How Compound beat MakerDAO in just one day and became the leader in the DeFi market

How Compound beat MakerDAO in just one day and became the leader in the DeFi market

By Kluma | InterestingCrypto | 7 Jul 2020

DeFi remains a source of fast financial ups, but also the same fast falls. Previously, the MakerDAO project was the main driver of this market. However, in a short time he was overtaken by a competitor in the person of Compound. As a result, the capitalization of the DeFi market has grown several times. Why did the crypto community show such compelling interest in Compound, how did the hype develop around the project, and why is the current situation still an alarming sign for the crypto market? DeCenter understood everything.

MakerDAO project for a long time remained the largest player in the DeFi sector in terms of user funds, and Compound followed at that time. Now the picture has changed. But before explaining this change in leadership, it’s worthwhile to elaborate on how the Compound protocol works.

Assound Markets in Compound

Unlike MakerDAO, where only four assets are accepted as collateral, there are already nine in Compound: Basic Attention Token, Ethereum, USDC, Tether, Dai, Augur, 0x and Sai (the “old” version of Dai stablecoin). Compound runs on the Ethereum blockchain, so all collateral assets are ERC20 standard tokens. In addition, an analogue of bitcoin - wBTC is accepted as a pledge (or contribution). This is also an ERC20 token, the price of which is tied to the rate of the first cryptocurrency.

Each asset in Compound has its own “market” - a pool of available for use assets, composed of user funds. Each market has its own financial parameters: the required amount of collateral, interest rates and so on. All markets are interconnected. Any user can leave a pledge in one of the nine possible assets and take out a loan in another asset (the value of collateral and loans is calculated in dollars). Such a structure is necessary for automated short-term liquidity provision, which is relevant, for example, for decentralized exchanges.

In addition, until recently, only loans were in effect at MakerDAO. A smart contract with deposits (that is, with the function of blocking your funds in the protocol for earning interest on the principle of a bank deposit) appeared only in November last year. However, now the rates on “deposits” in MakerDAO are zero , and there is no point in using them.

In Compound, on the contrary, in every market there are not only “buyers” of pool liquidity (borrowers), but also “sellers” (lenders) - users who send their coins to the pool so that the protocol can use them to issue loans. For this they receive interest at an annual rate (the size of which, as in any DeFi application, varies depending on the ratio of supply and demand). In essence, these are deposits.

The stability of the deposit and credit system in Compound is supported by the same principle of excess collateral as in MakerDAO: the size of the issued loan should be less than the size of the user's pledge. For example, on July 6, Compound provided collateral and deposits of more than $ 1.4 billion, and outstanding loans - $ 784 million.

Moreover, each asset has its own pledge coefficient. The more stable and liquid the underlying asset, the less the required collateral, and vice versa. This is a way to regulate risk: if a user's deposit is nominated in stablecoin (for example, USDC), then the likelihood that its value will decrease due to market volatility to a critical value is low. For an ordinary token, such chances are much higher.

Compound payout and interest

The Compound interest payment system is trickier than in MakerDAO. In fact, users do not pay or receive any interest payments.

When a Compound user blocks funds in a smart contract to take out a loan or receive interest income, he receives in return “synthetic” tokens (cTokens). These are the same ERC20 tokens, if desired, they can be withdrawn to a personal wallet, but then they will cease to be part of the deposit or deposit in Compound.

Each underlying asset has a floating cTokens rate. For example, on July 6, 1 ETH was 49.968 cETH. The exchange rate depends on the interest already distributed in the system, which means it is gradually (although slowly) growing.

When a user wants to take a deposit or pay off a loan, the system automatically converts cTokens into a base asset at the current exchange rate. If the rate has grown, the depositor will take the number of coins, which is more than he gave at the beginning, and the borrower is less. Thus, in the exchange rate are laid interest that “hit” during the term of the deposit or loan.

Let's take an example. The user decided to open a deposit of 1000 Dai tokens in Compound. The exchange rate of 1 cDai is 0.02 Dai. So the user will get 50,000 cDai. After a few months, he decides to withdraw funds from the protocol. At that time, the exchange rate of 1 cDai increased to 0.021 Dai. So, the user will get back already 1050 Dai.

What role did COMP tokens play in the success of Compound?

The idea of ​​deposits at Compound, of course, sounds attractive and is an advantage compared to MakerDAO, where there are no ways of passive income. However, this does not explain how Compound managed to increase the amount of user funds several times in a couple of months.

The reason for this explosive growth lies elsewhere. Namely, in the large Compound “decentralization” campaign. The project was launched in 2018 after the ICO, but, unlike MakerDAO, until recently it was completely centralized, that is, developers made decisions on changes in the financial parameters of the protocol (for example, the size of collaterals). In MakerDAO, for a long time, the system with the MKR management token has been used: its holders, in accordance with the sum of their savings, have a certain weight, which they can use to vote for various decisions. Compound also has its own control token, COMP, but until recently it was not in open circulation. According to white paper, 42% of the total issue of COMP should go to the public (the rest is reserved for the team, partners, key investors and so on).

At the end of May, coins began to be distributed among users, but according to an unusual pattern. COMP tokens are credited daily to all users who borrow or take loans at Compound, in proportion to the interest rate, as well as their interest or income payments. Moreover, COMP tokens are accrued equally among both borrowers and lenders in each “market” of assets. Because of the hype, the COMP price has risen sharply, and thanks to the easy way to get it, a huge interest in Compound products has arisen.

Why the price of the COMP token soared five times in a week

The financial success of Compound has provided a combination of two things. The first is the so-called “income farming” (Yield Farming). Initially, it implied a constant migration of users between various DeFi services in search of the highest percentage of income for a minimum period. However, unlike other services, Compound was able to further improve the offer with percentage earnings by offering additional cashback in the form of its COMP management tokens. Without this, Compound would have failed.

The second phenomenon that contributed to the growth of hype around the project was the entry of the COMP token into free circulation. So, on June 15, the token was listed on the Uniswap exchange. According to DeFi Pulse, by June 22, the total amount of all funds blocked in decentralized finance services increased one and a half times - from $ 980 million to $ 1.51 billion.

The total cost of all funds blocked in DeFi services. Source .

The day after the listing on Uniswap, on June 16, the price of the COMP token soared 60% per day, and Compound surpassed the previous leader, MakerDAO in capitalization , reaching $ 859 million (against $ 551 million from Maker). The capitalization of the entire DeFi market that day for the first time exceeded $ 3 billion. According to the aggregator DeFiMarketCap, today it is already $ 7.4 billion, of which $ 1.9 billion falls on the Compound project. However, it is worth noting that this service considers the capitalization of the project to be fully emitted, while other aggregators give a lower Compound rating of $ 640 million, since only tokens in circulation are taken into account (currently 3 million coins).

"Firewood in the furnace" threw an announcement on the upcoming listing of COMP on the Coinbase Pro exchange, made on June 18. As a result, the price of the token from June 17 to 21 increased almost fivefold - from $ 73 to $ 332, according to the Nomics aggregator.

Price Chart COMP. Source .

A bubble formed around the COMP token, which quickly burst. If on the first day of trading at Coinbase (June 23) a local COMP maximum was reached at $ 427, then the very next day it fell by more than 40% to $ 250. In the following days, the price repeatedly moved tens of percent in one direction or another against the backdrop of listing news on Binance and Poloniex.

By July 6, the price of COMP dropped to $ 198, the "swing" continues, but the "fever" does not stop. Compound pays COMP tokens to users (lenders and borrowers) daily in exchange for their activity. The higher the rate (it doesn’t matter on a deposit or a loan), the more tokens a user can receive in relation to the size of the collateral. This led to a massive influx of funds into the most risky token presented in Compound - Basic Attention Token, which has the highest rates.

Given the sharp rise in the price of Compound, it has become profitable for users to take short-term loans - after all, cashback in COMP tokens will pay them back quickly and with interest. Moreover, many began to operate the system, using the loans it issued to open new loans.

In the end, this forced the developers and largest holders of COMP to vote for a change in the rules : new COMP coins will be distributed based not on the liquidity of the asset (therefore, high rates), but on the cost of the funds used, calculated in dollars. By design, this should encourage users to switch to stablecoins, for example, USDC, USDT or Dai.

What will happen next?

However, this is unlikely to stop those wishing to make money quickly. If loans in BAT on the Compound platform have a rate of 33% per annum, then stablecoins - less than 5%. This means that the cost of servicing such loans will also be relatively lower.

CoinDesk published the calculation of various strategies for "income farming" along with the COMP token . So, with the most “conservative” approach, using USDC and Dai stablecoins to open one deposit and one loan with a capital of $ 10,000 per year, you can earn 5%, and with the most risky approach (if you conduct transactions with BAT and 0x tokens) - more 85%, taking into account the received coins of COMP at a price of $ 200. However, the risk is much higher - lowering the price of BAT and 0x can simply “wash away” the collateral.

The “income farming”, whose profitability has suddenly grown due to the introduction of the COMP token, is an easy way to make money quickly, so it led to a hype. However, the rapidly soaring popularity of Compound rests on the unreasonably high price of its token, which is distributed free of charge to participants. This state of affairs involuntarily brings to mind the “ICO boom”, which ended in disappointment and heavy losses for many investors.


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