Simple Summary
A proposal to launch Morpho-powered lending vaults on Polygon, with $1.5 million each from Polygon and Compound for incentives. This collaboration would give Compound improved risk controls, faster asset listings, and a path towards sustainability.
Motivation
Since Compound V3 was released in August 2022 by Compound Labs, the protocol has not made meaningful updates to its tech stack. Over the past year, Compound’s market share has declined. Compound V3’s competitiveness will be further pressured with the upcoming versions of Aave V4 and future iterations of Morpho and other protocols. At this time, most of the original Compound Labs team has moved to other projects, including Legend. Existing development work is now one-off and often with open questions. Without a well-capitalized team dedicated to developing the protocol, Compound risks losing market share.
Partnership Solution
As one of the first successful money markets protocols in DeFi summer, Compound benefits from strong brand equity and a robust treasury. Morpho is a trustless lending primitive with permissionless market creation, with Morpho vaults launching in 2024 and growing to $6.1 billion today. Polygon PoS is an EVM-compatible, proof-of-stake sidechain with $1.06 billion TVL as of January 2025.
This proposal is for the Compound DAO to launch its own Morpho Vaults on Polygon. With Aave deprioritizing Polygon, there will be natural product-market fit with Compound vaults. The motivation for the Polygon community is to grow TVL in their ecosystem - once vaults and markets are deployed, they will be immutable. The Compound DAO will be Owner
and Gauntlet will serve as the Curator
of the vaults to optimize risk-adjusted returns. The Morpho Association will assist in the technical implementation.
The Compound DAO will unlock a new revenue source from the vaults and accrue all revenue generated during the joint incentives trial program. As part of the partnership, Polygon Labs will offer $1.5 million in POL tokens for incentivization with a target deployment timeline over 3-5 months. The Compound DAO will match this with $1.5 million in COMP tokens for incentivization.
Benefits to Compound
- The benefits of Morpho’s tech stack include faster asset listing (<1 day) and dynamic parameter adjustments (real-time rather than governance overhead). This results in more efficient interest rate optimization and higher capital efficiency, given the stronger risk control mechanisms that curators can leverage
- Asset listing and parameter adjustments are governance minimized, thus reducing overhead for the Compound community
- Clear line-of-sight to TVL growth as Aave deprioritizes their Polygon deployment and recently disapproved a Polygon partnership, with $518M TVL looking towards an alternative solution on Polygon
- Morpho contracts are immutable once deployed, therefore it is technically infeasible for Compound to lose ownership over the vaults without a governance vote
- The Morpho protocol is extensively audited, and little development resources are required from the Compound DAO to launch vaults
- Joint incentivization with contributions from Polygon to boost ROI for the Compound DAO
- Case studies
- There is no leap of faith required to be confident in Morpho’s ability to supercharge growth
- Gauntlet vaults have grown to be the largest on Morpho, expanding to $760 million supply across Ethereum and Base after launching from zero in March 2024
- In a similar fashion to this partnership, Moonwell launched Morpho vaults on Base, growing to $165 million supply over the past several quarters
- Seamless <> Morpho vaults, curated by Gauntlet, have grown to $12.5 million in deposits in under a week
- Ionic <> Morpho vaults, curated by Gauntlet, have grown to $40 million in supply in the last several weeks
- There is no leap of faith required to be confident in Morpho’s ability to supercharge growth
Benefits to Morpho
- Greater distribution channel as Morpho aims to serve as an underlying infrastructure for decentralized lending
- Expansion to Polygon chain following Morpho’s multi-chain vision
- Collaboration with Compound, a keystone on decentralized lending, will allow both core teams alongside curators to scale Compound into becoming the pillar for lending within Polygon DeFi
Benefits to Polygon
- Mitigate chain TVL concentration risk following Aave’s move to deprioritize their Polygon deployment
- Bring Morpho, a faster-growing lending protocol, to the Polygon ecosystem ahead of many chains
Partnership structure
- Incentive share
- $3.0 million distributed over a target of approximately 120 days to bootstrap growth
- Split equally between Compound DAO and Polygon, with token pricing at the time of the on-chain proposal
- Revenue share
- The Compound DAO will be the sole Owner of the vaults and will accrue all revenue generated during the joint incentives trial program. The Performance Fee will be set initially at 10% (roughly equivalent to a 10% “reserve factor” in Compound terminology).
- At some future point, Gauntlet may introduce a fee-splitter contract as revenue share for the work Gauntlet performs as the vaults’ Curator. An example fee splitter contract between Moonwell and Block Analitica is here. This revenue split cannot be implemented without permission from Compound DAO, given the DAO will be the Owner of the vault. For now, Gauntlet will not charge any fees for the Curation work.
- Morpho’s fee switch is currently off (0%). The Morpho DAO may turn on the fee switch at some point in the future, though so far, it has never been activated and has no plans to do so soon. The fee recipient address and the fee rate are the only parameters that the Morpho DAO can operate in Morpho markets.
- Onchain partnership structure
- Owner: Compound DAO
- Curator: Gauntlet
- Allocator: Gauntlet
- Guardian: Compound DAO
- For more details on Morpho Vault roles, see here
- Front-end and user interface for vaults
- The user interface for supplying and borrowing is intended to be supported on the Compound user interface following community approval. We also invite external third-party providers to build their own interface to increase the distribution of the vaults
- Timeline
- Pre-launch requirements
- Initial vaults and markets launched on Polygon
- Morpho rewards contract deployed
- COMP tokens bridged to Polygon and deposited into the Morpho rewards contract
- Gauntlet’s internal curation risk management systems to be built and then deployed for Polygon
- MVP user interface developed for users to deposit, withdraw, and borrow
- Launch phases
- Phase 1: Bootstrapping Markets (Weeks ~1-4)
- Determine initial supply assets and respective collateral markets
- Launch vaults with targeted risk levels
- Begin incentives distribution to vaults and markets
- Prioritize supply growth while building organic borrowing demand
- Phase 2: Drive Market Equilibrium (Weeks ~4-8)
- Fine-tune rewards distributions and allocations to optimize for utilization levels and ensure sticky TVL
- Phase 3: Expand Integrations (Weeks ~8-12)
- Continuously identify and implement new collateral markets for addition and launch any separate vaults as needed
- Partner with integration providers to broaden distribution
- Phase 4: Taper Incentives (Weeks ~12-16)
- Gradually reduce incentives iteratively, informed by Gauntlet’s simulation models, to minimize market shock and maximize ROI
- Phase 5: Retrospective (Weeks ~16-20)
- Conduct analysis on incentives spend ROI, market growth, and risk management to inform future iterations of similar programs
- Phase 1: Bootstrapping Markets (Weeks ~1-4)
- Success metrics
- 30 days: vault TVL, insolvency risk
- 60 days: vault TVL, utilization levels, insolvency risk
- 90 days: vault TVL, utilization levels, insolvency risk, incentive spend efficiency
- Pre-launch requirements
Mechanism Improvements
Newer lending infrastructure such as Morpho offers benefits to Compound’s mechanisms. Below, we outline key features in Compound V3 across critical areas such as liquidation mechanisms, interest rate curves, reward distribution, development speed, and governance risks.
1) Liquidation Mechanism
The liquidation mechanism in Compound V3 has fundamental drawbacks, which increase the tail risk to the protocol. We posted a more in-depth analysis of this liquidation mechanism in the forums in January 2024. In short:
Unlike other lending protocols that use a collateral factor and liquidation threshold to provide a buffer against insolvency, Compound V3’s mechanism relies entirely on liquidation penalties and the storefront price factor as the buffer.
In Compound V3:
- When a user gets liquidated, their entire position is absorbed by the protocol.
- The protocol takes ownership of the user’s collateral and repays the liquidated user in the base asset minus a liquidation penalty.
- As a result, the liquidation penalty becomes the primary insolvency buffer—which is a substantial risk.
Potential Risks:
- Lower Liquidation Penalties = Lower Buffer
To remain competitive, protocols must offer low liquidation penalties, as users won’t engage if the penalties are too high. However, low penalties drastically reduce the buffer against insolvency. Per our analysis, in Compound V2, a 70% liquidation threshold and a 5% penalty provided a significant post-liquidation insolvency buffer, allowing for a 42.9% collateral price drop until the protocol faces insolvency. In V3, that same setup is far riskier because the liquidation penalty alone determines the buffer, allowing for only a 2.06% collateral price drop until the protocol faces insolvency.
- No Partial Liquidations = Inconvenient UX
Compound V3 does not allow partial liquidations. Instead, it removes the entire user from the protocol. This creates an inconvenient user experience and increases the protocol’s risk of insolvency when absorbing large positions.
- Collateral Risk After Absorption
Once collateral is absorbed, the protocol takes on the risk of selling that collateral at a stable price. If the collateral’s value decreases post-liquidation, the protocol can suffer significant losses. We’ve already seen instances of this risk materializing on Arbitrum and Base Comets, where liquidated collateral wasn’t repaid by liquidators for over 10 hours, leaving the protocol vulnerable.
In contrast, Morpho’s liquidation mechanism allows for a greater insolvency buffer by avoiding the absorption mechanism. It offers more traditional partial liquidations that minimize the variance in risk and better protect both users and the protocol.
2) Interest Rate Curves: Dynamic Reserve Factor
Unlike Compound V2, which uses a linear kink model with a static reserve factor, Compound V3 introduces independent borrow and supply curves that create complexity.
Potential Drawbacks:
- Dynamic Reserve Factor = Unpredictable Outcomes
In Compound V3, the implied reserve factor changes dynamically based on utilization. This makes it difficult to maintain a positive reserve growth at lower utilizations without setting a high borrow APR intercept. The result is either:
- Negative reserve growth at low utilization, cutting into protocol reserves.
- Poor UX, as users are discouraged by strange interest rate curves.
- Higher Governance Maintenance
The dynamic reserve factor also requires frequent governance updates to fine-tune interest rate curves, especially during periods of low utilization. This introduces more opportunities for errors and risks to reserves.
In contrast, Morpho’s adaptive interest rate curve:
- Dynamically updates based on market conditions.
- Incorporates a Reserve Factor, ensuring consistent positive reserve growth.
Morpho’s design significantly reduces governance overhead and risk to reserves.
3) Reward Distribution: Inefficiencies and Overhead
The reward distribution mechanism in Compound V3 requires constant maintenance.
Complications:
- Separate Reward Contracts for Each Chain
Compound V3 requires a separate rewards contract deployment on each chain. These contracts must be topped up through governance to ensure users can claim their COMP rewards. This process is inefficient and creates maintenance burdens for governance.
- Unused COMP Tokens Locked in Contracts
Once COMP is allocated to a rewards contract, it cannot be withdrawn. If rewards are reduced or cut, any remaining COMP in the contract is effectively stuck and can no longer be used.
- Lack of Visibility for Other Rewards
For example, during the ARB rewards campaign in the Arbitrum USDC comet, users were unaware of these additional rewards because they weren’t visible in the front end. This further highlights the UX complexities in Compound V3’s reward distribution.
Morpho’s reward distribution system is more efficient and requires less maintenance, making it easier to manage rewards across multiple chains.
4) Development Speed
Development speed on Compound V3 is structurally limited, with weeks or months of development time and auditing needed to deploy new comets, including USDT, DAI, and USDS mainnet comets, which could have unlocked greater TVL potential had they been deployed sooner.
In contrast, Morpho’s architecture allows users to create markets on demand. These markets are immutable and can be deployed quickly without requiring constant governance intervention.
5) Governance Risks: Mutable Parameters
Governance risks in Compound V3 are higher due to mutable risk parameters such as liquidation bonuses and thresholds.
Key Risks:
- Proposals Are More Prone to Errors
Because the protocol requires more frequent governance updates (e.g., for interest rate curves and reward contracts), the risk of errors in proposals increases.
- Governance Attacks
Compound V3’s mutable parameters make the protocol more vulnerable to governance attacks. For example, an attacker could manipulate liquidation penalties or thresholds to trigger large-scale liquidations.
In contrast, Morpho’s immutable markets are not susceptible to governance attacks on risk parameters. Once a market is deployed, its parameters cannot be changed, reducing the risk of harmful governance proposals.
Summary of mechanism improvements
Morpho’s architecture can benefit Compound when it comes to the liquidation mechanism, interest rate curves, reward distribution, development speed, and governance risks. Morpho’s design offers:
- Safer liquidation mechanisms.
- Adaptive interest rate curves with reserve factors.
- Efficient reward distribution across chains.
- Faster market deployment.
- Immutable markets that reduce governance risks.
Scope of Work
Gauntlet agrees and undertakes to:
- Flagship Vaults. Develop, design, implement, and launch a range of flagship Vaults that allocate deposited assets to widely-used collateral and strategies, including USDC, ETH, BTC, USDT, and other relevant assets.
- Allocator and Curator Responsibilities. Fulfill all relevant Allocator and Curator duties for each applicable vault, such as defining the boundaries and market parameters of each vault, adjusting supply caps, performing risk analysis and due diligence on vault assets to ensure security and sustainability, providing regular updates to the Compound community, and monitoring market conditions to adjust allocations as needed.
- Marketing. Market and promote the use and adoption of vaults
- Content creation and circulation (such as blog posts and how-to guides);
- Pitching press announcements to tier 1 crypto outlets and marketing agencies
on information such as launch, caps reached, high demand, and growth - Hosting Twitter spaces/discord/office hours/panels, tweets and Telegram messages
to integrate communities with the vaults - Work together for proper distribution among popular information channels for DeFi
users (like DeFiLlama, vaults.fyi, etc); and
- Ecosystem Development. Provide introductions and facilitate solution architecting to various partners in the ecosystem, including relevant partners and liquidators for the vaults
Performance
Gauntlet shall use its best efforts with regard to:
- Parameters. On a real-time basis, optimize risk and vault parameters, including, but not limited to, supply caps, vault liquidity, and market allocations
- Vault Set-up. Provide support for new Supply Vault (and associated borrow market spin-up) for key assets, including advising on parameters
- Risk Monitoring. Monitoring and tracking key risk actors like liquidity, price swings, whale activity, concentration risks, and parameter deviations, including developing and maintaining an alerting system to notify about critical risks
Next Steps
- On-chain vote details and timelines
- In the coming weeks, Gauntlet will spin up the relevant vaults and markets prior to the on-chain vote
- The on-chain vote will:
- Grant Compound DAO ownership of the vaults
- Transfer $1.5 million in COMP tokens to a rewards contract to begin distribution
- Community engagement plans
- Gauntlet will present this proposal on community calls, including Compound community calls as well as Polygon and Morpho spaces if there is interest
- Monitoring and reporting commitments
- Following the vault launch, data around market usage, interest rates, collateralization, and risk levels will surface across various venues, including but not limited to the Gauntlet App and Compound User Interface. The development will be iterative, and we welcome feedback from the community to inform feature iteration