Compound Changes COMP Distribution Rules Following 'Yield Farming' Frenzy

The daily distribution of the Compound protocol's COMP token will soon change dramatically.

Compound governance proposal #11 passed today at 18:37 UTC. It will go into effect in two days, after the cooling-off period passes. When that happens, it's very likely yield farmers will exit the riskiest markets of BAT$0.1759 and ZRX$0.1322 and move their activity into safer assets, stablecoins such as USDC and DAI.

A week ago, the Compound team put forward a proposal to shift how COMP gets distributed to liquidity providers and borrowers on Compound, the premiere collateralized lending application in decentralized finance (DeFi).

"When the Compound token distribution began, no one really knew what to expect," Robert Leshner, Compound's founder, told CoinDesk. "Our team was surprised by how powerful the impact of the distribution was on incentives, and so was the community." Compound staff wrote the proposal but Leshner said they abstained from voting.

The vote closed Tuesday with 771,804 COMP staked in favor and less than one COMP staked against; that is the equivalent of 26% of all liquid COMP voting in favor of the change, based on CoinGecko statistics. A total of 115 wallet addresses participated with only four voting against the motion.

Compound started distributing COMP tokens on June 15 following the announcement of the distribution mechanism on CoinDesk.

COMP changes

Under the original rules, users are given COMP based on the amount of interest they earn or the amount of interest they pay (or both, in most cases).

The theory in designing it that way, Leshner said, was that "if you are paying a lot in interest or earning a lot of interest you have skin in the game [for governing the protocol]."

Read more: Compound’s Approach to DeFi Governance Starts With Giving Away COMP Tokens

The hope had been the system would favor the most fervent users with an actual need for Compound's services, but no one expected the gap between the cost of yield farming COMP and the price of COMP on the market to diverge so dramatically.

This became very attractive for investors looking to find ways to game the system, and they did.

There was a dramatic shift in the usage patterns on Compound and markets that had not been very popular before saw a spike in activity. BAT offers the starkest example.

On June 15, total supply of BAT on Compound was just under $2 million. As of this writing, it is $333 million.

What will happen?

Every day, 2,880 COMP are distributed to users. That's not changing. But under the new rules, which go into effect Thursday, users will simply earn COMP on the dollar value of assets they have put in or borrowed from the system.

By simply allocating COMP based on dollars in the system, stakeholders say the overall interest in COMP yield is unlikely to drop, but the assets will almost certainly shift to different markets.

"By distributing on the basis of total borrow, the incentive to self-deal in niche asset pools largely dries up, and we're likely to see much of this capital (particularly the BAT market) flow out of the protocol," Brendan Forster of Dharma, which uses the Compound protocol to offer stablecoin "savings" accounts, told CoinDesk in an email.

Read more: Some Numbers That Show Why Yield Farming COMP Is So Seductive

"The goal of the COMP distribution is to allocate COMP to users who are generating value for the protocol, whether by supplying capital or by paying interest on borrow," Forster continued. "The change to the distribution mechanism, in my opinion, better achieves this goal."

Sowmay Jain, a co-founder of Instadapp, which has tools to help investors maximize their COMP yields, expressed support for the newly passed proposal to CoinDesk in an email. He wrote, "This will incentivize the genuine user of the protocol and make it harder to game the system."

MakerDAO’s concern

One group that's nervous about the change is MakerDAO. Cyrus Younessi from MakerDAO's risk team wrote a post on the project's forum that the change could cause a spike in demand for dai. (MakerDAO has not responded to a request for comment.)

"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," he wrote. "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 order books."

That said, there's an additional advantage for an investor to extend their yield farming to dai: By focusing on stablecoins, they are much less exposed to underlying volatility in their investments (far less than what might be expected yield farming with ZRX or BAT).

On that note, Forster wrote, "This change de-risks the protocol, and so should increase demand for COMP."

Read more: Compound Tops MakerDAO, Now Has the Most Value Staked in DeFi

Dai aside, if the change works out as planned, longtime Compound users should start earning more COMP each day, which has the potential to put upward pressure on COMP's price as proportionately less gets sold on exchanges, as Forster explained.

"The current 'yield-harvesters' or 'yield-farmers' aren't really interested in COMP as a governance asset, only the economic gains they get from the distribution. They are likely selling off COMP on a regular basis," Forster wrote. "This change will likely result in COMP being distributed to users who are more likely to be long-term believers, and therefore more likely to be COMP hodlers."

There is currently $977 million in assets supplied to Compound as of this writing and $361 million borrowed, making it the largest DeFi protocol in terms of total value locked. The price of COMP is $215, down from an all-time high of $373 on June 21.