COMP Distribution Speeds - The End of CompSpeeds?

Over the last few weeks, we have analyzed Compound and particularly compSpeeds for each market. We have modeled a wide range of speeds and did our best to estimate the resulting liquidity. While we have learned an immense amount about the protocol, its interest rates, and the effects of adjusting the supply and borrow compSpeeds, the result wasn’t what we hoped for.

When we jumped down this rabbit hole, the goal was to optimize the existing compSpeeds so that the protocol gets more bang for its buck. That is, we wished to find a way to reduce compSpeeds without decreasing market liquidity too much. Unfortunately, it wasn’t as meaningful as we hoped.

The questions we asked ourselves went something like this:

  1. How do we optimize the compSpeeds such that the protocol gets more bang for its buck?
  2. Do legacy markets (and markets with a clear excess of capital) require compSpeeds at all?
  3. If the goal is liquidity for borrowers, are there more efficient methods to achieve that? (eyeing DAI)
  4. How much participation is Farmers vs. Borrowers? (Farmers are seeking the best yield by parking their capital. Borrowers are users who supply a different asset than they are borrowing)
  5. What are the target yield rates for each market? Why do the yield rates differ on DAI vs. USDC & ETH vs. WBTC?
  6. How much liquidity does each market require? (Isn’t the kink supposed to ensure there is sufficient liquidity?)
  7. Is COMP farming influencing interest rates and utilization?
  8. What is the cost-benefit of compSpeeds?
  9. What is the objective of a compSpeed?
  10. Do we need compSpeeds on substantiated markets?

Many of these questions are rabbit holes in themselves. We have found answers to several of them. (Abbreviated answers below. We’re happy to go more in-depth)

  1. How do we optimize the compSpeed such that the protocol gets more bang for its buck?
  • A complicated question that is difficult to prove. If we assume all participants are Loopers (users supplying and borrowing the same asset for profit), then incentives change in tandem with market participation. Hard to say what will happen with all of the external factors involved.
  1. Do legacy markets (and markets with a clear excess of capital) require compSpeeds at all?
  • No.
  1. If the goal is liquidity for borrowers, are there more efficient methods to achieve that? (eyeing DAI)
  • Yes, lobbying MakerDao to implement the Direct Deposit Module would be a good example. (Something GFX Labs is working on)
  1. How much participation is coming from Farmers vs. Borrowers? (Farmers are seeking the best yield by parking their capital. Borrowers are users who supply a different asset than they are borrowing)
  • Focusing on the ETH market and its participants shows significant natural activity.
  1. What are the target yield rates for each market? Why do the yield rates differ on DAI vs. USDC & ETH vs. WBTC?
  • We know the market is happy with the current rates, but beyond that, it is a guess. The next best data points are the much larger perpetual futures and futures markets.
  1. How much liquidity does each market require? (Isn’t the kink supposed to ensure there is sufficient liquidity?)

  2. Is COMP farming influencing interest rates and utilization?

  • Not if we assume all participants are Loopers (half-answer).
  1. What is the cost-benefit of compSpeeds?
  • At a high level, the protocol pays in COMP and collects via the reserve factor revenues from the additional funds deposited.
  1. What is the objective of a compSpeed?
  • In our opinion, the compSpeed is for bootstrapping new markets.
  1. Do we need compSpeeds on substantiated markets?
  • Probably not.

Questions 8-10 are the ones to focus on. The protocol is currently spending ~$160m in compSpeeds. If we agree the primary use case of compSpeeds is incentivizing liquidity (also known as TVL), it can be said that the protocol has more than enough liquidity in most markets and is thus overspending on liquidity.

While we wish there were a clear optimal proposal for the community to consider, we are left with a much harder question: how valuable is liquidity?

If reducing annual compSpeed spend from $160m to $80m would result in the TVL dropping by $2b, would this be problematic? What about a reduction from $160m to $40m that causes TVL to drop by $4b? What if we got rid of it altogether and TVL dropped by $6b?

Instead of projecting future activity, we can also look at historical performance. Over the last month, COMP has dropped nearly 40%, and thus the dollar value of rewards dropped by nearly 40%. However, TVL only dropped 12% over the same period, while ETH dropped by 11% at the same time. This, along with a significant decrease in yields, demonstrates that Compound participants are inelastic to yield.

We have spent close to 100 hours trying to find an objective conclusion to present to the community. At this point, it is clear we could spend hundreds more hours researching and analyzing the protocol but we wouldn’t be addressing the main point anytime soon if we did that.

What is the primary objective of Compound? We think it is to provide a place for people to borrow assets. To achieve that objective, Compound has users who supply assets, and to operate without a central entity, interest rates are chosen programmatically.

What is the difference between the interest rate curve’s purpose and compSpeeds?

  • The interest rate curve has one main goal: to ensure there is liquidity available to be borrowed and for lenders to withdraw from the pool. The invention of the v2 interest curve (in use by modern ctokens) includes a “kink” parameter. Simply put, when the market utilization exceeds the kink (generally 80%), the curve steepens to incentivize new deposits and repayments. The interest rate curve’s subgoal is to provide an opportunity for lenders and borrowers to utilize the protocol by providing competitive interest rates.
  • compSpeeds distribute a fixed amount of comp per block to a market and thus its participants. The COMP distributed acts as an incentive to participate in the market. Markets with low participation (like new markets) may benefit from an incentive to increase participation.

What should the protocol do?

In an ideal world, we go back to a neutral state and adjust from there. Reduce compSpeeds to zero and let the market rebalance. Once the market is at its neutral state without incentives, we can update the interest curves so that it targets a sufficient amount of liquidity while offering competitive interest rates. Then, for markets with low participation, we can add compSpeeds until there is sufficient participation.

However, that path is more of the “rip the band-aid off and do some aggressive physical therapy.” Perhaps a more balanced approach for the protocol to consider is to update interest rate curves and simultaneously and linearly reduce compSpeeds across the board. The primary downside is that it will take a long time to linearly reduce compSpeeds, and it introduces noise into the process of updating the interest rate curves.

So we leave the community with a decision to make:

  • Option A: Rip the band-aid off and aggressively perform physical therapy, at the cost of shocking market participants but with the benefit of getting healthy faster.
  • Option B: Carefully remove the band-aid and build a long-term physical therapy schedule.
  • Option C: Y’all crazy. Compound is fit af. Nothing is wrong.
  • Option D: Other - comment below

Here is a link to a Google Sheet with the entire protocol modeled. If you are interested in playing around with the protocol and seeing how it functions, feel free to make a copy. We have it configured so it pulls the current info straight from the blockchain into the sheet. If you notice the info on the sheet is dated, send Getty a message and he can call the function to update it. Unfortunately, it is not at a state where we can make the function publicly available.

Separate from the options above but related, GFX Labs has a long list of improvements it wants to bring to Compound, and this post is the first big project we’re interested in tackling. We think Compound is in need of significant maintenance and improvement and we’re interested in allocating significant resources towards the protocol. Getty is currently receiving 500 COMP/year as a part-time contributor. If the community is interested in GFX Labs (Getty & crew) participating in a more meaningful fashion, we would love to talk about canceling Getty’s grant and opening a new one for GFX Labs. More information to follow at a later date, just want to begin floating the idea.

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Over the last month, COMP has dropped nearly 40%, and thus the dollar value of rewards dropped by nearly 40%. However, TVL only dropped 12% over the same period, while ETH dropped by 11% at the same time.

Whales and protocol are often making their decisions relative to other options for using capital. If everyone else’s reward tokens went down in price at the same time, then one would expect little change.

In the medium run, capital is indeed sticky, because as a large holder, when you transfer your funds from one protocol to another, the rates go down on the one you moved to, and up on the one you left, just by virtue of your move. And chasing a half percent is going to cost you a bucket of gas, and only benefit you a week or so, maybe. In general it’s better to pick a risk profile, and let other people’s money balance things out between protocols. Now if gas prices were tiny, sure, move aggressively, but not in the world we currently live in.

So any small changes in rates are probably going to take months to see the effect of. Lenders will over time balance lending across platforms based on rate and a little on risk. I’m less concerned about the lenders (even though I am one). Large lenders will just shift to roughly equalize yield, over longer timeframes.

Borrowers are the primary concern to me. In the current scheme, borrowers are doubly incentivized. First the base rate they are paying is reduced because of lender’s willingness to lend at reduced rates for rewards, and then regular rewards they get are on top of that. I’d be interested to see any guesses as to how this would affect things.

As for loopers, perhaps they come in two kinds. Leverage loopers are looking to gain exposure on coin prices moving up, by lending eth/btc and borrowing stables. I don’t think they would be very affected by changes, since most of their expected profit is from elsewhere. COMP farming loopers, who are borrowing and lending stables, would be the most affected by dropping yields. A lot of the apparent TLV in the system comes from them (judging only by the size of the loop winds and unwinds that I see).

In your spreadsheet, what do you mean by loop costs and loop rate? I would have assumed that there were more loopers than 10% of lending and 10% of the borrowing (if that’s what it means).

[Edit: Or is this just saying how profitable it is to loop?]

Great writeup @GFXlabs, and welcome to the community.

Broadly speaking, I think the protocol should be willing to experiment with rather drastic changes if the downside of those changes isn’t permanent. For example, if for one week we cut “growth spend” from $160M to $0M in COMP subsidies per year, we would clearly lose some TVL. But if the week after that we go back to spending $160M (or more) per year, TVL would likely return rather quickly.

In short, the cost-benefit of running an experiment like this one is rather skewed towards the benefit. More specifically, the cost is losing some TVL in the short-run in return for the benefits of (i) gathering data on Compound’s users, and (ii) potentially, learning that the protocol is overpaying for TVL, cutting COMP growth spend, and saving dozens of millions in the process.

I’m hugely in favor of choosing Option A or B.

  • Option A: Rip the band-aid off and aggressively perform physical therapy, at the cost of shocking market participants but with the benefit of getting healthy faster.
  • Option B: Carefully remove the band-aid and build a long-term physical therapy schedule.
  • Option C: Y’all crazy. Compound is fit af. Nothing is wrong.
  • Option D: Other - comment below

Entirely separately, the game theory of running this experiment could be fascinating. No protocol loves handing out what is now hundreds of millions of dollars in its native token to get users to use the project; it’s simply a necessary evil if the guy you’re competing with is doing it. If Compound stops issuing so much COMP, it’s possible others will follow, which may improve the economics of the entire category of lending and borrowing protocols. On the flipside, it’s also possible that competitors will spend more in an effort to take advantage of what Compound is doing (spending less). Either way, the only way we’ll find the outcome is if we play the growth spending/no spending game. I think we should play ball.

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Loop costs is the interest paid & earned on the base market.
Loop comp supply earnings are the comp earnings from the supplying side of looping.
Lopp comp borrow earnings are the comp earnings from the borrowing side of looping.
Total loop rate is the sum of the three.

I just broke it down because it was helpful for some of the work we were doing. Generally, the entire sheet could be simplified, but I think it is beneficial to exam each component and be able to manipulate them.

PS: I think if you click on the cell, you should see the math/query.

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Finally saw some constructive discussions on fixing the dying token economics.

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I believe it’s worth reminding, that it isn’t protocol-owned tokens are being distributed to begin with.

I’ll refer you to source:

Distributing COMP

A collection of Compound’s most important stakeholders share the ability to upgrade the protocol:

  • 2,396,307 COMP have been distributed to shareholders of Compound Labs, Inc., which created the protocol
  • 2,226,037 COMP are allocated to our founders & team, and subject to 4-year vesting
  • 372,707 COMP are allocated to future team members (we’re hiring!)
  • 4,229,949 COMP are reserved for users of the protocol
  • 775,000 COMP are reserved for the community to advance governance through other means — which will be announced at a future date
  • 0 COMP will be sold or retained by Compound Labs, Inc.

So, those approx. 4.2M COMP tokens, are tokens of users of Compound protocol, not protocol-owned tokens. And they are being distributed to users of protocol over 4 years. There’s nothing about subsidising anything at the core. So yes, of course it’s always make sense to talk about more efficient distribution, but stopping it completely is kind of out of the question, unless we talking about team and VC portion of tokens reduced proportionally as well and returned back to protocol.

It’s kind of easy to say let’s not pay someone else share and keep your own intact. :slight_smile:

Indeed, there are certain issues with distribution like recursive farming, which kind of makes distribution kind of unbalance in favor of big capital owners, but things like some markets are doing well by themselves and don’t need distributions is kind of slippery road. They getting it not so much because they NEED for something, but rather because it’s a mechanism of distribution governance tokens to protocol users.

Again, it’s not some mystery unallocated protocol-owned treasury tokens, that is portion of governance tokens specifically allocated to users of protocol, and primarily not for financial benefits, but rather for a governance rights.

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While we agree the original intention by Compound Labs was to use the compSpeeds to distribute COMP to users of the protocol, we think there are more efficient methods to distribute COMP to users. Currently, the majority of COMP is accruing to farmers who are selling COMP. As the protocol decreases its spending on compSpeeds, we can fund new initiatives to drive growth and distribute COMP.

We don’t seek to end compSpeeds altogether but suggest reconsidering their current usage and changing to a more targetted approach.

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GFXLabs has brought up some really good questions and points.

Okay, sure, COMP token is intended to be distributed to its users for governance rights, but how do we evaluate the extent to which we are succeeding in this? What does success look like? What does failure look like?

How can Compound grow when the metrics to self-evaluate are so unclear?

I believe option A - dropping compSpeeds to 0 - is the best option. I don’t see the purpose of continuing such a large liquidity mining program. We should focus liquidity mining on new initiatives like starports and Compound Gateway not the OG protocol on Ethereum.

If the primary concern is the continued distribution of COMP to users, then refocusing towards new initiatives will solve that.

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