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Compound: Community Now, Cashflows Later

Jun 17, 2020 · 5 min read

By Tom Shaughnessy

Compound is a decentralized lending middleman: anyone can deposit ETH, DAI, USDC or other assets and earn interest as they are lended out to users on the other end. The launch of the COMP governance token has attracted the attention of everyone in the crypto sphere. The release has also driven the market cap of the top ten DeFi protocols to $3B+.

 

There are a few interesting tidbits we should hit on

 

  • Compound successfully grew its platform and attracted suppliers/borrowers without a token initiaLlly.

  • The lending market is full of competitors; from traditional players like BlockFi to other protocols such as dYdX, Maker and Aave. Despite the idea that Compound couldn’t maintain a moat without a token or differentiation, it clearly has.

  • Currently there is $309M in assets being supplied on Compound and $81M being borrowed, being offered by 22.4k/2.5k users on each side, respectively. Over 20k users supplying assets, and people say Crypto has no users (yawn).

 

Turning to the COMP token; this token is strictly released as a governance token for now. Users can obtain the COMP token by yield farming, aka depositing assets in the protocol or borrowing. Roughly 2,880 COMP tokens are being distributed daily for the next ~4 years (based on Reservoir supply of 4.23M COMP). This COMP is distributed 50/50 to borrowers and lenders on a pro rata basis based on the distribution of interest on both sides of the protocol.

 

A few implications from all of this

 

  • The distribution of COMP to both sides of the market is a killer way to solve the chicken-or-the-egg issue of incentivizing both sides of the protocol.

  • Users can earn interest on their dormant assets in a trustless way, while also earning COMP.

  • The COMP token currently has no claim on any “cashflows”, future issuance or realistically any value today. Although, since COMP governance is totally in the hands of users (socially it appears to be, and 0 COMP is being held by Compound Labs Inc. It’s worth noting that the core team does control 23% of the tokens though) the idea is that token holders have the ability to implement a claim on “cashflows” later on in the future which is the sticking point.

 

Legacy finance folk will laugh but the world has changed from requiring a dividend from an investment in stocks to an all out focus on share price appreciation through the vicious reinvestment of profits to fuel growth. To paint this picture, imagine choosing Walmart’s ~2% dividend yield over Amazon’s growth sans dividend. Walmart is on the chart below (just hard to see), the point is just that Amazon’s massive return has outpaced it – granted this chart doesn’t include reinvesting WMT’s dividends but that wouldn’t put it anywhere close to AMZN’s growth. AMZN beat WMT even before Amazon Web Services took the company to new heights.

The point of this story is a few things.

 

  1. COMP’s massive market cap of $650M+ (topping Maker’s $550M+) might be driven by some exuberance, but the tokens will likely derive their value from both governance and the ability to implement some cash flow scheme in the future. Maybe it’s 1% fees on the borrow side which are sold for DAI and granted to holders or burnt – there are a lot of possibilities.

  2. You can launch and nurture a community pre-token, and add one later on.

  3. Unrelated, but DeFi is gaining all the attention in the space. COMP is dominating twitter, not new Layer 1’s. It’s hard to compete as a new Layer-1 when you’re competing for attention against things already built on other platforms (DeFi) that you hope may be built on your own layer 1, someday.

  4. The UX and ease of interacting with full fledged DeFi platforms is falling to laughably low levels. It takes seconds to borrow or lend on Compound. Lower hurdles equals more interest, which drives a virtuous cycle.

  5. The COMP core team is literally handing this protocol off to the world – holding limited tokens and releasing it to the token holders. We’ll see just how much input they have, but if the community steps up, it could create a truly decentralized DeFi protocol without a figure head – we’ll see.

  6. It’s super easy to delegate voting rights on COMP, it’s easy to find a key leader or friend to vote for you. I’d expect the majority of COMP to be delegated to those in the know (No one wanted to deal with Maker’s daily interest rate voting changes at one point). Maybe these voters can even extract a fee for their services.

  7. COMP could be easy to model. A % fee on the borrowing side could yield an easily modelable “cash flow” for which COMP can trade on (yield basis or multiple) depending on the dynamics of the burn or offer to users.

  8. Yield farming is driving up the borrow rates for stablecoins to insane levels.

 

One outstanding question is if users and liquidity will remain after COMP farming ends. Based on the issuance of COMP on the platform, it might take 4 years to find out.

 

The future is in protocols. Decisions will be made by their communities (on or off-chain governance). DeFi is hitting its stride and the space will continue to accelerate. Strap in.

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