double-counts. When Instadapp first started facilitating operations with MakerDAO, it could easily look like ETH deposited in Instadapp was also in MakerDAO, Lewis explained. That was the first double-count the site had to deal with and it's been chasing them ever since.

Read more: InstaDApp DeFi Site Raises $2.4 Million From Prominent Crypto Investors

But if a deposit creates a new cryptocurrency and that goes somewhere else, DeFi Pulse just counts the new asset.

"We are trying to make what is an extremely complicated system, of smart contracts and interlocking and interweaving DeFi protocols, into something that's interpretable," Lewis said. "As DeFi grew and DeFi got more complex, the edge cases started showing up."

The fact that members of the community criticize DeFi Pulse is part of how Lewis knows it matters. All of DeFi Pulse's code is checkable on GitHub. Anyone who wants to suggest improvements can do so.

"Our goal with TVL was not to assume that we ourselves had all the answers or even to know all the edge case are determinable or knowable," Lewis said.

Concourse Open Community, a sort of blockchain co-op, has a history of providing content that's useful to people in the Ethereum ecosystem. Its first content project was ConcourseQ, a way to learn about initial coin offerings (ICOs) before they went live.

"It was mainly known for due diligence for kind of less-reputable ICOs," Lewis said. That project has since been retired, but it started developing a community there.

It has since built ETH Gas Station (for helping to make sense of gas prices) and DEX.AG (a decentralized exchange aggregator).

Concourse started work on DeFi Pulse in December 2018 and launched it in February 2019, Lewis said.

"The main reason we wanted to launch it was because we thought there was this really interesting story where these DeFi projects, especially MakerDAO, had really figured out product-market fit," Lewis said.

Read more: Why DeFi’s Billion-Dollar Milestone Matters

The Internet Archive's Wayback Machine took its first capture on Feb. 23, 2019, when MakerDAO had a meager $277 million and it was 90% of the DeFi sector's TVL. The site currently lists a TVL of $7.22 billion.

The point, Lewis said, was to give "the community a good sense of the DeFi protocols that were actually getting value."

At the time, he explained, a lot of people in Ethereum didn't understand these projects. MakerDAO was just a stablecoin factory that most people didn't grok.

"Only a really small portion of the crypto community was understanding," Lewis said.

Lewis was partly inspired by a site that existed at the time called "ETH Locked in DeFi," but he thought they could improve on the model by counting other assets too. 

After all, Concourse Open Community did not believe that all the tokens that came out of the ICO boom were worthless. Some might even become collateral-worthy themselves.

Including "MakerDAO Dominance" in that initial design was a nod to "Bitcoin Dominance." It was also a nice way to measure increasing decentralization in the sector.

MakerDAO is bigger than it has ever been, and yet it is far, far less dominant.

Read more: One Billion, Two Billion, Three Billion, Four? DeFi’s Knocking on TradFi’s Door

"I think it's cool because MakerDAO has grown many Xs, but at the same time the rest of the DeFi ecosystem has grown and gotten more complex," Lewis said.

In fact, Lewis was a bit worried about whether DeFi Pulse was coded right to handle it when Compound took the top spot. But it turned out to work quite smoothly, same as when Aave became dominant on Tuesday.

His fundamental view, however, is that it doesn't really matter who has "dominance" so long as the DeFi sector keeps progressing. Lewis takes a very optimistic view not only about DeFi but about blockchains in general. He believes it is a sector where everyone's good work helps everyone else.

"One of the things we're seeing in DeFi is when one project wins, it's helping all the other projects too," Lewis said. "We are seeing a lot more collaboration in the DeFi community than we see in other communities." It's not a zero-sum game.

Read more: Aave Becomes Second DeFi Project to Overtake MakerDAO for Most Crypto Deposited

But Lewis takes this all a step further than many Ethereans do. He actually extends this view out to other blockchains.

Much like Andreas Antonopoulos, he doesn't think anyone has or will build an "Ethereum Killer," but he also doesn't think work on other blockchains has been wasted. In fact, as the footprint of DeFi expands beyond Vitalik's creation, DeFi Pulse is ready to expand with it. The site is currently seeking a grant from the Interchain Foundation that would enable it to start keeping track of similar projects in the Cosmos ecosystem.

"As the bridges to Ethereum and other smart-contract platforms get launched and get iterated, different types of transactions find homes at different places," Lewis said. "It will kind of be a win-win for everyone."