Compound Proposal 022: Systematically Reduce Emission Quantity

Proposals
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Background

As discussed in @monet-supply’s post Adjusting COMP distributed model, it is clear that there is quite a bit of optimization that can be done to the COMP distribution model. We (Gauntlet) believe that the network should begin to increase the incentive for long-term holding of COMP relative to short-term holding and trading by yield farmers. While the introduction of COMP led to the ‘agricultural revolution’ and the usage of liquidity mining as a growth tool, it has become clear from on-chain and off-chain data that holding times, voter participation, and ‘real’ borrowing activity can be improved by distribution tweaks.

By distributing COMP to borrowers, the protocol encourages recursive leverage, which both brings little value and reduces security of the protocol. Based on the survey in that post, it is clear that at the very least, the COMP emission system needs to three control mechanisms:

  1. Adjusting COMP emission rate
  2. Scalar multiplier to allow for more uneven distribution between borrowers and suppliers
  3. Time-locking mechanism

Proposal CP011 demonstrated that a reduction in the emission rate (e.g. via a call to _setCompRate) can be a useful tool for alleviating both sell pressure on COMP and as a way to encourage long-term COMP holdings.

However, as DeFi has become increasingly interconnected via farming and COMP has been utilized as a farming asset in a number of protocols (e.g. YAM), we believe that these changes should be made in a cautious, security-forward, and incremental manner. For instance, if the COMP emission was reduced 90% and subsequently, a large yield farming incentive led to COMP holders putting large fractions of the supply in a third-party contract, then we can expect both a supply-side crisis and an increase in recursive leverage.

To handle the fact that any change to the COMP distribution will ripple through the ecosystem, we propose a making changes via series of proposals. Each proposal will make an incremental update to the protocol which will be monitored for two weeks before the next incremental state is taken. This way, we can observe the market reaction (both in asset price, volatility, and usage in farming) and use the three control mechanisms to adjust the protocol. This will allow us to utilize an online learning approach to quantitatively choose the parameters for each of these incremental adjustments.

The sequence of incremental proposals that we will use is the following:

  1. Reduce emissions rate (no technical risk, yields estimates of market demand for COMP)
  2. Adjust the distribution to suppliers and lenders (minimal technical risk)
  3. Add in a vesting period / time-lock (larger technical risk, would be the proposal with the largest risk so far)

Parameter Selection and Justification

We have constructed a Monte Carlo model (partially described in a working paper for optimizing emissions that can be found here) that shows that the current market demand for COMP in both centralized and decentralized exchange implies that COMP is being overproduced by 35-40%. However, this can also be illustrated more simply via some descriptive statistics and illustrations. Using tagged exchange addresses provided by Flipside’s Will Price, we looked at the both the distributions of holding times — how long an address held COMP issued via the comptroller before they sent it to a tagged exchange address (CEX and DEX) — as well as the amount of COMP that was held over time.

First, lets look at what fraction of COMP wealth was kept by addresses that didn’t sell all of their holdings (e.g. amount farmed - amount sent to exchanges > 0)
image

This distribution is unimodal [0] with a median of roughly 56%, implying that 50% of COMP holders kept 44% of their COMP earnings (e.g. used in farming, hodl’d). However, include COMP farmers who sold all COMP they earned we have a much more skewed distribution:
image

This is strong evidence that large fraction of COMP holders are selling all of their earning and not staying long-term holders. This data shows that roughly 17.2% of COMP issued is completely sold on exchanges and not held by long-term holders.

If we look at the length of time that COMP farmers hold COMP on their balance sheet, we find that most short-sighted COMP farmers sold their assets via DEXs such as Uniswap and Balancer:

image

(Note that the x-axis is the base-10 logarithm of the holding time)

Given these descriptive statistics and combined with some cursory simulation results, we believe that emissions should be reduced by 20%. Currently, emissions are 0.44 COMP / block and we believe that it should be lowered to 0.352 COMP/block. Once this change is made, Gauntlet will observe the changes to on-chain behavior and market data to estimate whether further reductions are needed.

Proposal Description

We will call _setCompRate on the uint input 0.176e18 to execute this reduction.

Post-Proposal Analysis

If the proposal passes, we will monitor the following data sources for changes after the proposal is executed:

  • COMP trading volumes, order book liquidity, DEX liquidity
  • Usage of COMP in other farming protocols (e.g. YAM, YFI, etc.)
  • Changes to borrower / supplier statistics (e.g. avg. loan size, avg. borrow)

We will combine these with our simulation model to estimate how much excess supply and/or demand there is in the market post-change and use this to guide our next emission-related proposal.

Proposal Timeline

  • Three (3) days for community feedback and analysis on this post
  • Proposal submission on August 26, 2020, 3pm UTC / 11am EST / 8am PST (proposal will incorporate feedback)

Acknowledgments

Thanks to Hsien-Tang Kao, Rei Chiang, John Morrow, and Victor Xu from the Gauntlet team for feedback and analysis.

Furthermore, thanks to Flipside Crypto and Will Price for providing tagged exchange data that was used for descriptive analysis and well as for simulation stress testing.

Finally, thanks go out to Peteris Erins of Auditless for feedback and analysis.

[0] The blue line is a plot of the probability density function of the best fit Beta distribution, which is a one-parameter family of unimodal distributions on [0, 1]. There are a number of reasons for comparing this distribution to a Beta distribution, which have to do with the generative processes that one can construct to sample a Beta that can represent the behaviors of the COMP holders in the system.

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To achieve the stated goal, I wish to present 3 alternative proposals:
a). Put a vesting period of x month on $COMP (similar to $SNX rewards’ 12 month vesting).

b). Put a vesting period on $COMP AND increase current period emission, which is to be balanced out by lower/decreased future period emission.

c). Put a x-month vesting period on $COMP on y% of token farmed, and the rest of the $COMP are immediately transferable.

I believe my alternative proposals can:
1). decrease market selling pressure.

2). Change the return estimation for $COMP farmers (e.g. bring discount factor into the equation), discouraging $COMP farmers whose only objective is selling $COMP on the open market.

and specifically for b).
3). Incentivizing long-term $COMP supporter/holders by increase their current period $COMP yield (bring discount factor into the equation. More yield now and less yield in the future is better than having the same yield in all periods).

Edit:
Also, it is worth considering the potential downsides of our proposals:
i). Potentially decreasing the stablescoins and tokens supplied in Compound ecosystem.

ii). Potentially decreasing the sell side liquidity of $COMP on both CEX and DEX.

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Thank for your the feedback! We note that the third control mechanism (which we termed ‘time-locking’) is equivalent to individual cToken vesting. Currently, the current cToken design does not have a mechanism for vesting. The main complications with adding vesting is purely technical implementation — it would cover a lot of surface area and making sure that we have a minimal surface area implementation that doesn’t significantly increase gas costs for users will take a bit of time. We’ve been working on an implementation of this and once we have this tested and audited, we will submit a proposal to add in vesting functionality.

We think option b) is actually the most palatable in the long-run for all stakeholders, but requires vesting to be audited and implemented.

Regarding your latter two points about downsides: Order book signals and analytics suggest that there sufficient COMP liquidity, especially compared to other DeFi assets, as it has the most professional market makers trading it (thanks to the Coinbase listing). Only option c) would have a direct impact on market makers’ ability to tightly quote $COMP, at least based on simulations and backtests.

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I feel this is misguided - it seems to be in response to the fact that the price of COMP is under-performing competing protocols because farmers are selling it.

COMP’s value is entirely determined by the discounted value of future cash flows that go to COMP holders. The best way to increase COMP’s value is to credibly show that value will come to those holders. This comes from increasing TVL and fees given to protocol owners.

This proposal wants to decrease the amount of COMP distributed for the very simple reason that it means that people won’t be able to sell as much. This is merely attacking a symptom and not the actual problem. Furthermore, this slows the progressive decentralization of the Compound protocol, when there is a clear trend of liquidity providers preferring to use platforms where they share in more of the economics and have more influence on the protocol’s future.

A long-term COMP investor should be happy that farmers are indiscriminately selling COMP today, depressing the price, and granting investors who believe the protocol will generate significant value in the future a better entry price. In fact, this creates a better, more fair distribution, as miners are not hoarding their COMP tokens and consolidating control over the network.

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I agree with @oooh_fa that extending the decentralization process of Compound is far from ideal.

What I’d be more interested in seeing is vesting and alternative methods of COMP distributions. Some that come to mind are: incentives for voting or staking COMP in voting contracts, rewarding community members who submit successful proposals, and maybe tipping in discord. An additional advantage of these other distribution routes is that the COMP will be given to users who understand and value its use as a governance token.

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We certainly agree, but until we have a good generic method for adding vesting and lock-ups for issued COMP, we believe the network will bleed COMP and the majority of it will end up held by centralized market makers and exchanges. Given that COMP, unlike other liquidity mined assets, doesn’t incentivize on-chain pools (e.g. akin to Synthetix’s rewards contract), it also appears that a lot of the centralized exchange volume is held by market makers and exchanges rather than by new participants. Our first priority is making proposals is increasing the number of long-term active governance participants.

We have been working on code for vesting COMP rewards to cToken and have the following sequence of proposals in mind:

  1. Add vesting (4-6 weeks): This is a large change and we want to get it audited and do a testnet trial for the community to analyze
  2. Add pay-to-address (1-2 weeks): Allows the protocol to pay individual community members for successful proposals in a governance-transparent manner
  3. Adding payments to governance participants (2-3 weeks): This will utilize the vesting code

Once vesting is in-place, we believe that emissions should probably be higher as @odette has suggested and we will provide numerical evidence for how to choose how much higher it should be. We think that @oooh_fa’s point is true for COMP in a world where COMP is on the same footing as the other liquidity mined tokens. However, as COMP has much more exposure to centralized exchanges and market makers, it is becoming increasingly clear that tokens incentivizing on-chain liquidity are doing a better job of distributing their tokens to a large number of people. We believe that once vesting is in-place, the Compound protocol can similarly incentivize on-chain liquidity in a manner that yields more long-term governance participation.

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It sounds like there’s agreement that adding a vesting period is preferred vs. reducing per-block COMP distribution.

I would argue that there is not a pressing / urgent need to reduce COMP distribution, and so I would encourage Gauntlet to skip this unnecessary intermediate step and focus on the long-term step of introducing a vesting period.

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I’m not sure if the goal of reducing farming and recursive leverage is in the best interest of COMP holders. I think these are the current effects of farming:

  • Massively inflated TVL
  • Great supply APY on DAI due to high utilization
  • Reserves filling at increased rates

The key driver behind all this (and the entire farming craze) is that we’re dealing with an irrational market. The key driver of the current market price is hype/good news and a limited supply. Reducing emission would reduce selling pressure by rational actors (as intended by this proposal) and therefore an increased price. The increased price will raise the farming APY, thereby possibly negating the effect of the reduced emission.

I think those who hold COMP because they farmed it or paid for it have no interest in stopping farming as that is what makes Compound look more valuable with high TVL. Vesting COMP could get rid of farming, massively dropping TVL, causing the hype to falter, causing a large drop in COMP price.

As a side-note, I doubt the ‘open’ community feels the voting rights are useful considering all the real voting power is in the hands of a select group of early partners, etc. At the current rate it will be years before there is enough COMP out there to speak of community. So at the moment COMP is just another speculative asset with no current intrinsic value. So price and price expectation are the main motivators in the market.

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If the COMP Distribution rate (to users) is lowered, an increasing amount of COMP becomes available for other purposes; rewarding/incentivizing governance, community development, and new use-cases decided by the community.

In tandem with modifying the distribution of COMP, the community should actively discuss additional ways to distribute COMP.

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I agree with @brendan_dharma that the community seems to prefer the introduction of vesting schedule vs. reduction of COMP distribution. Although modifying COMP distribution can also happen in tandem of additional ways for COMP distribution, including to third parties, which might be good for the future of compound. Some concrete examples:

  • Setting aside x% of remaining COMP for a bug bounty program that will focus on the long-term sustainability of compound protocol
  • Incentivize integration of compound to smart contract wallets or even financial institutions (i.e. CeFi actors)

However, I acknowledge that such proposals might be contentious for the community if not done carefully1

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Yes, I probably should have been more clear about this. Our goals with the reduction are really two fold:

  1. To allocate a portion of the COMP emissions for usage in the protocol later (e.g. bug bounties, audits, payment to developers)
  2. To incentivize long-term holding of COMP

In order for the former to be viable, we need to add in vesting (see: Vesting for the Compound protocol). However, we believe that lower emissions now and then adding vesting is the correct ordering for the following reasons:

  • Builds a larger reserve for bug bounties, contribution/security, incentivized voting participation, and to protocols that build on top of Compound
  • Will lead to a lessened concentration of COMP on centralized exchanges and increased holding times, especially as farming adds perverse incentives for long-term holders
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Reposting what I wrote in the Discord here:

I’m pretty unconvinced on the proposal to reduce COMP emissions. If the goal is “building up a reserve of COMP that can be used for paying for other community needs” it seems like it’s a very roundabout way to get to it. Why not just create a proposal to re-allocate a portion of undistributed COMP? Or why not use the COMP already allocated to that purpose? Thinking of “775,000 COMP are reserved for the community to advance governance through other means — which will be announced at a future date”

The secondary goal is to stop people from farming + dumping COMP – I’m all for that but don’t see how reducing emissions will help with that.

Finally, we’ve already reduced emissions since COMP launched. Reducing again seems to actually be going against the current evidence in the market that faster emission rates lead to both broader and deeper governance participation.

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The $COMP sold will be lower, by 20% and I don’t see how reducing COMP emissions would help stop from farming + dumping either.

@tarun With COMP emissions, you are trying to privatize system’s shares to users. A similar system of giving shares to workers happened back when Soviet Union collapsed and privatized government owned factories to workers who promptly sold it for a dinner and a bottle of vodka to a few folks hoarding them who are now known as oligarchs.

With COMP a basic question remains - why would anyone keep COMP ? Answer this and you will solve your problem.

As I see it now, the current answer is to govern the protocol by an elite few and the majority is on for a ride, for whom it wont matter anyway as we cannot get enough of it to voice our point of view.

And this emission reduction is a prime example of that. Someone with a lot more shares will do as they please, always, imposing their will on the majority ( With all due respect to the Monte Carlo simulation from above).

And that’s life.

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Gauntlet’s ill-considered proposal seems like nothing more than a thinly veiled attempt to cause a short term pump in COMP prices. Gauntlet fails to demonstrate how reducing yield benefits the users of the protocol in the long term, indeed, they fail to demonstrate why yield selling is actually a problem.

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Gauntlet’s proposal is not even worth consideration without a clarity on how that COMP would be spent and the benefits it would provide to the platform and its users. Further, such extreme volatility of COMP yields at the whims of preminers will destabilize trust in the platform.

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To preserve control in the hands of users, a system must restrict the commodification of that control. This is why most (if not all) democracies forbid the outright buying and selling of votes.

A better system for true user control of Compound would be a hybrid. For example, say 50% of total voting weight is distributed among active users proportional to their current stake in the platform (the value lent/borrowed) and it is not tokenized (cannot be taken off platform, bought or sold). The remaining 50% is commodified as COMP governance tokens that can be bought and sold on the open markets.

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@RacerX - an interesting point. Potentially $MKR / $DAI type of relationship would work better. Separating voting coin (shares) from common coin (shares).

In the current stock market the “owners” are the voting shareholders (of course much less hands on, however still with some voting power) And then the incentive is to either a) hold the coin (share) to leverage appreciating value or to receive the dividend or both, seems to work out okay …

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At first i’m largerly unconvinced that Community opinion actually matters, as Compound Governance is just pretend to be decentralised, while in reality it’s heavily centralised with like 20-30 entities can pass (or block any decision). So only their opinion actually do any difference and everything else can be just discarded as irrelevant noise. It’s worth noting, that pretty much none of controlling entities actually got their voting power from “user distribution”.

The argument that it’s in transition of transferring governance to users, while theoretically good quite contradicts with current proposal. Initial distribution time of COMP tokens is about 4 years to fully distribute. Which is a VERY LONG time for crypto. And yet, less than 2 month from start here is talking that it is too fast. So, here we come to point

1 : If COMP distribution a process of transferring Compound protocol to decentralised governance than we should abstract from current price valuation, which is just temporary noise. In that perspective, decreasing emission is just a way to preserve current status-quo, delay transition to community governance and hold voting power by initial voters, who probably should vote yes. (and i encourage community to pay close attention who will vote yes to that)

  1. Proposal title suggest decreasing emission by 20%, while proposal itself suggest to decrease from current 0.44 COMP/block to 0.176 COMP/block, which is more like 60%, isnt it? How to understand that?

  2. I want to remind everybody, that current price valuation of COMP is fueled by yeild farming hype and big bubble. It’s hardly real and hardly sustainable long term, regardless of what would be done with emission. At the same time COMP and Compound itself is one of the few actual products with long-standing and proven value , sitting at the core of it. Extreme care should be taken, as any radical change can be the pin which blow that bubble.

  3. I don’t really getting argument about centralised exchanges having big portion of COMP. Centralised exchanges are not the owners, but custodians of the COMP, which is likely in hands of many small owners, who (for reason of point 1) can basically benefit from COMP holding only by price speculation, as votes of single-double-triple digit COMP owners are largely irrelevant in decision making process (and holding COMP isn’t incentivesed in any other way either) , not even talking about those who have less than 1 COMP. Besides, do we know that holdings of centralised exchanges are from COMP distribution and not from initial seeded Uniswap liquidity leaked to that exchanges overtime?

To resume, i don’t really see what decreasing emission is trying to acihieve aside of delay of decentralisation process. Maybe attempt of price manipulation? Or attempt of blowing down all that house of cards defi constructed around Compound’s idea of distribution of governce token to users.

However, all of that being said, there is definitely some logic behind saying that might be there should be some improvement in distribution model.

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Nice write-up and insights.

I don’t fully understand what the connection is between reducing emissions and increasing long-term hodling. I get that there will be funds for other things, but I don’t think the items mentioned will necessarily help.

One of the biggest reasons there are few long-term holders of COMP is because the (perceived) value of governance today is much less than the market value of the token. Why would I keep COMP knowing that governance is heavily centralized and my vote won’t count? Look at projects like yEarn, etc. No one is selling FYI (quite the opposite) because the expected value of governance (and potentially future cash flows) is much higher than today’s market price.

IMO increasing emissions + vesting would have been a much better solution. This way only people willing to lock up their rewards long term would provide liquidity.

Another way to increase long term hodling is giving COMP utility. Yam.finance showed, unsurprisingly, that when the token is useful for something, farmers/traders will want to own it. Enabling COMP as collateral like CREAM does or partnering with other protocols to support COMP in their projects are two of the many ways this could be accomplished.

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As a new participant in this ecosystem, it is surprising to see that there are quite a few thoughtful responses and counter arguments to the proposal that are left completely unanswered. And governance poll is already setup without first attempting to at least provide more clarification to these counter arguments.

As many others have asked, I would also be curious to understand why is it considered a problem that most of the earned COMP is sold immediately?

One of the points of COMP distribution, as I understand, is to increase awareness of the platform and increase its user base, integrations and overall usage. Even though most of the new lenders are joining to “wash borrow” to maximize their yield, they are still becoming familiar with the platform and building a relationship with it. They will most likely remain as lenders even in future, as long as over time there will be natural demand for borrowing. (hopefully everyone understands that APRs of >40-50% can’t be sustainable)

The fact that most of the COMP is sold right away seems an extra positive too, because this is potentially bringing other new users too, who believe in compounds future and want to own piece of it without becoming liquidity providers right now.

Of course most important part is to continue to build things that will increase actual borrowing demand, but changing COMP distribution either way wont make a difference for it. COMP distribution is already set over a long enough time period. If actual borrow demand doesn’t increase to much higher levels in next 2-4 years, slower COMP distribution wont really change much.