Compound is the third biggest lending and borrowing protocol on Ethereum according to total value locked (TVL). At its core, Compound operates as an algorithmic money market protocol. Users can supply their cryptocurrency assets to earn interest on them. Borrowers can borrow tokens they need in an overcollateralized manner. Borrowers need to pay interest on their borrowed assets.
Compound was launched in 2017. Compound v1 had a fairly simple monolithic structure in which all the tokens are stored by a single contract. Accounting and risk management tasks were also handled by this single contract. Compound v1 was depreciated in June 2019.
Compound v2 was launched in 2019. In v2, each asset had its own treasury contract. Accounting is also distributed. The co-founder of Compound, Robert Leshner once said “The architecture of [Compound v2] was too risky in that one bad asset can theoretically drain the entire protocol.” So for better capital efficiency and risk management Compound launched V3 in 2022.
With V3 Compound Finance introduced some key lending and borrowing features. This report will provide information about those features in depth. We will explore these features with live data of Compound V3 markets.
Single Borrowable Asset Model
In Compound V3, users can only borrow base assets of each market. Currently, two major markets are active on Compound V3:
• The USDC market
• The Ethereum market
USDC market
In the USDC market users can supply – ETH, WBTC, UNI, LINK, and COMP as collateral to borrow USDC. As of April 29, 2024, the total value of assets supplied as collateral for the USDC market was $1.02 billion.
Here is the asset-wise value and percentage share of Supplied Assets.
From the above chart, it is clear that wBTC and wETH are the most preferred and dominant collateral assets to borrow USDC. Primary reasons for this are marginally lesser price fluctuations, higher liquidity, and huge demand for these blue chip crypto assets in the market.
As of April 28, 2024, the total USDC borrowed from Compound v3 USDC markets is $415.18 million.
Ethereum market
In the Ethereum market users can supply wstETH, rETH, and cbETH as collateral to borrow ETH. As of April 29, 2024, the total value of assets supplied as collateral for the Ethereum market is $301.5 million.
The primary reason behind the sudden increase in collateral supply in November, 2023 was the proposal passed on Nov 27, in which Gauntlet proposed decreas of the base borrowing interest rate of wETH to almost half of its previous value along with other parameter changes.
The reason behind another sudden spike in collateral value in early February this year was an increase in ETH price from $2200 to $3900.
Here is the asset-wise value percentage. As of April 8, 2024, the total ETH borrowed from Compound v3 Ethereum market is $86.78 million.
Decoupled Interest rates
In V3, only the base asset (e.g., USDC) earns interest in V3 markets. Collateral assets do not earn interest, which was the case in v2.
Total earned assets (yield + native tokens) have increased by ~150% over the last year. It also reached a peak of $529.31 million for the USDC market on April 2, 2024, and $26.71 million supply and borrow interest rates, allowing for more granular control by the protocol. This means that rather than being dependent on each other, both supply rate and borrow rate is now independently dependent on the utilization rate.
Compound V3 also decouples supply and borrow interest rates, allowing for more granular control by the protocol. This means that rather than being dependent to each-other, both supply rate and borrow rate is now independently dependent on the utilization rate.
Supply APR & Borrow APR for Compound Finance is directly proportional to the utilization rate. Utilization rate above a certain value can result in a sudden increase in Supply and Borrow APR.
Here is the live example using our dashboard.
📅 February 5, 2024:
Supply APR for USDC: 33.16%
Borrow APR for USDC: 28.18%
Utilization rate for USDC: 99.88%
Supply APR: Supply APR on Compound represents the annual percentage rate (APR) earned by suppliers of an asset.
Borrow APR: Borrow APR on Compound is the annual percentage rate paid by borrowers of an asset.
Utilization rate: The utilization rate of an asset in Compound refers to the percentage of the asset that is currently being borrowed out of the total available supply.
Both Supply and Borrow APR are calculated using a similar formula.
Collateral and Borrowing
Users can either supply the base asset to earn interest or supply other supported assets as collateral and borrow the base asset. However, a user cannot simultaneously be a lender and borrower in the same V3 market. This design simplifies the borrowing and lending process in Compound V3 compared to V2. It reduces complexity and potential risks associated with users simultaneously supplying and borrowing the same asset.
Portal, Isolation Mode, And Account Management
The portal enables cross-chain transfers of assets between different Compound V3 deployments. Isolation Mode allows segregation of high-risk assets when lending and borrowing to limit risk exposure.
Compound V3 introduces advanced account management features, allowing users to grant permissions to other addresses or protocols to access specific functions of their account, like repaying debt or borrowing on their behalf.
Along with these, Compound also implemented permissioned forks and simplified governance. All these improvements were introduced to address key limitations and vulnerabilities present in the Compound V2 protocol. With a lesser number of supported tokens and new architecture, V3 is much more optimized and easy to scale compared to V2.
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