[COMP] Collateral Onboarding Risk Evaluation

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  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

Risk Premium: 3%
Liquidation Ratio: 175%
Debt Ceiling: 7 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

Overview

Protocol Summary

Compound is an algorithmic, autonomous interest rate protocol enabling lending and borrowing of the pooled assets, initially controlled by Compound Labs, Inc and later transitioned to governance. Compound Labs has raised $33.2M from several well-known investors in the crypto space, like Polychain capital, a16z and Coinbase Ventures. Compound v1 launched in September 2018 and the v2 version launched in May 2019, being one of the first operational DeFi protocols on Ethereum. In June this year, Compound released COMP governance token and transitioned into DAO. Rougly 50% of COMP tokens were distributed between mentioned investors and team members, while the rest was reserved for distribution between users of the protocol via liquidity mining. Liquidity mining is issuing COMP tokens linearly each block, which will last for 4 years. COMP total supply will be 10M tokens.

COMP token allows for delegation of votes to another address and a certain threshold of voting weight is required to propose a change to the protocol, making governance organized and effective.

Compound managed to attract large amounts of capital into the protocol after they initiated liquidity mining and arguably, started a new trend of “liquidity mining or farming” in crypto, which largely impacted the state of the DeFi economy and demand for Dai as a domestic stablecoin on Ethereum.

Metrics and Analysis

Trading volume on CEX & non-custodial venues

COMP is widely present across CEX venues including Coinbase Pro, Binance, Kraken, Bittrex, Poloniex, Huobi Global, OKEx, Kucoin and others. The following exchanges which represent the majority of real trading volume are Binance, Coinbase and Huobi, which were also used for trading volume aggregation. Some venues like OKEx and Kucoin also report significant trading activity, but due to relatively proportionally smaller asset deposits in their custody we omitted the activity from the time series. On the DEX or non-custodial trading venues, COMP is present across the majority of popular venues, but the vast majority of trading activity in this group comes from UniswapV2 COMP-ETH pool which had an average daily trading volume of $2.56M since inception of the market. The median aggregated daily trading volume across all included venues in the analysis since Coinbase listing on 6/23/2020 is $14.2M, which is large relative to other “non-native” collateral assets currently in MCD.

Source of data; CryptoCompare (CEX), Uniswap.info, Kyber Tracker, 0xTracker

Token distribution & Issuance schedule

In total there will be 10M COMP tokens. Initially, 24% of tokens were allocated to Compound Labs shareholders (Coinbase VC, Polychain, a16z and others) and ~26% were allocated to Compound founders & team, which are subject to 4-year vesting. Finally, ~50% is allocated for liquidity mining. The issuance schedule for liquidity mining will release ~2880 tokens daily or approximately 9.5% of total supply per year. As we are currently in the beginning stages of the public distribution (only 243k COMP earned to date), the initial shareholders hold a large majority of circulating supply.

Token Deposits on Trading Venues

Majority of tokens in custodial venues are deposited in Coinbase and Binance. OKEx and Kucoin have much smaller token custody compared to Binance and Coinbase, which signals that their reported trading volume might be inflated and is not reliable. As seen on the chart below, UniswapV2 holds more tokens compared to Binance, which is positive as the liquidity is accessible at any time.

Source of data: Nansen-d5

Downside Risk

COMP just entered its fourth month of trading, thus downside risk analysis is not something we can rely on for modeling jump risks. COMP also did not exist during the events of Black Thursday, where the majority of crypto assets realized their most severe negative returns. The largest daily pullback of COMP was -36%, which occurred shortly after token liquidity mining distribution started, and is more related to initial price discovery than serious price pullback due to market conditions and uncertainty. (Note; considered time-period for COMP is much shorter than ETH in this analysis)

Source of data: CoinMarketCap

Summary of Notable Risks

  • Given that COMP is a relatively new asset, historical data is not indicative. Additionally, due to fast changing DeFi ecosystems and development, we will monitor its development and reevaluate when necessary.
  • Compound Labs shareholders were allocated a very large token amount (~24% of total supply & ~93% of current circulating supply), which gives them dominant power over the protocol’s governance and ability to sell the tokens and influence the price disproportionally to other potential holders (farmers and others who acquired the token on the open market).
  • Compound protocol like any other collateralization based protocol is exposed to the risk of insolvency, which could potentially be reflected in the COMP token price, which would occur simultaneously with large market sell-off.
  • In the instance of appetite for yield farming and/or general DeFi space cooling down, COMP linear issuance schedule would continuously apply selling pressure potentially driving the price down.

Proposed Risk Parameters

Risk Premium: 3%
Liquidation Ratio: 175%
Debt Ceiling: 7 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

We use the model described from the governance call here: a credit risk model that estimates the loss distribution of a portfolio of COMP Vaults. Risk parameters are estimated from this hypothetical loss distribution. Inputs to the model are derived from trading data along with stressed input parameters. A link to our model specification with inputs and outputs can be found here. Auction parameters have been selected to mirror those for ETH.

Lead Researcher: Marko Štemberger

Sources

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