How Compound’s DeFi Service Caught up and Surpassed the Competition?

DeVersiFi Invades the Market and Tries to Recapture Leading Positions

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Image by Miloslav Hamřík from Pixabay

The landscape of the decentralized finance (DeFi) market has changed dramatically over the past few months. Landing project Compound, long ranked second in the DeFi Pulse rankings, suddenly took the lead.

Thanks to the hype around the distribution of tokens, Compound is now by a large margin ahead of Maker DAO in the amount of ETH coins locked on smart contracts. Recently, the capitalization of the DeFi segment has grown significantly, as has the trading volumes of decentralized exchanges (DEX).

COMP background

The Compound was founded in 2018. It is based on Ethereum and is a money market protocol, where interest rates are formed algorithmically based on the ratio of supply and demand.

In 2019, the San Francisco-based startup raised $ 25 million in a Series A funding round led by Andreessen Horowitz. Also participating in the round were Bain Capital Ventures, Polychain Capital, and Paradigm.

Early in the project’s lifecycle, founder Robert Lechner announced his intention to gradually “decentralize” the protocol, depriving Compound Labs developers of administrative privileges in favor of the community. According to him, the community could change the list of supported coins, influence risk parameters, interest rate curves, etc.

On April 16, 2020, management issues on Compound passed from administrators to COMP token holders. The latter is intended to encourage community participation in the project by acting as a voting mechanism. Hence, anyone with a good idea has the opportunity to organize support for changing the protocol.

In total, Compound Labs issued 10 million COMP coins. 55.71% of them are to be distributed among the project team members, founders, investors, and partners. The remaining 42.29% will go to users within four years. The rate of the so-called “liquidity mining” will be 2,880 COMP coins per day.

Half of the assets will be distributed among the suppliers of the offer on the Compound service, the remaining 50% — among the borrowers. The dynamics of the accrual of coins depends on the interest rates set by the market. For example, if USDT has the highest rates, then those who deposit and borrow in stablecoin from Tether will be credited with more COMP tokens.

Changes to the DeFi landscape

In early June, the value of blocked funds on smart contracts for DeFi applications was approaching $ 1 billion. Until recently, this segment was dominated by the MakerDAO project, occupying about 55% of the market. It was followed by the synthetic asset platform Synthetix and Compound by a wide margin.

In the second half of June, the balance of power in the segment has changed dramatically. As of June 29, Compound leads the DeFi Pulse rankings. The value of ETH blocked in this application exceeded $ 600 million.

Changes to the DeFi landscape
Stat: DeFi Pulse

A powerful inflow of funds to Compound began after the start of the distribution of COMP tokens. The chart shows a sharp rise in the value of ETH, which began on June 16, locked in the DeFi ecosystem. We can also note a significant lag behind the new leader Maker, whose dominance index is 38.85%.

On June 15, the volume of assets blocked on Compound was about $ 98 million. Later on this figure exceeded $ 600 million.
Stat: DeFi Pulse

COMP price, according to CoinGecko, skyrocketed from $ 92 (June 16) to $ 372 (June 21). Subsequently, the token quotes were adjusted to $ 240.

Price raise
Graph: CoinGecko

The sharp rise in the market value of COMP, the appearance of the coin on various trading platforms (primarily on Uniswap and Coinbase Pro), and applications have positively influenced the market capitalization of the DeFi market and the turnover of decentralized exchanges (DEX).

Many market participants are probably wondering why the rise of the DeFi market and the growth in trading volumes on the DEX are still not particularly reflected in the price of Ethereum? According to Vadim Koleoshkin, co-founder of Zerion, nothing is surprising in this, since the trading volumes on decentralized exchanges are still much less than on liquidity-charged sites like Bitfinex or Coinbase Pro.

“Also, a large amount of Ethereum is still not transferred from ICO wallets or is stored in custody services by institutional players. DeFi now holds less than 3% of total ether,” he said.

However, Koleoshkin is sure that capital from centralized services will gradually migrate to decentralized applications and DEX.

“I think earning potential and usability will be the main drivers of DeFi’s growth in the near future. Thus, the price of Ethereum will depend more on the demand for it in the ecosystem of decentralized finance.”

According to DeFi Market Cap, the total value of DeFi tokens exceeds $ 6 billion as of June 29. Back in early June, this figure was at around $ 2.1 billion.

Market Capitalization
Data: DeFi Market Cap

In the CoinMarketCap ranking, COMP coin is ranked 23rd as of June 29.

Market Capitalization
Data: CoinMarketCap

In less than a week, the Compound token has nearly grown to capitalize on coins such as Neo, Ethereum Classic, and Dash, and has already outperformed IOTA, Zcash, and VeChain.

Largely due to the hype around COMP, trading volumes on DEX grew by more than 80% in just seven days. Uniswap further strengthened its position in the segment.

The non-custodian platform sector is dominated by the Uniswap exchange.
Data: Dune Analytics

Probably inspired by the success of the Compound, the Balancer automated market-making protocol launched its coin. The token demonstrated significant growth on the very first day of trading, jumping from $ 7 to $ 22. Thanks to this, the project was on the second line of the DeFi Market Cap rating.

Currently, according to DeFi Pulse, Balancer is in 4th place for the value of blocked ETH, behind the newly minted leader Compound, MakerDAO, and Synthetix.

Soon there was news that an unknown hacker had managed to withdraw $ 500,000 in altcoins from the pool of the DeFi project Balancer Labs using a smart contract vulnerability.

The “fashions” for governance tokens have not only changed the balance of power in the DeFi segment but also became one of the reasons for the growth of the median Ethereum commission to a maximum in almost two years.

According to Koleoshkin, many companies are indeed preparing to launch their tokens. However, the hype around coins is unlikely to be comparable to what it was during the “ICO fever” in 2017–2018.

“Unlike the ICO wave, projects will most likely need to show what they have done before raising money. At the moment, this can be compared to raising funds from around A venture funding.

A big plus for these projects will be that the infrastructure for trading and use is already ready. There is no need to pay big money for listing on exchanges — it is enough to create a Balancer or Uniswap pool for a token,” the co-founder of Zerion shared his thoughts.

According to him, the development of the decentralized finance market is proceeding at a rapid pace:

“Over the past two years, DeFi has gone from concept and first working examples of smart contracts to one of the most talked about trends in the industry and the billions of dollars in capital that circulate on the open market every day. If a year ago only enthusiasts who were interested in the very concept of programmable finance used it, now thousands of people from all over the world manage their capital and savings using new services.”

The expert stressed that there is still a lot to go into the field of decentralized finance. The main challenge ahead is the launch of the second version of Ethereum.

“The industry will face a big migration, I would even say the evolution from DeFi to DeFi 2.0. ETH 2.0 will open up new opportunities for developers, but there will be many restrictions. Projects will need to take all the experience gained and re-create their products in new conditions. I think DeFi and DeFi 2.0 will exist side by side, as bitcoin and Ethereum exist now, and the transition will take years,” Koleoshkin concluded.

The controversial “Coinbase effect”

On June 15, COMP made its debut with Ethereum on the leading non-custodial exchange Uniswap (v2). 25,000 COMP and 2,000 ETH were deposited into the platform pool. The price of the token was initially about $ 18.50 or 0.08 ETH, but in just three days it reached $ 145 and continued to rise amid news of the upcoming listing on Coinbase on June 22.

Dynamics of trading volumes and liquidity of the COMP / ETH pair on the Uniswap exchange.
Graph: Dune Analytics

As you can see in the following graph, the majority of COMP coins were initially distributed to users of Tether’s USDT stablecoin, and then to Dai holders.

Dynamics of trading volumes and liquidity of the COMP / ETH pair on the Uniswap exchange.
Graph: Dune Analytics

The initially excessive bias towards USDT was likely due to much higher deposit and lending rates compared to other popular DeFi assets. As already mentioned, the dynamics of the COMP distribution directly depends on interest rates.

Dynamics of changes in annual interest rates for various DeFi tokens for the period from June 15 to 25.
Graph: Dune Analytics

One of the reasons for the subsequent decline in popularity and, therefore, the rate on USDT could be the approved proposal of COMP holders to redirect 10% of the interest income generated by this stablecoin to the reserve fund.

The revival of activity in the DeFi market was reflected in the number of its participants. The number of liquidity providers on the Compound service jumped 200%, the number of borrowers — by 238%.

Ration of Borrowers and Suppliers
Graph: Dune Analytics

The total outstanding debt of Compound users since June 15 has grown by 470% to $ 137 million. More than 80% of this figure is attributable to USDT.

The demand for loans in USDT rose sharply in the second half of June.
Graph: Dune Analytics

The volume of liquidity supply has grown along a similar trajectory:

The volume of liquidity supply has grown along a similar trajectory
Graph: Dune Analytics

Note that the shares of USDT, USDC, and ETH in user deposits are comparable to each other — 35%, 26%, and 28%, respectively. Such a uniform distribution, in this case, is due to several factors: the rate on USDT is the most attractive, ETH is the most popular asset among DeFi platforms. In turn, the USDC stablecoin may be the collateral of choice for risk-averse investors. So, by borrowing USDT against USDC collateral, you can avoid the risk of liquidation.

It is possible that the so-called “Coinbase effect” could serve as one of the growth drivers for the Compound token. The fact that the “hot” asset will appear on the leading American stock exchange became known almost immediately after the COMP issue.

On June 23, immediately after the start of trading with the token on Coinbase, there was a serious and unexpected price dump for many.

Coinbase COMP / USD chart by TradingView.
Graph: TradingView

COMP trades opened above $ 400, but soon the price was below $ 200. As of June 29, the coin is trading at $ 240.

Experts from Galois Capital suggested that some of the early investors could take advantage of the hype around COMP, which was growing rapidly ahead of the listing on Coinbase.

Analysts recorded 25 transfers of 2000 COMP to the wallets of the exchange against the background of the opening of trading. The company does not exclude that Bain Capital or Coinbase Ventures could be behind them. The coins could be transferred for subsequent sale at a relatively high price.

Messari experts believe that the effect of listing digital assets on Coinbase Pro is significantly overestimated. The company claims that the news about the listing on the exchange does not have a significant impact on the overall market trends of the selected cryptocurrencies.

According to CoinMetrics researchers, many assets show negative changes in market value within ten days of listing. Only a few coins rise in price over this period by more than 5%. The average effect is estimated by analysts at + 4% to the price.

Will COMP keep the lead?

The meteoric rise of COMP so far seems to be one of the most striking episodes in the still short history of decentralized finance. The experiment’s success is confirmed by the explosive growth of unique users, the dynamics of outstanding debt, interest rates, and other key metrics.

The sharp growth in the capitalization of COMP is also impressive, which is a short time exceeded the indicator of the Maker DAO project by almost five times. The latter, until recently, reigned supreme in the DeFi market.

It is difficult to outline the future medium and long term prospects for Compound. For the further development of the project, not only an increase in outstanding debt is necessary, but also a more or less fair distribution of COMP. The latter factor determines the decentralized nature of project management, potentially reducing regulatory and other risks.

The equal distribution of digital wealth has never been the industry’s strength. The Compound is no exception: the top 10 borrowers in the USDT market account for over 60% of the debt in this stablecoin.

The share of the largest borrowers in the total amount of USDT debt on the Compound service.
Graph: DeFiMarketCap

It can be assumed that competition between protocols will grow, as similar Compound initiatives are implemented by Curve, Ren, Synthetix, Balancer, FutureSwap, and other DeFi projects.

This means that liquidity will flow smoothly between different protocols, affecting interest rates. Consequently, the effect of the huge funds spent by Compound on customer acquisition may soon be offset by arbitrage operations.

The inflow of liquidity into the protocol largely depends on the market value of the COMP token. The higher the coin price, the more profitable it is for the user to interact with Compound, and vice versa. In other words, changes in market value are reflected in interest rates and the attractiveness of the service as a whole.

Nevertheless, the distribution of COMP tokens is a striking, exciting experiment. It can serve as a sort of standard for the distribution of DeFi governance tokens.

The successful implementation of such programs by various projects can attract funds from participants in the traditional market unfamiliar with cryptocurrencies, who are “tired” of low-interest rates.

How Compound’s DeFi Service Caught up and Surpassed the Competition? was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

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