Compounding Confusion - The Daily Gwei #142
I have some things to say about some things.
I want to start today’s piece by saying that I really respect the Compound team and what they have built and continue to build - they’re Ethereum DeFi pioneers through and through. In saying that, today’s announcement of a new ‘Compound Chain’ caught me off guard because it just doesn’t really make sense to me. I’m not alone in thinking this either - I haven’t really seen much public support for this - just more of the same confusion that I have over it. On top of that, the Compound Labs Twitter account limited the replies on the announcement tweet which signals to me that they knew this announcement would not be a popular one.
Okay so first I’ll unpack what Compound actually announced. It’s basically a new Proof of Authority (PoA) blockchain called ‘Compound Chain’ that has a new stablecoin called ‘CASH’ that is used as the networks native currency. Additionally, Compound/COMP governance on Ethereum will be used to govern Compound Chain and its validator set.
Compound claims that there are 3 main challenges that this new chain solves:
High transaction fees on Ethereum
Aggregated risk of supported assets; one bad asset can spoil the bunch which limits the universe of acceptable collateral
The Compound protocol has no way of supporting assets that aren’t tokenized on Ethereum
Let’s start with the first one - high transaction fees on Ethereum. Well, of course it’s hard to argue against this - it’s expensive to transact on Ethereum - there’s no debating that. Though the reason it is expensive is because Ethereum’s throughput is limited due to its extreme decentralization - Compound Chain will only have low fees because it will be much, much less decentralized as it’s a PoA chain (where the validators are chosen by COMP governors). On top of this, Compound could get the same benefits from using a layer 2 on Ethereum rather than spinning up a new chain with a new validator set. I know what you’re thinking - wouldn’t layer 2 break composability? Well, it does in some way, but I believe that moving to a layer 2 and retaining Ethereum’s network effects and security is still the better move over creating an entirely new chain (which also breaks composability).
The second issue that’s stated in the whitepaper is around “aggregated risk of supported assets”. There’s not much information about this in the paper itself with basically just one section about ‘Asset Caps’ describing the act of limiting the market risk of individual assets by restricting the maximum quantity of an asset that can be “uploaded” to Compound Chain. I can’t really do a proper analysis on this since the information is sparse but, from what I know, the Compound Protocol already has the ability to cap, add and remove assets. Maybe I’m wrong here or misunderstanding what problem Compound is trying to solve here but as I said, there isn’t much more information about this yet.
The third issue that’s stated is that the Compound protocol has no way of supporting assets that aren’t tokenized on Ethereum and they claim to be able to solve this with Compound Chain by using “starports” - contracts that exist on “peer” chains such as Ethereum. Though I imagine there’s going to be compatibility issues that need to be ironed out for each chain and I’m assuming that the Compound Chain validators will have the final say over what assets can be bridged across from which chains (and the maximum amount of those assets due to the ‘Asset Caps’). On top of this, there’s issues of trust and liquidity. By sending your assets across to Compound Chain, you are giving up the security guarantees of Ethereum and trusting that the Compound Chain validators don’t act maliciously. You’ll also be dealing with much less liquidity than what you would get on Ethereum which will make Compound Chain very capital inefficient.
I actually think the more interesting part of this announcement is ‘CASH’ - Compounds new interest-bearing stablecoin which is an asset that can be created through collateralization and borrowing - similar to Maker/Dai. So, in other words, Compound is launching a Dai competitor - something that many people speculated that they would do eventually. Though, CASH is a bit different to Dai in that it will be used to pay transaction fees on Compound Chain and validators will earn a portion of the interest paid by CASH borrowers as an incentive. Of course, CASH can also be sent over to Ethereum or other peer chains if the user so wishes.
Robert Leshner, the founder of Compound, was on Twitter today offering up some of his reasoning as to why they are launching this new chain. The most interesting point he made was that he thinks that Compound Chain can act as a bridge chain for non-Ethereum assets like central bank digital currencies (CBDC’s) and others into Ethereum. Though, I feel like this point is grasping at straws because why do you need a bridge chain for this? These off-chain assets can just go directly to Ethereum - why would they need to pass-through an intermediary like Compound Chain? Would these issuers trust a PoA chain over a fully decentralized PoW (and in the future, PoS) chain? Would they even take the time to evaluate all their options or just default to going to Ethereum since it’s the most well known, widely adopted and secure chain? There’s a lot of open questions here which just adds to my “compounding confusion”.
There is so much more to unpack here and I could probably write a much longer piece about why I think “app chains” are not a panacea and do not fix most of the issues that their proponents think that they do. At the same time, the elephant in the room is that Ethereum does need to scale to meet demand, but why not do the “app chain” thing at layer 2 where you can retain the security properties of Ethereum and interoperability is easier and simpler to achieve? Well, Brock Elmore believes that by spinning up their own chain, Compound “future-proofs” itself in case Ethereum loses its stop as the dominant DeFi chain - this is something that I obviously don’t see happening.
Anyway, I do think Compound will find some success with this new chain given how popular their protocol is but as I stated above, I think they would’ve been better off building on layer 2 Ethereum - something like Connext would’ve probably been a better solution. Of course, I’m still curious to see how this all plays out and which solution wins (Ethereum layer 2 or sidechains) - my bet is, of course, on Ethereum’s layer 2 ecosystem.
Have a great weekend everyone,
Anthony Sassano
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All information presented above is for educational purposes only and should not be taken as investment advice.