With the continuous hype surrounding the Compound protocol and the recent buzz in liquidity mining, the growing excitement is a cause for concern for some experts.
Primer of Compound Liquidity Mining
Tweeting on Sunday (June 21, 2020), Nelson Ryan of VC firm Eden Block highlighted the massive growth in the Compound protocol, the largest DeFi project based on Total Value Locked (TVL). Given the sudden increase in annualized returns (APY) over the past few days, some pundits are expressing worry about the long-term sustainability of the lending platform.
Compound, which came on board in 2018, is an algorithmic protocol built on the Ethereum network which engages in liquidity mining. Back in May 2020, the Compound team released its governance token COMP to the community, which allows token holders to make decisions for the Compound protocol. The DeFi project supports lending in eight different tokens, including ETH, WBTC, USDC, and BAT.
As previously reported by CryptoPotato, liquidity mining incentivizes participation in the protocol by rewarding investors in COMP tokens for contributing digital assets to the project. Both lenders and borrowers receive this compensation, which is currently on a 50/50 split.
Naturally, high-interest lending has become the norm over the last few days, with investors looking to obtain a larger share of the Compound rewards. Wih APY north of 100%, such high-interest borrowing is mitigated by the rising COMP token price.
However, investors appear to have found a useful workaround in obtaining higher interest rates by electing to borrow more non-stablecoins. More liquidity for some particular tokens can trigger temporary price gains that leave investors with unhedged exposure at risk of significant losses if the price action for these tokens moves in the opposite direction.
The current risks do not even take into consideration the emergence of FTX Comp perpetual swaps, which brings shorting into the equation. According to Ryan, a likely safe strategy would be for investors to provide liquidity on Curve Pools.
Security Issues Rocking DeFi
While the DeFi market has experienced exponential growth in recent times, the market, however, has not been devoid of attacks. In February 2020, lending protocol bZx reportedly experienced two attacks, with close to $1 million compromised. Later in June, a group of miners managed to carry out a 51% attack on another decentralized network called PegNet, by manipulating the price of a Japanese yen-pegged stablecoin (pJPY).
The security crisis in the decentralized market continued, with dForce, a Chinese DeFi protocol, losing $25 million in an attack. Shortly after the attack, the hacker returned most of the stolen funds, with dForce consequently refunding affected users.
At the time of writing, the TVL in DeFi is almost at $1.5B, with Compound leading the market with 37.92% according to data on DeFi Pulse.