Reflections on Decentralized Lending - An Overview of Compound and Its November Data
Introduction
In a previous article about Aave, there was more of a focus on business data comparison with Compound. This article primarily introduces Compound’s development status, project background, token incentives, etc., with relatively less emphasis on data analysis. Compound itself is quite interesting.
This article involves discussions by the E2M team on the decentralized lending space.
Writing a separate article is also a way to show respect for the innovations made by Compound.
What innovations has Compound made? (Similar to Curve’s Ve token economics, regardless of their merits)
cToken architecture
Liquidity pool (point-to-pool) lending
Dynamic interest rates
Asset segregation
A key promoter of liquidity mining
The concept of governance tokens
As the development of Web 3.0 matures, does its open-source nature lead to each innovation quickly becoming a boon for others, ultimately benefiting capital investors? And does this vicious cycle eventually lead to a decrease in original ideas?
For example:
Recently, a friend who works on a payment and wallet project mentioned that many projects use the same open-source code. However, wallet projects with Silicon Valley backgrounds manage to secure investments from a16z and gain access to top resources, even though their underlying technology has no breakthroughs. The same is true for hardware wallets; after Trezor became open source, most hardware wallets could directly use its source code for commercial purposes without any cost. They only needed to address the lack of a security chip in Trezor. Decentralized derivatives exchanges essentially target a similar user group, but MYX, led by Sequoia China, can achieve high fundraising and valuations.
As Web 3.0 becomes more mature, does its open-source nature lead to a situation where every innovation easily becomes a stepping stone for others, ultimately benefiting investors the most? Does this vicious cycle lead to a decrease in creativity?
Better lending solutions will emerge, but it’s unclear how. Besides waiting for these solutions, what long-lasting actions can we take? For example, what elements should a good decentralized lending platform include? High capital efficiency, lending without collateral; low liquidation thresholds, protecting users’ assets even in highly volatile assets or extreme markets (like the Llama algorithm of CrvUSD).
Dongzhen: Is gaming similar? Gameplay can be easily copied. In categories like card and early simple games, Tencent, with its control over social networks and traffic monopolies, can reap substantial profits. However, this doesn’t entirely preclude companies like Blizzard, miHoYo, and NetEase from breaking through with products and IPs. In fact, the number of fun and creative games isn’t decreasing; games like Genshin Impact and PUBG are counterexamples, disproving the notion of stagnation in gaming.
How do we view decentralized governance?
CM-Marco: The Curve framework is quite good; its governance is centralized around functionality and is on-chain decentralized. The advantage is its simplicity at the base level, which reduces the likelihood of security risks. Vitalik advocates for minimal governance, avoiding governance wherever possible. Centralized governance in the early stages of a project is acceptable. Regardless of decentralization, the ultimate goal is minimal governance, with no governance module or tokens, and the protocol operating independently. This is not investor-friendly but is an ideal concept.
Dongzhen: The first principle, the protocol baseline: Compound has a poor baseline, requiring seven days to address issues, lacking sufficient hedging strategies. The second principle, the ability to correct mistakes. Setting up a framework requires maintaining basic freedom, and secondly, the ability to adjust. Vitalik’s approach is very interesting.
1. Introduction
1.1 Development History
Compound is one of the earliest DeFi projects, contributing significantly to the early development of decentralized lending. It pioneered many popular DeFi business models, tokenomics, and practices.
In 2017, Compound was founded by two University of Pennsylvania alumni, Robert Leshner and Geoffrey Hayes, and launched in September 2018. Robert Leshner, an economics graduate, had worked as a web designer and in financial services. He was a product manager at Postmates (a food delivery service focused on connecting locals with stores for last-mile delivery, essentially a take-out delivery company) before founding Robot Ventures. Geoffrey Hayes also worked at Postmates as an engineer and was the founder of Safe Shepherd. They attracted many to join, including senior developers like Antonina Norair, Design Director Jayson Hobby, Strategic Head Calvin Liu, Legal Advisor Jake Chervinsky, and others.
In 2019, the well-known Ethereum lending protocol Compound Finance v2 was officially launched, introducing the concept of cToken - interest-bearing assets.
In June 2020, Compound officially launched the COMP Token, transferring governance of the Compound protocol to a DAO organization, and using COMP coin as the core governance token. The primary purpose of introducing the COMP Token was to incentivize both borrowers and lenders to use the Compound protocol, a move that was extremely popular at the time. Many users participated in the protocol to earn COMP Tokens. The “earn-as-you-borrow” model kick-started the trend of “liquidity mining”.
COMP tokens were the first “governance tokens”, allowing anyone to own a stake in Compound and have voting rights on protocol proposals. According to its design, COMP tokens were directly distributed to its most important stakeholders, such as the protocol’s users. This distribution empowered and incentivized the community to collectively manage the protocol’s future through good governance. The primary reason users started using Compound was for mining, popularizing the term “liquidity mining”.
Compound also experienced several security incidents during its operation. For instance, on November 26, 2020, the price of DAI on Coinbase Pro rose to $1.34, leading to abnormal fluctuations in the Compound oracle price and triggering over $80 million in cryptocurrency liquidations. On September 30, 2021, after Proposal 62 was passed and executed, a contract error caused COMP tokens, which were supposed to be distributed slowly, to be wrongly issued, affecting about 280,000 COMP, valued at $80 million at the time.
These events laid the groundwork for Compound’s future strategic development. On August 25, 2022, Compound Labs launched Compound III, removing the concept of interest-bearing assets. Even the collateral for each loan was stored in the corresponding smart contract and could no longer be re-lent or accrue interest.
1.2 Team situation
According to the number of employees displayed on the official website, there are currently 17 employees. Many employees left with Lianchuang to work on Superstate.
Image source: https://compoundlabs.xyz/#hiring
1.3 Financing situation
2. Business situation
2.1 Overall TVL
After Compound TVL pioneered the concept of “liquidity mining”, its fluctuations increased significantly, and it basically coincided with the Defi Summer time period. Then, the major security incident that occurred at the end of September 21, accompanied by the arrival of Shenxiong, caused Compound to continue to decline and also changed its strategic direction.
Data source: https://defillama.com/protocol/compound-finance
2.2 Compound V2
TVL
After the launch of liquidity mining, the Total Value Locked (TVL) in Compound skyrocketed, coinciding with the DeFi Summer and the bullish crypto market, reaching its peak.
Data Source: DeFi Llama - Compound Protocol
Loan Analysis
The significant updates in V2 are quite similar to Aave V2, with the core features being cToken and Comptroller (Auditor).
Similar to Aave, each asset is integrated via a cToken contract, which represents the protocol’s balance in a format compliant with EIP-20. By minting cTokens, users (1) earn interest through the exchange rate of cToken, which increases in value relative to the base asset; (2) gain the ability to use cToken as collateral.
The Compound V2 Market section is somewhat misleading, giving the impression that each asset is a separate pool. At first glance, it seemed like many people had deposited a large amount of Eth in the protocol, but few were borrowing.
Looking at the Earn Distribution, apart from DAI, all are at 0%. This indicates that Compound’s token incentives to boost TVL have now fully shifted focus to Compound III.
Assets like Eth, WBTC, Chainlink, including some blue-chip DeFi, show high Total Earning but very low Total Borrowing. Low utilization of assets indicates a predominance of users on Compound who are long on BTC, ETH, and similar assets.
https://app.compound.finance/markets/v2
On the other hand, it can be judged to a certain extent that the utilization rate of UDSC, USDT, and DAI is close to the optimal utilization rate.Users exchange Eth, BTC and other collateral into stable coins.
https://app.compound.finance/markets/v2
2.3 Compound III
For large-amount loan users, there is a demand for absolute security. In addition, the collaterals are basically long assets.
TVL
The TVL of Compound III has been in a state of increasing TVL since its launch, breaking through $1b around November.
Data source: https://defillama.com/protocol/compound-v3
Overall lending situation
Because of the particularity of Compound III, the concepts of lender (Lending/Earning) and collateral (Collateral) are distinguished.
Total Supply = Lending/Earning + Collateral
Earning = $554.37M
Borrowing = $456.88M
Collateral = $993.66M
Data source: https://app.compound.finance/markets
Incentive situation
The coin-based incentive is 2,150. The Compound team is relatively traditional and conservative as a whole. It started liquidity mining in 20 years to stimulate V2 TVL. Now it has gradually transferred the incentive from V2 to III. It can be seen that the team does not have much desire for innovation. By resting on its laurels Come and stabilize TVL.
Data source: https://compound.finance/governance/comp
Lending status
Incentivized by COMP tokens, Net Earn APR is very popular.
USDC V3
Taking a single USDC V3 pool as an example, there is a rate of return of up to 8.34% under incentives. At the same time, because the most incentives are distributed, the lender pool is currently the highest, reaching $850M.
2.4 v2 VS III
COMP V2 returned the liquidity of interest-earning assets to users, and III took it back. The initial feature was the creation of a peer-to-peer pool to pursue capital efficiency, but III ultimately isolated assets and chose safety first. Thinking of what Brother Mo said about decentralized lending, the order book may still be one of the potential optimal solutions.
3. Token Economics
COMP itself basically does not have much utility other than its governance role.
3.1 Token distribution
Released June 15, 2020. The maximum supply of this token is capped at 1,000,000,000, and it is expected that all will be released in July 2024. The initial token distribution is as follows:
- 42.15% is allocated to liquidity mining
- 23.95% distributed to shareholders
- 22.46% allocated to founders and team
- 7.73% allocated to the community
- 3.71% allocated to future team members
Data source: https://www.coingecko.com/en/coins/compound/tokenomics
3.2 Token holdings
The overall distribution is relatively healthy, with 210,000 Holders, and the largest holder is less than 4%.
Data source: https://etherscan.io/token/tokenholderchart/0xc00e94cb662c3520282e6f5717214004a7f26888
3.3 Governance
In terms of governance, Polychain Capital’s token holdings do not have a monopoly, but with a large number of entrustments, Voting Power is basically the only one, even a bit like the “veto power” of traditional Web2.0 investment institutions.
What is very interesting is that essentially delegating voting rights to others is not like Convex or like that can make more profits, but it is a transfer of voting rights.
1.Governance process
Refer to the official release:docs.compound.finance
COMP token holders use three different components for management and upgrades; COMP token, governance module (Governor Bravo ) andTimelock. Together, these contracts allow the community to propose, vote, and implement changes through the governance functions of cTokens or auditors. Proposals can modify system parameters, support new markets, or add entirely new functionality to the protocol.
COMP token holders can delegate voting rights to themselves or an address of their choice. Addresses that have delegated at least 25,000 COMP can create governance proposals; any address can lock 100 COMP to create an autonomous proposal, which becomes a governance proposal after being delegated 25,000 COMP. Once a governance proposal is created, it goes into a 2-day review period, after which vote weights are recorded and voting begins. Voting lasts for 3 days; if the proposal receives a majority with at least 400,000 votes, the proposal will be queued in the Timelock and can be implemented 2 days later. In general, any changes to the protocol will take at least a week.
2.Decentralized governance: Brother Mo mentioned the Buddha during the previous discussion. In fact, if you think about it the other way around, a strong team can actually become stronger and bigger through centralization. Looking back at the decentralized governance of Compound and Aave, not only are they inefficient, but the proposals are essentially small changes that may make the protocol better, but to a very limited extent.
4. Limitations of Defi - Introduced by Compound Founder’s re-starting a business
Defi is more like a derivative of cryptocurrency. In the previous bull markets, it was closely related to the trend of the crypto market, and it has not yet reached the stage of actually solving a certain application scenario.
4.1 Turning Point - September 30, 2021 - Compound’s Erroneous Distribution
This content is adapted from: “Compound Upgrade Flaw: Over-issuance of 4 Billion to Users, Weaknesses in Decentralized Governance.”
Aave has not yet experienced any major security incidents, but the significant security incident that occurred with Compound on September 30, 2021, highlighted the fragile side of decentralized governance. This incident also seems to have been one of the motivations behind Robert Leshner’s departure from his position.
Start of Liquidity Mining in July 2020
In July 2020, Compound took the lead in issuing governance tokens COMP, symbolizing voting rights. Users who lent or borrowed using Compound would receive additional COMP token rewards. When the price surged, the COMP token rewards earned from borrowing could exceed the interest paid, effectively meaning users could make money from borrowing.
Proposal 62 - September 22, 2021
According to the operational rules of the protocol, Compound distributed 2,880 COMP tokens daily to all liquidity providers, half to borrowers and half to lenders. However, this equal distribution did not fully consider market demand conditions, leading to market distortions such as negative interest rates.
Developer Proposal No. 62 aimed to adjust the COMP token distribution rules, allowing for flexible adjustments of rewards. For instance, rewards could be directed only towards lenders to attract more deposits, or vice versa to attract more loans. The proposal stated that the current COMP token rewards, being identical for both lending and borrowing, could create adverse market conditions, such as negative interest rates. An example was the WBTC lending market, where the plan was to offer more COMP tokens to lenders, but the existing rules required the same rate for both lending and borrowing, which ultimately led to negative interest rates for borrowing WBTC.
In short, Proposal No. 62 sought to allow future lending and borrowing rewards in COMP tokens to be adjusted according to market demands, shifting from a fixed 50/50 to a flexible ratio like 70/30 or 20/80.
The Compound community began discussing this proposal in July and officially voted on it at the end of September. It was passed unanimously with nearly 730,000 COMP tokens in favor, and zero against, approving this functional upgrade. After the vote on September 28, there was a two-day waiting period (timelock) before the smart contract functionality would be altered.
Vulnerability Emerges on September 30, 2021
Unexpectedly, just as the new function was launched on September 30, reports of abnormal reward distributions surfaced. Some users even posted screenshots showing they had received tens of thousands of COMP tokens unexpectedly. According to Compound founder Robert Leshner, the “Compound: Comptroller” contract had a limited total amount of COMP, and the additional COMP tokens for mining distribution were actually in another contract, “Compound: Reservoir” (0x2775b1c75658Be0F640272CCb8c72ac986009e38), which was still distributing at a normal rate of 0.5 COMP per block. In the worst-case scenario, if the “Compound: Comptroller” contract’s tokens were depleted, about 280,000 COMP tokens, worth approximately $80 million, could be affected. Compound might have over-issued 280,000 COMP tokens, accounting for 2.8% of the total issuance.
In theory, the software bug could be quickly patched, but according to Compound’s governance rules, every new proposal required a two-day review period, a three-day voting period, and an additional two-day waiting period, totaling seven days. This meant that even if a new smart contract was proposed immediately, it would take at least seven days to become effective.
Therefore, the development community started by removing the COMP reward screen from the Compound website. Although the incorrect rewards had been issued and the functionality could not be updated immediately, at least without the visual interface, it was harder for users to widely share screenshots.
Within two hours after the incident, the community drafted Proposal No. 63, urgently seeking to halt the distribution of COMP token rewards. The proposal stated that it would temporarily stop the COMP reward distribution due to an error in the allocation mechanism of Proposal No. 62, which allowed users to borrow certain assets and receive excessive COMP token returns. The proposal aimed to halt COMP token distribution until the correct mechanism was restored.
Twelve representatives voted in favor, while 17 voted against. However, in decentralized governance, it’s not the number of people that counts, but the number of ‘votes’ represented by COMP tokens. The proposal was ultimately passed with 1 million votes in favor versus 160,000 against.
What is the reason for voting against the proposal ?
The reason for voting against the proposal is explained in the discussions on the Compound forum. Developers of automated finance bots like Yearn and idle.finance have spoken out, stating that this emergency proposal would disrupt the integration with other DeFi services. As a result, they recommend voting against it.
Compound, as a pioneer in lending services, has many DeFi applications built upon its lending market. These applications leverage Compound’s lending rates and COMP coin rewards to create more diverse financial innovation services.
To use a metaphor, Compound is like the foundational brick at the base, while Yearn and idle.finance are like other building blocks constructed upon it.
Proposal number 63 is an emergency brake measure that could potentially damage the integration of services like Yearn and idle.finance with Compound, affecting the normal operation of other DeFi applications. Hence, the community is divided. Some believe that it’s necessary to “stop the bleeding” for Compound first to prevent a drop in coin value. Others think it’s important to consider the DeFi applications built on Compound.
Usually, DeFi is likened to LEGO bricks, but in critical moments, it seems more like a house of cards built from playing cards.
Moreover, Compound developers have also urged on Twitter for users who received unexpected rewards to return 90% of the excess to the smart contract, keeping 10% as a white-hat hacker reward.
Compound’s founder, Robert Leshner, has threatened on Twitter those who received excess COMP coins, warning that if they do not return the funds, their information would be turned over to the IRS, implying they could face tax investigations and doxxing.
October 8, 2021
On October 8, the decentralized lending protocol Compound Finance announced the adoption of Proposal 064 to “fix the COMP Accrual Bug”. The purpose of this proposal is to fix the previous bug of abnormal COMP allocation in liquidity mining. The proposal states that this update will attempt to “fix the token distribution vulnerability caused by the implementation of proposal 062.” Until the problem is completely resolved, the exchange rate of the 6 affected trading markets (cTUSD, cMKR, cSUSHI, cYFI, cAAVE and cSAI) will be affected. Users will not be able to receive rewards from their staked COMP.
The proposal, largely drafted by community members who originally proposed the upgrade, received 1,037,107 votes in favor (voters included 27 key addresses including Compound CEO Robert Leshner, a16z, Gauntlet, and Pantera Capital) and 0 votes against.
4.2 Robert Leshner leaves Compound and starts his own business again
On June 28, 2023, Blockworks reported that it received US$4 million in equity financing. Investors participating in this round of financing include ParaFi Capital, 1kx, Cumberland Ventures, Coinfund and Distributed Global. On June 29, 2023, Compound founder and CEO Robert Leshner announced the establishment of a new company, Superstate. The company is targeting the current hot field of RWA. They are committed to purchasing short-term U.S. Treasury bonds and putting them on the chain, making secondary records through the blockchain, and directly The ownership share of the circulating fund is traded on the chain.
At the same time, Compound announced the appointment of a new CEO-Jayson Hobby, who works at well-known companies such as Coinbase and Uber. If compared to many other projects, CEO starting a business is considered a negative behavior, but the optimistic market sentiment is considered to be a message for Compound to explore RWA. In the six days from June 25 to June 30, the maximum increase was about 100%.
Superstate is focused on developing regulated, compliant investment vehicles using public blockchains that are accessible to U.S. investors. The company, led by Robert Leshner, founder of DeFi lending platform Compound, has earmarked funds for team expansion, creating a private equity fund for institutional investors, and developing a framework for a tokenized public fund.
Robert Leshner said of DeFi at the Permissionless conference in Austin, Texas (September 11-September 13, 2023): “I have a strong opinion on this, institutions are not coming. These institutions are not interested in trading. Or borrowing Ethereum, or Chainlink tokens, or some random shitcoin that someone made last night at 2 a.m. isn’t that exciting. “They (financial institutions in this case) like the idea of DeFi — they like to use it as a more powerful, more The idea of a transparent, more efficient, cheaper and better way to build financial products,” but they are more inclined to use it to trade traditional assets like stocks, bonds and currencies rather than cryptocurrencies. He believes that TradFi institutions Want to use DeFi technology without buying into the token economy that the ecosystem relies on. In his view, traditional financial companies joining DeFi will need to tokenize traditional financial assets and abandon crypto-native assets. Leshner said: “This is A huge divide that will define the next decade of DeFi. “
Leshner believes that the first wave of DeFi protocols showed institutional investors what was possible with tokenized assets, and that these tools were perfect as proof-of-concepts about what smart contracts or distributed technologies could do.
On November 15, according to Coindesk, the blockchain-based asset management company Superstate completed US$14 million in financing. This round of financing was led by CoinFund and Distributed Global, and included Arrington Capital, Breyer Capital, CMT Digital, Department of XYZ, Folius Ventures , Galaxy Digital, HackVC, Modular Capital, Nascent and Road Capital Management participated in the investment.
So looking back, the market distortion in June was entirely due to the rise of RWA narratives at that time, and the market’s FOMO sentiment was obvious. Whether judging from Robert Leshner’s speech and Twitter title, or judging from the official websites of Compound Labs and Superstate, the core members of Compound Labs should have differences in strategic development.
4.3 Thoughts
In fact, the small case mentioned above is a microcosm of the development trend of Web 3.0—simply put, it’s what many people have been discussing recently, the coin and blockchain circles. One school of thought believes that Web 3.0 loses its meaning without tokens, thus requiring wave after wave of new narratives, and then innovations on top of economic models and Ponzi schemes, such as Friendtech and Blast. Another school of thought believes that a critical process of Mass Adoption is to abandon tokens and directly introduce the technical advantages of blockchain into traditional industries, for example, RWA (Real World Assets) proponents (Of course, there are also those who choose a balance between the two, such as MakerDAO, with EndGame mining + the treasury becoming RWA).
Regarding the Compound team’s extremely slow iteration speed and the TVL accumulated through its first-mover advantage, Leshner realized that DeFi has no barriers to entry, and decentralization cannot become a barrier. He believes that the truly wealthy people might not be interested in even Chainlink or Ethereum, but are interested in how blockchain can revolutionize the financial system.
After the last discussion, I’ve been thinking about some questions: What problem does decentralized lending solve? Maybe Compound’s choice could one day seamlessly integrate with RWA, introducing a “huge pump”? But if Compound has this idea, would Robert Leshner still resign? Wouldn’t it be possible for Compound IV to directly combine with RWA?
Disclaimer：
- This article is reprinted from [mirror]. All copyrights belong to the original author [Steven，E2M Researcher]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
- Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
- Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.
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