I have been watching the evolution of COMP farming extremely closely over the last two weeks, and I’m concerned that an upcoming governance change to their protocol could significantly affect the Maker ecosystem. On Friday the balance of power among their collateral assets is going to change dramatically
Up until now, Dai has been left out of the COMP farming craze. This is because COMP is currently rewarded to farmers paying/earning the most amount of interest. Because the BAT rate maxes out very high (~37%), BAT farming has been exceedingly popular. By comparison, at 100% utilization rate, Dai only pays 15% interest.
Under the new rules, COMP will be allocated to every dollar borrowed, as opposed to interest paid. This means that farmers will now try to borrow the most amount of money, and will naturally try to pay the least amount of interest. My expectation is that the two most popular farming assets will be USDC and Dai due to the shapes of their (attractive) interest rate curves. While USDC is easier and safer to farm (fixed oracle price of 1, larger supply, larger potential supply, greater liquidity), Dai will earn more COMP up to a 98% utilization rate. Above 98%, USDC does technically become slightly more attractive but I think that is somewhat irrelevant.
DAI Interest rate curve
USDC Interest rate curve
There are more or less two types of COMP farmers: natural Dai holders and natural ETH holders.
- Natural Dai holders currently hold roughly 130 million Dai (total Dai supply). The optimal tactic for these people is to deposit Dai into Compound, borrow Dai, re-deposit, etc. This recursive loop can gain up to 4x leverage. In other words, 1 million Dai can create 4 million cDai (earning plenty of COMP). Additionally, there is only a very tiny liquidity / liquidation risk here. As long as you cover your interest rate payments, you bear basically no price risk.
- Many farmers are natural ETH holders. They will first deposit ETH, borrow Dai, and then re-supply and go through the loop. These farmers carry liquidation risk (if ETH crashes, or if Dai spikes up). If they are also re-suppliers (what I call ‘double-dippers’) then they also face liquidity risk (cannot withdraw Dai if the utilization rate stays at 100%). Single-dippers (merely depositing ETH and borrowing Dai, without re-supplying), can always pay back their loan since they have the Dai sitting in their wallet. Farming is still extremely profitable for single-dippers.
Due to the high APY for COMP farming (circa ~70-100% APY), there is a chance (likelihood, even) that we see an unprecedented demand for Dai. Much of the natural supply for Dai could also be locked up in COMP farming, thinning out sell-side orderbooks. It is almost certainly more profitable to farm COMP than to sell Dai for a small premium. This could break the peg sharply. Even the creation of new supply (generated through Maker) might go to COMP farming rather than selling. All of the debt ceilings might instantly be maxed out (except maybe USDC-B).
Does the community generally agree with the above analysis? I’d really like to get some other perspectives. My first instinct is that the typical response to such an event would be the threat of Emergency Shutdown. Only if Dai holders are at risk of taking an instant loss (if they are purchasing Dai significantly above $1) might they think twice about undertaking such an activity. But I think we should explore other options such as special risk parameters for ETH or USDC (lower LR, higher DC), or maybe even reach out to and participate in the Compound governance process. It would be ideal if we could have more than the 4 remaining days to plan for what’s about to come.
Thank you to Will Price for walking me through these scenarios.