The TVL represents the entire number and value of assets that are being staked in a protocol. Often used in DeFi.
When it comes to DeFi, TVL is an important factor to consider. On a basic level, it is the value that is coming from all the assets that are currently locked into a protocol. The TVL value is not representative of the value of outstanding loans, but it aims to explain the total amount of underlying supply that is being secured by a specific application by DeFi in its entirety.
The reason that this is an important number to look at when venturing into DeFi is that it can be used as a good metric for the overall health of the DeFi as well as its yield market.
Many sites and services offer the opportunity to see the TVL off a DeFi protocol, but they consider three factors in determining the number: calculating the supply, the maximum supply as well as the current price
Firstly, the market cap is determined by multiplying the circulating supply by the current price. Then to get the TVL ratio, the market cap is taken and divided by the TVL of the service.
It also makes sense that the higher the TVL ratio is the lower the value of the asset can be. This also comes into play when determining if the asset is overvalued or undervalued because if the ratio is under 1 it is probably undervalued.
One criticism of TVL is that it can be incomplete. TVL that is expressed in USD is misleading as it is often driven by fluctuations in the price of ETH or the underlying asset's price. Additionally, projects that lock collateral in ETH and a stablecoin like DAI, TVL denominated in ETH actually increases when the ETH price goes down because the DAI/ETH price ratio gets larger, and vice versa.