Compound – the sector-leading lending protocol – is experiencing new paradigms as a result of its COMP token distribution. Since its start on Monday, Compound’s TVL has spiked more than $300M, putting it on track to take the top position on DeFi Pulse should this growth continue.
Perhaps what’s most interesting about this trend is that the vast majority of liquidity is coming from other DeFi protocols, including the likes of centralized counterparts like Nexo. To summarize, liquidity protocols are taking their user’s capital and putting it to work in Compound, all on the assumption that the COMP earned from yield farming will continue to outperform standalone lending returns.
Nexo pumped in another $28.4m to Compound 30 mins. This farm is so harvested…
They have deployed 59.5m to farm $COMP so far.
— Arthur (@Arthur_0x) June 19, 2020
As traders race to farm the hottest new governance token, we’ve seen projects like InstaDapp design “COMP Maximization” strategies that encourage people to take out leverage on stablecoins using Flash Loans.
While it’s mostly been bells and whistles so far, we’re starting to reach an interesting tipping point in which so much attention being pointed at one protocol is starting to stack the number of risk vectors. For starters, yield farming is the first time many non-technical DeFi users are playing with leverage, all under the assumption that nothing wrong can happen with borrowing USDT on margin. While we have full faith in InstaDapp, it is interesting to consider how much longer this trend will surge without hiccups.
Compound Governance Proposals 008 & 009
We’ve also seen two new proposals added for voting – both aimed at trying to address USDT farming to try and protect lenders from default from the massive influx of new borrowers with increased reserve ratios. Here’s some great context on proposal #9 from Dharma – requesting to raise the USDT reserve ratio to 20%.
While Dharma’s proposal to increase the reserve ratio would better protect lenders and provide a bigger cushion for lenders in case of any liquidations, half of the intent behind the proposal is to use the reserve factor as a way to address the disproportionate returns on USDT lending. Yes – USDT liquidity mining needs to be addressed. That part is very clear as borrowing USDT actually has a higher rate of return than lending USDT when factoring in COMP rewards (despite the fact you’re paying nearly 20% interest on the loan). However, we believe increasing the reserve factor isn’t an effective way to go about better aligning incentives from liquidity mining. Even if the reserve ratio of 20% was implemented, USDT would still dominate the protocol in terms of interest accrued. The high reserve factor just gives lenders a lower rate. To this, DeFi Rate is voting “No” on proposal 009 and is excited to explore new ways to help better align yield farming incentives
With that in mind, there’s a very rational argument for having a higher reserve ratio (20-30%) as it may become the norm for Compound in the future. As Compound Labs Founder, Robert Leshner highlighted in Discord:
Regardless of which side of the vote you fall on, the fact that so much thought and discussion is going into governance this early on is an increasingly positive sign for progressive decentralization.
For those curious, COMP currently sits at #24 on the leaderboards, just above the long-time DeFi king Maker and its MKR token.
Cooper is the Editor of DeFi Rate. He is an ambassador of Set Protocol and an active contributor to MetaCartel where he seeks to find emerging consumer-facing applications that propel the Ethereum ecosystem. He often works with projects as the Director of Fitzner Blockchain Consulting where he coauthors the weekly publication Token Tuesdays.
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