State of Compound Q3 2021

Introduction to Compound

Launched in September 2018, Compound is a leading interest rate protocol built on Ethereum that enables users to permissionlessly borrow and lend assets from a pool of collateral. It sets interest rates for those assets algorithmically using an interest rate model based on the proportion of assets lent out which it calls the utilization ratio. Compound launched its V2 protocol in May 2019 which introduced additional assets, and individual risk models and smart contract gateways for each asset, among other features. In April 2020 Compound replaced the administrator of the protocol with community governance, empowering COMP token holders to take control of the protocol. In June 2020 Compound began distributing COMP to users via a pioneering liquidity mining program reserving 42% of the total COMP supply to be distributed to users over the next four years.

Macro Overview

After seeing metrics fall across the board following the May market crash and subsequent slow down, activity picked up substantially as we reached the end of Q3 2021. By the end of the quarter, Compound reached new all-time highs in loans and deposits outstanding - a number that would’ve been even higher had it not been for the ~$3 billion of withdrawals from Compound markets following the COMP distribution bug on September 30th.

Outstanding loans grew 57% in the quarter as the market recovered following the crash and depositors looked to take out more leverage again. A significant driver of this growth was the increase in Compound markets liquidity over the past six months, which itself drove interest rates across all markets down to their lowest levels in history. Between rising collateral values, more favorable market conditions, and attractive borrowing costs, borrowers returned in droves in Q3. Unsurprisingly, most of this borrowing activity was denominated in USDC and DAI.

Including COMP borrower incentives, rates touched zero percent at the nadir of the market in July. It was only until the second half of the quarter that rates began to rise again as utilization increased in Compound’s most popular borrowing markets - USDC and DAI.

Outstanding deposits grew 48% in the quarter, driven by rising token prices as the market recovered, as well as fresh deposits chasing higher yields as activity picked up. WETH, USDC, and DAI contributed most to growth in Q3, though USDC and DAI’s impact is understated in the final numbers for the quarter due to the aforementioned withdrawals on September 30th.

Depositors are now receiving the least amount of interest they’ve received in Compound’s history as Compound markets liquidity builds. Although the story is nuanced across individual markets, with stablecoin yields having picked up materially in the quarter after reaching lows in July.

This trend of depositor growth outpacing loan growth is perhaps best captured by Compound’s aggregate utilization ratio. Since the beginning of 2021 utilization fell 20% from 58% to 38% as depositors flooded Compound markets with liquidity.

Historically low interest rates also caused Compound to have its first quarter in over a year with lower interest income than the prior quarter. Despite loans growing 57% in the quarter, interest income declined 19% from $96 million in Q2 to $78 million in Q3. This largely reflected lower interest rates charged on DAI and USDC loans for most of the quarter. DAI and USDC are the largest drivers of interest income.

Although Compound does not directly implement a fee, it implements a “reserve factor,” which is the percentage of the borrowers’ paid interest which can be used by governance or act as an insurance against borrower default which protects all the suppliers. Reserve factors vary by asset, with DAI having the highest reserve factor of all stablecoins (the most borrowed assets on Compound) on the platform at 15%. For this reason DAI is the largest contributor to this form of protocol income, contributing nearly 50% of protocol income. Thus with borrowing rates on DAI and other stablecoins at historic lows, protocol income saw its first down quarter in over a year falling 17% from $11 million to $9 million, despite strong loan growth.

Borrowing volume (originations) and deposit volume also decreased significantly in the quarter, despite strong loan and deposit growth. This is not surprising considering how activity only picked up in the tail end of the quarter as market conditions heated up.

Similarly, liquidations fell substantially in the quarter reaching their lowest level in over a year. Considering the first half of the quarter saw relatively muted volatility, and the second half of the quarter saw one-directional market movement to the upside, it is unsurprising liquidations fell 92% in the quarter from $333 million to $27 million, following Q2’s extreme market volatility.

Finally, one of the key drivers of all this activity and ultimately what jump started growth in Compound markets back in June of 2020, COMP token incentives, also were lower this quarter. This was driven by lower COMP prices following the May crash. Including token incentives paid to depositors and borrowers, Compound is not yet generating more interest than it is paying out in token rewards.

Micro Overview

Across the board Q3 was one of Compound’s quieter quarters in terms of parameter changes to Compound markets; all but its LINK market remained unchanged. However, Compound added four new collateral assets in the quarter including MKR, AAVE, SUSHI, and YFI. Below we overview Compound’s five largest markets.

USDC

In Q3 USDC became Compound’s largest market by loans outstanding and was the single largest driver to loan growth in the quarter increasing 101% from $1.1 billion to $2.4 billion. This far outpaced deposit growth in the quarter driving utilization up from 50% to 85% by the end of the quarter. This caused interest rates in the USDC market to rise substantially from 2.7% at the beginning of the quarter to 7.6% by the end of the quarter.

Despite the $1.3 billion of loan repayments following the COMP distribution bug on September 30th, USDC still accounted for 43% of all Compound loans outstanding by the end of Q3.

DAI

DAI was the second largest driver of loan growth in the quarter increasing 27% from $1.6 billion to $2.1 billion. Similar to USDC, this growth far outpaced deposit growth in the quarter driving utilization up from 69% to 83% by the end of the quarter. This also caused interest rates in the DAI market to rise from 3.4% at the beginning of the quarter to 4.7% by the end of the quarter. DAI has a slightly more favorable interest rate curve than USDC, which causes rates to be lower for a given level of utilization.

On September 14, 2021, Compound Proposal 059 - a proposal to compensate users affected by the unexpected increase in the DAI price to $1.30 on Coinbase Pro on November 26, 2020 - passed. A total of 6,817,798 DAI from the 16.4 million DAI in the market reserve at the time was used to compensate users (more on this in the governance section).

WETH

WETH is Compound’s largest market by deposits outstanding and was the largest driver of deposit growth in the quarter increasing 119% from $2.5 billion to $5.5 billion. About 40% of this increase was driven by ETH’s price rising throughout the quarter from $2,275 to $3,000, a 32% increase.

ETH accounts for 39% of Compound’s deposits outstanding.

USDT

USDT was largely a similar story to DAI and USDC in Q3. Loans outstanding increased 89% ub the quarter from $341 million to $645 million. Likewise utilization increased from 57% to 86% by the end of the quarter. This also caused interest rates in the DAI market to rise substantially from 3.0% at the beginning of the quarter to 5.6% by the end of the quarter.

WBTC

WBTC deposits increased 78% in the quarter from $1 billion to $1.8 billion. Similar to ETH, about 45% of this increase was driven by BTC’s price rising throughout the quarter from $35,047 to $43,825, a 25% increase.

Governance & Key Events

Key Events

COMP Distribution Bug

On September 30, Compound community members reported unusual activity regarding COMP’s distribution following the execution of Proposal 062, a proposal to split COMP rewards distribution. In the following days an address called drip() on Compound's Reservoir, triggering 202,472.5 COMP (~$68M) to be sent to the Compound Comptroller. According to Yearn Core Contributor, Banteg, about 1/4 of that COMP could be drained, although the exact amount of COMP at risk of being drained following this transaction has not yet been confirmed by the Compound Labs team.

Following the COMP distribution bug, the community passed a proposal to temporarily disable the distribution of COMP rewards. This change will prevent further COMP from being distributed until the correct logic is restored.

Governance Decisions

September 27, 2021 - Split COMP rewards distribution and bug fixes (Proposal 062)

On September 16, 2021, Compound Proposal 062 - a proposal to change the Comptroller logic to have two different COMP distribution rates for each and every market - borrow-side (compBorrowSpeeds) rate and supply-side (compSupplySpeeds) rate. This change enables governance to change the ratio, and more effectively incentivize, develop, and maintain markets. The proposal also includes COMP rewards distribution bug fixes.

September 16, 2021 - Dynamic Risk Parameters (Proposal 061)

On September 16, 2021, Compound Proposal 061 - a proposal to stream grants to Gauntlet for continuous market risk management to optimize yield, capital efficiency, and mitigate depositor losses - passed. The supported risk parameters include Collateral Factor, Close Factor, Borrow Cap, Reserve Factor, and Liquidation Incentive. As part of this engagement, Gauntlet will also build a Risk Dashboard and API for the community to provide key insights into risk and capital efficiency. The dashboard will focus on both the system-level risk in Compound and the market risk on an individual collateral level.

September 16, 2021 - Address Whitelist for Submitting Proposals (Proposal 060)

On September 16, 2021, Compound Proposal 060 - a proposal to create a whitelist for contributor addresses who will be able to submit Compound proposals regardless of the amount of COMP delegated to them - passed. The whitelist will be managed by a community multisig. The proposal will keep the 65,000 COMP threshold, which serves as a good spam deflection, but alleviates the burden for core contributors to have enough COMP delegated to them to make proposals.

September 14, 2021 - Compensation Plan 2 (Proposal 059)

On September 14, 2021, Compound Proposal 059 - a proposal to compensate users affected by the unexpected increase in the DAI price to $1.30 on Coinbase Pro on November 26, 2020 - passed. A total of 6,817,798 DAI from the 16.4 million DAI in the market reserve will be used to compensate users. This amount was determined by applying the 8% liquidation penalty to the 85,222,475 DAI that was repaid on November 26, 2020. This proposal follows the first Compensation Plan proposal for the Nov. 26, 2020 liquidation event that was rejected.

August 24, 2021 - Set Guardian to Community Multi-Sig (Proposal 057)

On August 24, 2021, Compound Proposal 057 - a proposal to transfer ownership of "Pause Guardian" from Compound Labs to Community Multi-Sig - passed. The proposal aims to further decentralize and ensure the security of the Compound Protocol. The Pause Guardian is emergency functionality used to pause supply, borrowing, or liquidation within a Compound market. The Multi-Sig requires 4-of-6 signers to approve any transaction, and currently includes @TennisBowling, @arr00, @blck, Compound Labs, Dharma Labs (@0age), and @jared.

August 16, 2021 - Collateral Factor Additions (Proposal 056)

On August 16, 2021, Compound Proposal 056 - a proposal to set the initial collateral factors for recently supported assets - passed. The vote enable LINK, MKR, AAVE, SUSHI, and YFI to be used as collateral on Compound. The initial collateral ratios were set as follows: Chainlink (LINK) 50%, MakerDAO (MKR) 35%, Aave (AAVE) 50%, SushiSwap (SUSHI) 40%, and yearn.finance (YFI) 35%.

August 2, 2021 - Add AAVE, SUSHI, YFI (Proposal 054)

On August 2, 2021, Compound Proposal 054 - a proposal to add AAVE, SUSHI, YFI as supported assets to Compound - passed. The initial parameters were set as follows: 25% Reserve Factor for each market, a borrow cap of 60K for AAVE and a borrow cap of 1500 for YFI.

August 1, 2021 - Add MKR (Proposal 053)

On August 1, 2021, Compound Proposal 053 - a proposal to add MKR as a supported asset to Compound - passed. The initial parameters for MKR were set as follows: 0% Collateral Factor, 25% Reserve Factor, and 25,000 MKR Borrowing Cap.

July 12, 2021 - Lower Proposal Threshold to 65,000 COMP (Proposal 052)

On July 12, 2021, Compound Proposal 052 - a proposal to reduce the governance proposal threshold from 100,000 COMP to 65,000 COMP - passed. The proposal comes after Compound governance was migrated to Governor Bravo, its new governance contract, in March. Governor Bravo introduced many new ways for the compound community to modify the governance process, including the ability to change the proposal threshold. The proposal was inspired by the observation that many CAPs (Compound Autonomous Proposals) struggled to make it to the 100k threshold even when there was clear communal support.

July 12, 2021 - Contributor Grant: Getty Hill (Proposal 051)

On July 12, 2021, Compound Proposal 051 - a proposal that creates a streaming COMP grant to Getty Hill as a Compound protocol price feed coordinator - passed. Over the last 6-months, Getty Hill has worked to improve Compound’s oracle system, having coordinated Compound Proposal 047 - a months-long effort to harden the Compound price feed. Getty requested an streaming grant for his prior and future efforts to coordinate oracle development.

July 5, 2021 - Close Deprecated Markets, Gas Savings (Proposal 050)

On July 5, 2021, Compound Proposal 050 - a proposal to reduce the gas costs of claiming COMP from multiple markets, and to allow deprecated markets (SAI, REP) to be liquidated - was passed. This proposal optimized the claimComp function to significantly reduce the gas cost of claiming COMP across multiple markets at once, by combining all rewards into a single transfer.

Governance Discussions

Compound Finance COMP Rewards

On August 2, 2021, “getty” posted ideas to the forum about how to better build community and distribute COMP from Compound’s treasury. He proposed five ideas, the three most popular of which are as follows:

• Separate supply and borrow side COMP rewards - shifting rewards to supply-side would better distribute COMP and improve protocol liquidity (this was passed as a separate proposal)
• Supersizing the grants program - building out a full-time team to run the program and take a more active role in development along with a larger budget
• Compound protocol usage fee reimbursement - start a program to help cover fees related to using Compound to boost user growth

Deploying COMP on Arbitrum and Optimism

On July 5, 2021, a “phosoup” posted a protocol development idea in the forums about deploying COMP on Arbitrum and Optimism to enable cheaper trading for smaller holders. In a response Robert Leshner shared that he’d reached out to the Arbitrum team to add COMP as a supported asset, and believed the community will be able to directly add COMP to Optimism through a bridge interface following launch. After a September 8 developer call consensus was reached around a proposal for an upgradable COMP token on Optimism deployed by Compound Governance with Governance being able to upgrade the token proxy contract on L2 directly. Initial features for L2 COMP will be a simple ERC20 function set with mint & burn controlled by the Optimism Gateway.

Grant Program Overview

Since the Compound Grants Program (CGP) began in April the Compound Grants Committee has allocated over $750,000 in grants to over 30 recipients. The committee funded a wide variety of things including open-source dashboards, analytics, hackathons, and research. When the grants program reached its end in September, program lead Larry Sukernik gave his thoughts on what worked and what didn’t work. What worked were reasonable, but generous grant sizes, attached milestones to grants, and betting on doers. What didn’t work was expecting everyone to come and request funding without guidance after launching the program, and committing to a 2 week turnaround. The grants team will be using these lessons from CGP 1.0 in order to design a better CGP 2.0.

Below are a handful of the most significant grants by size since June.

ETH Global "Hack Money" hackathon - $37,000

CGP was a top-tier sponsor of the ETH Global “Hack Money” hackathon. It also carved out $12k for hackathon bounties and prizes.

Messari Integration - $50,000

Messari publishes research catered to an audience of institutional investors. As part of the grant, Compound will be integrated into Messari's research portal. Messari will also publish 4 in-depth research reports on Compound, including quarterly reports, which overview the state of the Compound protocol to Compound stakeholders.

Rabbit Hole Integration - $50.000

Rabbithole sends users on "protocol quests" with the goal of increasing usage and developments for projects. As part of this grant, Rabbithole wants to send users on quests to supply and borrow assets on Compound. In the future, Rabbithole will send its users on more complex quests (e.g., protocol improvements).

Powerful Compound Dashboard - $20,000

As part of the second batch of grants, the Paperclip Labs team started work on an independent and open-source dashboard that shows a variety of data on Compound. The team is back to make this dashboard even more powerful. Based on input from the community, the team will add even more data sources to the dashboard.

STATION - $50,000

STATION is creating a peer-to-peer network centered around self-expression, contribution, and values. STATION is tackling these issues by creating profiles for individuals to express their work and discover others and Terminals for organizations (DAOs and protocols) to build a central hub to attract and engage newcomers and contributors.

Roadmap

Compound Treasury

At the end of the Q2 2021, Compound Labs announced Compound Treasury, a product designed for businesses and financial institutions that wish to tap into crypto’s interest rate markets. The company partnered with Fireblocks and Circle to create a product that allows organizations to access the USDC interest rates available on Compound without needing to worry about crypto-related intricacies such as private key management and crypto-to-fiat conversions. The product guarantees a fixed interest rate of 4% per year on deposits. The Compound Treasury will bring more dollar liquidity into Compound, potentially making borrowing rates more attractive.

Compound Chain

In preparation for the increasingly multichain world, on December 17, 2020, Compound Labs released a whitepaper for Compound Chain - an independent blockchain intending to serve as infrastructure for cross-chain interest rate markets. Three months later Compound Labs announced a prototype based on that paper called Gateway - a Substrate based blockchain governed by COMP token holders on Ethereum. Gateway’s goal is to provide users with the ability to borrow assets native to one chain (i.e Ethereum) with collateral from a different chain (i.e Solana). Gateway will also introduce a new stablecoin “CASH” which is Gateway’s native unit of account that is created by the protocol through borrowing, similar to the creation of MakerDAO’s DAI. All interest on Gateway is earned and paid in dollars, using CASH.

In a nutshell, Gateway enables blockchain interoperability by using a type of connector contract called Starport as the core mechanism to connect and transfer value between different chains. Starports exist as contracts on peer ledgers (such as an Ethereum smart contract) and have the ability to lock assets until they are released by a Gateway validator node.

Since March 1st, Gateway has been running as a testnet, connected to Ethereum’s Ropsten testnet.

Closing Summary

Although Q3 got off to a slow start in depths of the summer slow down, growth returned in the back half of the quarter driving many metrics to all-time high levels. As with most financial services businesses, Compound protocol will always exhibit some degree of cyclicality as it continues to grow and be adopted. That past nine months in 2021 were a testament to that.

The Compound community has much to look forward to in the coming quarters with the impending launch of Compound Chain, the key pillar of Compound’s multichain strategy, as well as Compound Treasury, a key enabler of institutional adoption. Similarly as crypto markets continue to heat up Compound may continue to benefit from increased demand for leverage. All eyes on Q4.

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