DeFi Rate Votes “Yes” on Compound Proposal #11 – DeFi Governance

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Following Dharma’s recent governance piece on proposal #11 along with our continued efforts on transparent governance, DeFi Rate will be releasing our rationale behind Compound Governance votes in a series of blog posts.

While the launch of COMP yield farming has been a massive success, propelling the protocol to $1B in total supply and $383M in total borrows, it has also brought to light some issues surrounding the incentive design.

Proposal #11, proposed by Compound Labs CTO Geoffrey Hayes, addresses the first issue by requiring an externally-owned account to refresh the per-market allocation, rather than allowing a smart contract to execute this functionality.

The second issue regarding risky yield farming is addressed by removing “interest accrued” from the allocation of COMP across markets. Instead, the protocol will allocate COMP proportional to borrowing demand. Most Compound yield farmers will be affected by the second piece of this proposal as the protocol will now calculate COMP distributions based on the total amount borrowed from the market while continuing to distribute COMP 50/50 to both lenders and borrowers in each market.

Given the current issues and the looming systematic risks from cascading liquidations with Compound BAT farming, we believe this proposal (along with the increase in reserve factors from proposal #10) will help mitigate the existing issues and return the market back to a more sustainable equilibrium.

In short, this proposal will shift the COMP farming incentive away from borrowing from markets with the highest interest rates to borrowing from markets with the lowest interest rates.

To be clear, it creates an incentive to supply in markets with high interest rates and borrow from markets with low interest rates, applying as much leverage as desired. This should push towards something of a consistent floor in borrow rates across markets.

While BAT will still be the largest recipient of COMP in the short-term, the distribution change should drive users out of BAT as they’re no longer rewarded for paying a high-interest while the high reserve factor will also eat up potential profits. More importantly, the change will emphasize the importance of better interest rate curves across all markets – something we believe to be necessary for the long-term sustainability of Compound.

While we’re voting “yes” on this proposal, we believe it’s important to highlight the drawbacks too. For one, we’re not huge on the fact that we’re enacting monetary policy changes within a week of the protocol’s token distribution going live.

Looking forward, if Compound community governance wants to make further monetary policy changes (like an issuance reduction), it needs to be communicated well in advance as well as in accordance with some sort of social contract. In short, everyone needs to know about it. DeFi loses an important piece of its value prop if we’re relying on humans to consistently tinker with monetary policy.

The second piece is recognizing the impact COMP farming can have on other protocols. Cyrus from MakerDAO highlighted these concerns in a forum post here. To summarize, due to the high APY from COMP farming, there is a chance that there’s a sudden wave of demand for DAI with the upcoming distribution changes. As a result, a significant amount of the circulating DAI could be locked up in Compound and thinning its liquidity elsewhere, ultimately breaking the crypto-native stablecoin off its peg. We’re not entirely sure of the validity of Cyrus’ analysis but it’s important to recognize it nonetheless.

DeFi Rate has voted “Yes” on Proposal #11 due to the looming systematic risks with BAT farming. We believe Proposal #11 will create proper incentives to drive Compound to an equilibrium in the borrowing markets. Moreover, we believe the proposer – Geoffrey Hayes – enacted best practices with decentralized governance, allowing the community to discuss the issues at length and implemented the proposal in a sufficiently transparent manner.

If you appreciate our governance process and decisions, feel free to delegate your COMP to DeFiRate.eth. If you have any further questions or comments on how we can improve our governance processes, feel free to let us know by reaching out on Twitter!

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Analyst at Bankless – one of the leading resources for open finance. Lucas is an active contributor to the DeFi ecosystem with appearances in other notable DeFi outlets including The Defiant and Our Network. He has years of experience working with dozens blockchain and token startups where he focused on token economics, marketing, and growth.

Source: https://defirate.com/compound-governance-11/

World news – GB – DeFi Rate Votes “Yes” on Compound Proposal #11 – DeFi Governance

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