Initialize Compound III (WETH on Ethereum)

The USDC market has been live for over 2 months now, and undergone 4 governance proposals (116, 124, 128, 132). The market (as of 10/27/2022) has $91.33M of collateral assets, $45.33M of USDC borrowed, and $88.86M of USDC supplied. It has generated $22.84K of USDC reserves since its inception.

With the Compound III codebase having proven itself thus far, we think now would be a good time to launch a second market on Ethereum Mainnet, utilizing WETH as the base asset: cWETHv3. The deployment pull request can be found here.

We propose initializing the market with 2 collateral assets: wstETH and cbETH.

For the base asset, we use the ChainLink ETH/USD price feed, as is used for WETH in the cUSDCv3 market. For wstETH, we use a custom wrapper around the ChainLink stETH/USD feed to multiply by the wstETH/stETH exchange rate. This contract is currently in OpenZeppelin’s queue for audit. For cbETH, Coinbase has just launched a new cbETH/USD price feed together with ChainLink.

As before, we would first deploy the contracts to mainnet (with supply caps set to 0), and update this thread with the verified contract addresses. We would then initiate a proposal to raise supply caps and launch the market with an initial set of reserves. The contracts can be deployed once we have (1) received input on parameters from Gauntlet and the rest of the community here, and (2) received audit feedback from OpenZeppelin on the pull request.

We suggest following up with another proposal after this one (as was done for cUSDCv3), to migrate remaining rewards from v2 to cWETHv3 and cUSDCv3.

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Thanks, @jared and all for the proposal. Gauntlet is conducting analysis and will return to the forums.

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Hello @jared

Thank you for your proposal.

It would help to know more about the Chainlink/Coinbase price feed you mentioned - I couldn’t find anything with a quick Google search. In my work at Avantgarde, I actually handle asset listings for Enzyme, so am quite familiar with the requirements for Chainlink’s verified price feeds. It seems to me that cbETH doesn’t meet the bar for one of those in terms of liquidity, so I assume there’s some sort of alternate methodology and that it’s a custom feed. From my perspective, this will be important in evaluating cbETH as a potential collateral asset.

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Thanks for checking it out @ignaciorsg.eth, the feed can be found here: cbETH / USD | Chainlink. We welcome the input - what bar do you believe is not satisfied?

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Putting the chainlink listing process aside. The distribution of liquidity is what concerns us. In the event of a liquidation, the protocol would absorb cbETH and use its WETH reserves to do so. If those reserves were depleted, it would sell cbETH at a discount to replenish. Coinbase’s off-chain orderbook is the most liquid market for cbETH right now, making the arb difficult for any potential buyers.

With that said, we are hugely supportive of alternative liquid staking derivatives and appreciate the effort Coinbase is going to across the ecosystem to increase the adoption of theirs. A gated launch with a tiny borrow cap that gets ramped up as on-chain liquidity increases could be a sensible way to do it.

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one thing that @ignaciorsg.eth and I were chatting about is that even during a guarded launch, it’d be nice if Coinbase could provide some sort of backstop - e.g. a standing onchain bid for cbETH at the oracle price minus whatever the discount might be when the protocol has to sell collateral to replenish the base asset. Not sure what their appetite is to do that (or what the technical implementation might look like), but figured I’d throw it out there. Also totally open to hear other ideas to that end.

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With Compound III (unlike prior versions) illiquidity is not a significant obstacle to supporting an asset, due to the presence of supply caps. For any non-major asset, the question should be, “how much cbETH can be safely supported, and at what risk parameters?”

I’m excited for Gauntlet to provide this risk analysis for the community.

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Hello @jared, thank you for the proposal. I am curious to better understand the route Compound III is taking here.

First, I thought Compound II and Compound III had very little overlap: Compound II would enable an interest rate market for a large diversity of assets, while Compound III would be a much less risky way to earn interests or obtain financing in cash (~usdc). I remember @rleshner sharing similar thoughts in a Twitter Space with Instadapp (please correct me if I misunderstood).

In your opinion, should the Compound Governance decide to deploy more and more versions of Compound III with different assets (hence overlapping with compound II)? Or should it be just for USDC and ETH (~web3 cash)?

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Any thoughts on when this analysis will be available?

Hi @0x7751 - we are targeting in ~2 weeks, but it is dependent on several strategic decisions the community should make which would impact our recommendations. We will pose those questions to the community shortly to kickstart the conversation.

Gauntlet would like to kickstart the conversation around an important strategic consideration for the wETH market: how would wETH supply be encouraged?

On Compound V2 markets, there is natural demand to supply wETH, given that the wETH can be used as collateral. However, this natural demand as collateral does not exist on the Comet market, as the wETH supplied can not be used as collateral. Of course, wETH supply is a limiting factor to the growth of this market.

In the case of the wETH Comet market, the yield of supplying wETH will be significantly more important to attract wETH supply than it is on the V2 market.

Although Gauntlet does not make strategic recommendations to the DAO, we wanted to kickstart the conversation, as the decisions the DAO makes here may impact our recommendations on the interest rate configuration for wETH.

Several options for the community are:

Option A: Configuring the wETH interest rate curve differently on Comet than on V2.

  • Benefits: the interest rate curve can be configured to provide a higher yield to wETH suppliers on V3 to encourage supply while aiming to prevent excessive utilization.
  • Tradeoffs: there is currently a scarcity of data on the elasticity of users with regard to interest rate curves.

Option B: Pause supplying of ETH on V2 to encourage supply on V3.

  • Benefits: encourages migration to both the Comet USDC and wETH markets.
  • Tradeoffs: there are nuanced risk tradeoffs here. For example, pausing supply of ETH on V2 prohibits borrowers from adding more ETH collateral to their positions in times of market stress.

Option C: Distribute COMP incentives on Comet (for the supply side of wETH)

  • Benefits: encourages supply to wETH market.
  • Tradeoffs: cost to the protocol. In addition, there is currently a scarcity of data on the elasticity of users with regard to interest rate curves. Any future COMP incentive reduction should be made gradually to not shock the market.

We look forward to hearing the community’s input. Of course, the community may choose one or a combination of the above options.

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Thanks for starting this conversation, @pauljlei!

All three approaches are suitable (and possibly necessary), but as a subjective preference, I would order them as A (at launch), C (at launch, or immediately thereaftrer), B (after V3 wETH is stable). My reasoning is as follows:

There is no downside, cost, or risk for cWETH to use a custom interest rate model that is different than the legacy interest rate model. In fact, given the starting assets and parameters, the use-case for borrowing Ether from this market (likely to efficiently apply leverage to staked Ether) will create very different rate expectations than the existing Compound protocol. There is likely significant borrowing demand for Ether (say, 2-4% APR) below the staked Ether yields (currently about 6-8% APR), and these users will likely be borrowing for extended periods of time. On the supply side, users (individuals, institutions, or other applications) may tolerate a lower yield given the liquidity of Compound markets (say, 1-3%). This market should likely have an interest rate model that targets high levels of utilization, with a ceiling on borrowing costs in line with staked Ether yields.

In regards to including WETH in the distribution of COMP, you’re right that it makes more sense to include the suppliers of Ether (and not borrowers) in this market, as borrowing will be the more “obvious” use-case, whereas USDC is the opposite (massive supply of USDC seeking yield).

Only after this market is running, at scale, would it make sense for the community to debate whether to disable functionality in the V2 protocol (though my view is, it might make sense to keep it as-is in perpetuity, just incentivize migration in economic ways).

Excited to hear others opinions and ideas.

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As you can see in charts(weth utilization rate/sthETH deposit/ETH borrow on Aave v2), utilization rate has dramatically changed after March 2022(at that period, stETH collateral supporting has been started).

So, I agree that if we add liquid staking ETH as collateral in comet, it is likely to get increased demand of borrowing ETH(mainly from dapps using liquid staking ETH strategy such as instadapp lite, rocketpool, and coinbase)

source: Ethereum ETH Staking Deposits 🥩


COMP distribution

For user groups(wstETH, cbETH, and ETH), there is a strong incentive(for borrowing ETH) to deposit their wstETH and cbETH on comet but it has not much merit for native ETH holders. So, I think that it is good idea to assign some COMP distribution for ETH deposit side.


Improved IRM

  • With high utilization, it is important to keep low ETH borrowing rate level for liquid staking eth strategy players.(making maximum profit)
  • Currently, I’m not sure it should be using the same IRM for both wstETH and cbETH. Because cbETH can be considered as centralized asset in the community.

comments about this topic from instadapp: https://twitter.com/smykjain/status/1590835867798892544?s=20&t=AuARy3QcguITPE4cexE0fA

Is the analysis already available?

Lido is really glad to see the discussion of Compound III moving forward. I wanted to hop in to mention that we have been in touch with Gauntlet to make any data needed available. We would be glad to offer our analytic team’s time and effort to the Compound community as well if there is a need/opportunity in support of this discussion.

We also have a great deal of experience in helping protocols that integrate stAssets manage supply and borrow demand. We will be happy to consult!

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Gauntlet has conducted an initial market risk analysis on the parameterization of the wETH Comet market.

stETH

Our systems observe ample liquidity in the stETH/wETH market. The slippage/liquidation curve suggests that a $130mm market sell of stETH through 1inch only incurs 1.5% slippage, implying a liquid market. We also ran simulations hypothesizing the amount of insolvencies and liquidations given various CFs and stETH/ETH deviations for accounts that have historically supplied stETH and borrowed wETH - and found that only at high deviations is there a likelihood for insolvencies.

Because of this, it can prudent to initialize the market at $100mm supply cap, 90% CF (collateral factor), 93% LCF (liquidation collateral factor), and 5% LF (liquidation factor). Combining capital-efficient borrowing parameters with a stringent supply cap will be valuable to understanding and studying the pool behavior.

cbETH

We recommend a lower supply cap for cbETH but with the consistent CF/LCF/LF parameters as wstETH.

cbETH is less liquid on DEXes compared to wstETH (1.5% slippage for $1.3mm sell of cbETH, versus $130mm sell of wstETH). cbETH is also not very liquid on CEX - where a $1mm sell incurs roughly 2% slippage. In addition, cbETH is only redeemable to locked ETH on Coinbase, whereas wstETH is redeemable to stETH, which is more easily transferable and more liquid. There exists a 2-3% discount on cbETH, perhaps due to this intransferability.

However unlikely, we may imagine a situation in which insolvency news on the CEX leads to the cbETH market rate plummeting, creating risk for Compound. Although this existential risk is neither a market risk nor a quantifiable risk, a conservative supply cap can mitigate the potential loss posed to Compound.

Specification

  • wstETH: $100mm supply cap, 90% CF, 93% LCF, and 5% LF
  • cbETH: $10mm supply cap, 90% CF, 93% LCF, and 5% LF

By approving this proposal, you agree that any services provided by Gauntlet shall be governed by the terms of service available at gauntlet.network/tos.

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Thanks, good question (and sorry, I’ve been away). Personally I think a USDC and ETH market both make sense on Ethereum mainnet. Beyond that, I would think the focus should be on USDC and/or native token base markets on other chains, starting with popular L2s/natively bridged chains.

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Thanks Paul and Gauntlet team for these analyses. We’ve applied the parameters suggested to the deployment and initial proposal script. There was a last-minute change to the cbETH price oracle, which is going to be posted against ETH instead of USD from here on out, so we have some price feed wrapper contracts to handle that, which ought still be audited by OpenZeppelin before deploying and launching this market.

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