Compound’s objective is to provide a market where users can lend and borrow against their assets in a permissionless, trustless, and secure way.
A core tenet of Compound is that participants can use the protocol to enter and exit without seeking the approval or validation of anyone. It is available to anyone, anywhere, is completely open-source, and preserves liquidity so users can utilize the protocol for an instant or a year without a difference in pricing. In contrast to a central coordinator/underwriter of loans in traditional finance, Compound’s loan terms are the same for all users and available to everyone – with no regard to work history, geography, or even credit score.
The COMP token and its holders represent the governance of the Compound market. The contracts that define on what terms participants interact with Compound are owned by the protocol and upgradable by governance. Those contracts include everything from the interest rate model, which selects the supply and borrow rates, to the Comptroller, which contains the core protocol logic. In addition to upgrading existing contracts, governance can add new assets (contracts) to the protocol and develop additional products.
For Compound to succeed, the protocol needs to support assets from which the market wants to earn interest or to borrow for a fee, and provide competitive interest rates to both sides of the market. Supporting new assets and providing competitive rates is ultimately a risk management task. Governance needs to maintain the existing supported assets while continuing to add new assets as the market evolves. It is the responsibility of governance to manage those risks while continuing to innovate.
The reward for COMP holders (the governors of the protocol) for successfully performing risk management is the prospect of fees paid by users to the protocol. The oft-forgotten Reserve Factor (RF) defines the portion of the borrower’s interest that is paid to the protocol. The Reserve Factor is moderated by governance and can be anything from 0% to 100%, but typically is 25% for altcoins.
Today the protocol reserves are worth about $41m and consist mostly of DAI (RF: 15%) and USDC (RF: 7%). Assuming that the protocol usage remains constant, the reserves will increase by approximately $17m over the course of a year. However, the protocol spends roughly $100m/year on COMP incentives (one of our prior posts COMP Distribution Speeds - The End of CompSpeeds? discusses COMP incentives). We believe the protocol can significantly reduce (or end) the current COMP incentives and become substantially more efficient.
That brings us to the shortcomings of governance and the current state of the protocol. The protocol is largely unattended. While this is helpful from a decentralization perspective, it isn’t sustainable if Compound is to survive, much less thrive. Crypto and DeFi are still-nascent industries that will continue to evolve rapidly, and Compound must evolve with them.
We have developed a To-Do list for the protocol to return to a dominant market position and set forth on a path to profitability.
- End COMP rewards. There is ~$1B of capital in Compound providing little value to the protocol beyond printing a higher TVL at the cost of $100m in COMP a year. While the original intention of COMP incentives was to disperse COMP to its users, the incentives have brought in mercenaries that claim and sell COMP.
- Refactor COMP incentives to be used to bootstrap liquidity in new markets and scale back as liquidity enters.
- Seek liquidity from other protocols like MakerDAO via their Direct Deposit program. GFX Labs has successfully pushed forward a Dai Direct Deposit Module for Compound that will conservatively bring to the protocol a 100 million DAI credit line that is insensitive to liquidity mining rewards. GFX Labs plans to propose a similar program for USDC and USDP, though they are more complex from MakerDAO’s perspective and require more time and collaboration to prepare. Compound currently spends $38m in COMP incentives on the DAI market and another $38m on the USDC market. Sourcing liquidity from MakerDao can lead to substantially reducing stablecoin incentives.
- Add supply caps. While the protocol currently has borrow caps to lower governance hijacking risk, the protocol can similarly add supply caps to limit the amount of an asset that can be deposited to the protocol. Similar to MakerDAO’s debt ceilings, supply caps provide governance with an additional tool to manage asset risk. Adding a supply cap mitigates the protocol’s concern of an infinite-mint attack and empowers the protocol to onboard assets it might not otherwise support.
- Add more assets. The protocol makes money by supporting markets that are in demand. With the addition of supply caps, the protocol can support more assets, since it can better manage risk.
- Improve the oracle system to support more assets. The existing oracle system only supports assets with a Uniswap v2 market. GFX Labs has been working with Chainlink to develop UniswapAnchorView (UAV) v3 contract, which switches the protocol’s anchor to Uniswap v3. While this does support more markets, it is still somewhat limiting. Adding Balancer and other markets as available anchors will grow the range of assets Compound can safely support. In addition, the protocol should develop tooling to support other popular assets such as LP tokens and token derivatives. There are a number of large (by MCAP) assets the protocol could support that the market wants to use as collateral, such as wSTETH, that could significantly increase protocol revenues.
- Deploy Compound v2 to L2s and sidechains. Interacting with the protocol is expensive on mainnet and can crowd out users who do not have the scale of capital to justify the gas expenses. Deploying Compound on Polygon, Optimism, and other networks would grow the protocol beyond Ethereum and put competitors at bay.
- Transition off Legacy CTokens. The ETH, USDC, ZRX, & BAT markets are all running on a non-upgradable legacy ctoken contract. While WBTC has already migrated, the other markets have not. The protocol is currently missing out on additional revenue by not being able to configure those markets with the improved interest rate model, set a kink in the interest curve for ETH, ZRX, & BAT, and protocol liquidation fee. Generally, this change is easy and only has upside for the protocol.
- Interest rate curves. Every interest rate curve utilized is the original interest curve chosen when the cToken was first configured (except DAI, which was updated on July 28th, 2020). This is a critical piece of Compound’s borrow/lend market, and yet the protocol has done little to research alternative curves or test the interest rate curves already utilized.
- Deprecate old markets. Compound v2 is nearing 1000 days old. The crypto landscape has changed significantly over the last few years, and just as Compound needs to adapt to what participants want today, governance also needs to offload what isn’t required or safe to support. Depreciating REP & SAI, closing down legacy markets, and managing risk on older markets such as BAT & ZRX is important to maintaining the protocol.
- Update the liquidation system. The efficiency of the close factor and liquidation system as a whole hasn’t been researched meaningfully or iterated upon. As a critical component of the protocol, it needs more dedicated resources.
- Upgrade testing and developer code base. While Compound’s codebase and testing was state of the art at its launch, it has since fallen behind. Without a clear, incentivized, and responsible party to improve and maintain the tools, they have become hard to work with and outdated, which has hurt development efforts.
- Clean up the existing protocol. The Comptroller needs to be cleaned up and possibly entirely refactored. Similar to the prior point, the codebase was innovative at launch but has since fallen behind without incentivizing someone to improve the system.
- Separate revenue generation and risk management. Reserve factors should be optimized to balance protocol revenue and liquidity.
- Rebalance reserves. The stock of reserves should be adjusted periodically to minimize risk. Compound is not in the business of taking positions and should seek to offload the surplus of volatile assets for stablecoins or even COMP.
The v2 protocol has a lot that could be improved. While it has made progress with community members contributing individual improvements, it lacks a concerted, focused effort.
GFX Labs is offering its services to improve the protocol and build a concerted effort for the community. We have in-depth experience in Compound, the competing money markets, DeFi, and crypto markets as a whole. At GFX Labs, we are building a team with a wide range of skill sets and using those resources to develop products and improve DeFi. One of the most valuable things about our team is that we genuinely believe in DeFi and want to build a better financial system.
GFX Labs isn’t a fund. We don’t hold positions. We are a team of builders who love DeFi. Our participation in governance is rooted in a desire to see DeFi overtake legacy finance. We promise to be active participants who improve the protocol by action and input. We’ll promote innovation and provide constructive comments on proposals we disagree with. Our door will always be open to those who share our passion for DeFi & Compound.
Getty and Eddy, the two founders of GFX, are active contributors to Compound and have already made several proposals.
- 24: The first Compound Autonomous Proposal which raised the WBTC CF to 60%
- 36: Raised the WBTC CF to 75%
- 47: Oracle Improvement: lead a long-term effort to substantially upgrade the oracle system.
- 51: Getty became the first contributor to earn a streaming grant for his work on the oracle improvement.
- 53: Added MKR and organized a new price oracle to support MKR, AAVE, SUSHI, & YFI. Note: MonetSupply sponsored the proposal.
- 54: Added AAVE, SUSHI, & YFI. Note: Polychain sponsored the proposal.
- 56: Set collateral factors for MKR, SUSHI, AAVE, YFI, & LINK.
Notably, Getty started hosting the Compound Community Call last March and has been hosting them bi-weekly as a casual place for the community to talk about Compound.
In addition to Compound, GFX Labs spends material time on MakerDAO & Uniswap. We have worked on the last three proposals at Uniswap, including the proposal to introduce 1bp fee tiers, which has significantly improved stablecoin trading at Uniswap and taken market share from Curve. At MakerDAO, we have successfully pushed forward a Dai Direct Deposit Module for Compound that will conservatively bring a 100 million DAI credit line to the protocol. GFX Labs is planning to propose a similar program for USDC and USDP, though they are more complex from MakerDAO’s perspective, and require more time and collaboration to prepare.
The issue of compensation for contributors has been discussed in the community a few times, and is often the pain point of a proposal. Ultimately, it is incentives that drive resources or the lack thereof in the instance of many protocols’ governance/improvements. While “prestige” or the joy of interacting with the protocol is certainly there, it isn’t a scalable or long-term plan for innovation. Much of what is required to maintain a protocol isn’t sexy work. As a decentralized protocol, Compound needs to continue to experiment with incentives.
The existing incentives in crypto/DeFi are such that if you are a team with skills, you should raise a round and launch a project. The next best thing is probably to join an existing team. Or, if you know DeFi well, you can go the finance route and join/start a trading firm. Governance compensation has hardly begun to compete with the opportunities available in the rest of the industry. However, it has been remarked upon many times how governance improvements are greatly accretive, because if a small parameter change can improve the token price by even 1%, that can represent tens of millions of dollars of value created. The value that could be created by building out a product could be immense for the protocol.
KPIs are regularly used to guide a subjective process towards an objective one. By assigning clear and measurable goals, the protocol can incentivize contributors to work towards the desired outcome. We propose a base compensation and performance bonuses that are paid if specific KPIs are met.
Incentivized KPIs sometimes have adverse effects due to short-term interest. A CEO has significant power and lateral ability to achieve the KPIs they are incentivized to hit in a traditional company. While they might report to a board, they still have relatively little oversight. However, GFX Labs is still at the behest of Compound governance, and every change that we propose must be explicitly authorized by an on-chain vote. We thus believe that KPIs will allow us to strive to meet the high bar of safety, efficiency, and innovation that governance demands.
Possible KPIs include:
- Token price: a lot of noise but ultimately the thing everyone cares the most about.
- Revenues: a clear indicator of the efficiency and sustainability of Compound.
- TVL: helpful to see how trusted a product is but manipulatable by rewards programs.
- Dollar value borrowed: represents usage and affects revenues but manipulatable by rewards programs.
- Assets supported: While more choices are good for users, they might not be good for the security and safety of the protocol.
- Market share: the percentage of market share Compound has in money markets.
- Governance proposals: might be a good low bar but easily exploited.
While each of these options has its pros and cons, we think protocol revenues and token price best align us (the contributor) and the protocol. Revenues are something we are confident we can grow, and it is hard to manipulate. The token price is ultimately what holders care the most about. In regards to the external risks of using the token price as a KPI, the trade-off is simple: we can work really hard, and the price might not move, and thus we lose, or we could work really hard, and the price might go up and thus pay us more than what governance believes is justified. In the bear case, GFX takes the hit, and in the bull case, everyone wins. While progress and innovation should drive the token price up, we think most will agree that crypto is wild and not everything is easily explainable. We believe the other KPIs are more manipulable and less inefficient as metrics of our performance.
In addition to the KPI compensation, we also ask for a base compensation. In a sense, this is to guarantee that we have enough resources until what is hopefully the largest part of the compensation is realized after we hit the KPIs.
An interesting point of debate in governance compensation is what to pay with: governance tokens or stablecoins. Below is a simplified view of the trade-offs from the protocol’s and contributor’s point of view. We think it is in Compound’s best interest to pay contributors in stablecoins and not push more COMP into circulation. However, if governance feels strongly that it makes sense to pay in COMP, we would ask for a premium relative to the stablecoin price.
|Governance Token||The contributor’s payment is tied to the token price. Efficient if the protocol thinks their token is overvalued.||The protocol is putting more tokens into circulation and diluting the existing holders.|
|Stablecoin||Existing holders aren’t diluted, and the cost/payment is exact.||The contributor isn’t tied to the protocol.|
|Governance Token||Uncertain as to what the value is.|
|Stablecoin||Knows exactly what they are getting paid.|
Below is our proposed compensation structure. Since we think we can increase protocol revenues by 50% over the course of a year, we wish to let our base-fee cover up to a 50% increase. We earn bonus payments when we improve the revenues beyond 50% and the price of COMP increases. Both KPIs have to be met to earn the bonus. For example: if protocol revenues were to increase by 200% (very difficult in our opinion), and the token price was above $600, our bonus would be $30m. If the token price were above $600, but revenues had only increased by 100%, we would earn a $10m bonus. If revenues were to increase to 200% but the token price was $400, we would earn a $20m bonus. This model ensures that we only get paid if protocol performance has increased, and we do not become reliant solely on price. While certainly not a perfect model, it has good trade-offs which we believe properly align us with the improvement of the protocol.
|Revenue Increase||COMP Price||Bonus|
We propose $5m USDC streamed to us for our base fee over the period (1 year). While a guaranteed income would be preferred, we are willing to trust Compound governance. We will commit to completing/quarterbacking at least 6 of the items on the above to-do list. At the end of the period, if we have met any of our KPIs (revenue and token price), we’ll ask Compound Governance to award us our bonus. While a year may be a long time in crypto, we realize the community may be interested in us participating for another term or committing to a longer period. We’re open to exploring that and are submitting this proposal as a starting point for governance to consider.
We think Compound and GFX Labs can have a symbiotic relationship that is profitable for both parties. We look forward to hearing everyone’s thoughts on this unique proposal.
As long-term Compound participants, we are looking forward to seeing Compound Labs bring Wednesday’s announcement of v3 to life. We look forward to assisting with v3 as more information is shared about the new protocol’s timing, progress, and requirements. However, the v2 protocol differs significantly from v3. The announced protocol only has one borrowable asset, such as USDC, and thus one interest rate curve. While the protocol is excellent for participants who want to supply multiple assets as collateral and only borrow USDC, it is not a general money market like v2. Until the full vision of Compound Cash is built, we think v2 should be continued to be maintained, tuned, and improved.