Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Robert Leshner: Compound – An Automated Money Market for Ethereum Tokens

Episode Date: July 9, 2019

In this episode, we caught up with Robert Leshner, founder of the Compound protocol. Compound is a fascinating smart contract protocol, running atop Ethereum, that allows users to lend and borrow specific ERC-20 tokens with a duration-free interest model. The protocol acts as a central borrower and lender of user tokens and algorithmically prices the interest charged to borrowers and lenders. Compound is one of the first examples of a well-functioning lending market built using smart contracts. Topics covered in this episode: Robert's background and how he came to found Compound The workings of the compound protocol Statistics of usage of the protocol Intended plan for governance of the protocol in the future Business model of the company and the protocol Comparison of compound to other lending protocols on Ethereum Outlook and future plans Episode links: Compound Website Compound Protocol Stats Our plan to create Compound v2 Robert Leshner on Twitter Robert Leshner on Linkedin Compound Finance on Twitter Sponsors: Cosmos: Join the most interoperable ecosystem of connected blockchains - http://cosmos.network/epicenter Vaultoro: Trade gold to Bitcoin instantly and securely starting at just 1mg - http://vaultoro.com This episode is hosted by Meher Roy & Friederike Ernst. Show notes and listening options: epicenter.tv/295

This episode of Epicenter is brought you by Cosmos. Cosmos is building the internet of blockchains, an ecosystem where thousands of blockchains can interoperate, creating the foundation for a new token economy. If you have an idea for ADAP, visit cosmos.network slash epicenter to learn more and to get in touch with the Cosmos team. And by Volturo, the gold hedging platform for the crypto community. Trade gold to Bitcoin instantly and securely, starting at just one milligram. Go to Voltoro. Epicenter to get early access to their V2 platform and to start trading.

Welcome to Epicenter. I am Friedrich Ains. And I am Meheroy. And this is episode number 295. We have a short announcement to make. There will be a conference in Berlin during Berlin Blockchain Week this summer. It's called DepCon. You can find it online at DepCon.io. It's August 21 to 23rd.

And there is a discount code for Epicenter. EpiCenter listeners. The discount code is Epicenter Depcon 2019 and it gives you a 20% discount. Several of the hosts will be at that conference

and will moderate panels. And we will also record a second edition of EpiCenter Live with Sunny Sebastian myself. And just from the feedback that we got, the last one at the Interchain Conversations was

super. Cool. So you're one of the organizers for DAPCon, right? Frederica. Yeah. So NOSUS is organizing it. And it's a proud member of Berlin Blockchain Week. So a ton of other things are happening in Berlin at the same time or just before or after.

So there's the Web 3 Summit. There's ETH Berlin. There's Daocon and Meta Cartel. And it'll be a super interesting week starting August 19th. So if you can make it to Berlin, absolutely to come. Berlin is also a fantastic place to be particularly in summer. Yeah, I regret I won't be able to be there, but it seems like an exciting conference. Yeah, now moving on to our guest this time around.

We are going to chat with Robert from the Compound Protocol. He's the founder of the Compound Protocol. I'm sure many of you know about compound, but it is a money market on the Ethereum Protocol. you can furnish your assets that are just sitting there, like ESA, die, bat to compound and earn an interest rate. And then you can also do collateralized borrowing. So if you have supplied assets to the compound protocol, you can borrow against those assets as well. It is a super interesting use case because there is no way of earning interest currently no major way of earning interest on crypto assets that people hold.

And it was a much-needed building block of the defy ecosystem and caught on amazingly quickly. So without further ado, we'll give you the interview that we had with Robert Leshner, the CEO. So today we have Robert Lesnar, who is the founder of Compound. Compound is this fascinating money market protocol on Ethereum that allows people to make interest on the ether, die, 0x, bat and other tokens. Robert, welcome to the show. Thank you.

Excited to be here. So I'm curious to know your story, Robert, of how you entered the cryptocurrency space and what led you to build a money market protocol. So I've had a slightly long journey. So I originally noticed Bitcoin in about 2011 while I was working at first of bank and then a wealth management business as an interest rate analyst and economist. And I was dismissive at first. I said, oh, you can't create money.

This will never work. And my first attitude was one of hostility. But as it began to prove itself in the wild for a while, I eventually became interested in actually mining and participating in the growth of Bitcoin. I learned a lot. I was lucky to have probably broken even on my mining hardware. but it got me interested in what cryptocurrency was possible to create. Then when Ethereum came out, I was also initially dismissive. I thought that it was an order of magnitude more complicated than Bitcoin and couldn't work either.

And so I stopped paying attention to it for a while until the Dow hack immediately caught my attention. Some ways I thought it was a positive that you could create an organization on top of Ethereum, even while flawed and even while having issues, it proved that there was something possible that we could create decentralized autonomous organizations, financial markets, assets, and entirely new economic functions. And I was immediately home.

And then like a money market protocol. There are not too many entrepreneurs working on money market protocols. So why money markets? Well, in the real world, money markets one of the most boring financial instruments. But I think when it comes to crypto, they're one of the most interesting financial markets, simply because it unlocks so many more applications and use cases. Just having a boring, liquid, short-term risk-free rate, while it's not sexy,

it's fundamentally important as a composable structure for other use cases. So when did you start creating compound? So I started creating compound in the late summer of 2017. I began raising capital and hiring a team really with the idea of exploring whether this was even technically possible and feasible. At the time, you know, not many applications had launched on Ethereum of significant complexity. And I wasn't even confident that we'd be able to technically create a protocol like this. Interesting. So can you give us a brief overview of what compound is and how it? works? So compound is what we think of as a liquid pooled money market where there's an interest

rates set by market forces and anyone around the world can participate in this market by supplying assets to it and earning an interest rate. We're borrowing assets from it and paying an interest rate. The market is designed to replicate the equivalent of an overnight rate in that it's designed to have no credit risk and it's designed to be liquid and it's designed to fluctuate relatively frequently. Just for reference, could you explain to us how money markets work in the traditional financial ecosystem? So in the traditional financial ecosystem, money markets are really a set of instruments which have very limited credit risk and that have interest rates that closely mimic the short-term interest rates. And it's really just, um,

a series of assets that collectively generate an interest rate that's overnight in nature for the end users of it. And so like what kind of entities need a money market? So every entity in some sense needs a money market. So whether you realize it or not, large amounts of wealth are deployed into money markets when they're not being more productively used elsewhere. You have these, you know, long-term capital investments in economies. where capital is invested for long-term goals. And then you have the excess, the things that aren't actively invested, the things that are between investments,

the things that are mostly cash sitting in accounts. These are the assets that find themselves in a money market, earning the best possible rate, even though it's not going to be a high rate. But it's a way that wealth is passively deployed very frequently. So how does it work in practice? So say, I have five ether sitting in my account. What would I do with it?

So what you would do with five ether is you would send it to the compound protocol. You don't specify a duration that they're supplying it for, and you don't specify an interest rate that you're willing to accept. You're simply supplying it and earning the prevailing interest rate, whatever that might be. And it might be a very low interest rate if there's not a lot of demand for ether. It might be a high interest rate if there's a lot of demand for ether. But you're basically passively accepting the prevailing terms of the market. And then essentially there are a bunch of users that are supplying ether to the protocol. So this is some kind of pool of ether that is held by the protocol.

And then the protocol lends it out to other money market borrowers. That's exactly right. And the keyword that you mentioned is pooled. You're not actually lending assets to another user. It's not peer-to-peer. and that way it actually ensures that there's additional liquidity because you don't have to wait for another user to directly repay what they've borrowed.

So in essence, there's a supply pool, and then me as a borrower, I can borrow from that supply pool and the interest rate that I am being charged is determined by what exactly? It's determined by market forces, which are enshrined in an interest rate model. So philosophically,

there's really two ways that interest rates can be set. They can be set by user specifying the terms that they're willing to participate in, or they can be set algorithmically. Given the complexity of developing an on-chain system, we actually opted for the second approach, which is setting interest rates algorithmically. And the compound protocol uses an interest rate model to determine the interest rates at a given time. And fundamentally, it's based on supply and demand. When demand to borrow an asset is low, interest rates are low, and when demand to borrow an asset is high, interest rates are high. And at any given point in between, given the preferences of the individual users, you get an equilibrium interest rate.

If it's too high, people stop borrowing and it goes down. If it's too low, people are attracted to the market and it goes up. So would it be fair, in your opinion, to say that compound to money markets is very much like uniswap to exchanging tokens, in that there's an algorithmically governed automated market maker for the interest rate or the exchange rate. And there's not really someone who is actually making setting the rate other than that automated market maker. That's exactly right. Yes. It's extremely similar to uniswap in a lot of ways, and that the system functions without an order book at all. You know, Uniswap, functions without an order book for trading and compound functions without an order book for interest rates.

But does that also mean that I am never guaranteed a set interest rate, neither as a lender nor as a borrower? I can only know what the current interest rate is, but it could change either way after even a few blocks. That's exactly right, yes. So that's the one thing that you're giving up control of when you use compound versus a system that has duration. In some sense, you're basically because there's no duration to your participation, not saying, I'm going to lend for 30 days, where I'm going to borrow for 30 days. You're basically taking the best prevailing terms every 15 seconds. And so this can fluctuate.

As the markets get larger and have more supply and borrowing in them, the interest rates become significantly more stable. But in the short term, it is a little bit unpredictable. I think over time, this will continue to improve. And we've seen tremendous stability increase. as the protocol has existed for longer amounts of time, but you're right, there's no guarantee. Do you think this limits the number of use cases in some sense? Because, for instance, I wouldn't use it for financing my house, for instance, right? Correct. It's less useful for certain use cases and more useful for other use cases.

So it's less useful if you're making a long-term purchase or investment. It's just a terrible way to finance something. Just like, you know, in 2000, eight people who are using variable rate financing for their mortgages, you know, were dismayed when interest rates changed. Variable rate financing is not great for long-term uses. It is great in the short term, and it is great for machines and other smart contracts and applications. So we actually think that having this short-term interest rate that's interactable with smart contracts is actually great because smart contracts are very bad at managing time.

They're very bad at saying do something for 30 days, but they're very good at saying do something and then stop doing something. So we actually think that the ideal users aren't necessarily humans, but it's going to be other applications. The idea here would be that whenever there is a smart contract application that has some access to assets for some period of time, they should by default, just let it out to compound and make some return on those assets.

Exactly. A smart contract is able to say, I have extra assets that I'm sitting on, proverbially. I want to earn the prevailing short-term risk-pre-rate. And as soon as I need the assets back, I create the function call to retrieve them with an indeterminate amount of time. It's really designed from a application-first use case. Yeah. So in the future, there might be some kind of library that I as a smart contract developer just import and all of this functionality, all of this interest is automatically made for me for the smart contract from compound. Exactly. And a lot of our focus going forward is going to be creating those easy application hooks so that, you know, different smart contracts and different off-chain platforms can

interact with compound. So compound is not risk-free though, right? Would you, would Would you say that compound is risk-free or do I incur some risk when depositing an asset with compound? Well, it's designed to be an approximation of the risk rebate. So as with any smart contract platform, there's always the risk of code vulnerabilities. The protocol has been audited. The code went through formal verification. But as with anything involving smart contracts, there's non-zero risk. Our goal is to minimize that to zero as much as we can.

but it is, you know, non-zero. It took, you know, probably close to 10 years for people to say that Bitcoin is safe, fundamentally at a protocol level. And I think it's going to take the same thing with something like compound, where, you know, one month after launch, you know, there's questions about its code integrity. One year after launch, there's going to be significantly fewer questions. 10 years after launch, it's going to be almost assumed that it works and that's been battle tested. This episode of Epicenter is brought you by Cosmos, the internet of blockchains. Cosmos is live and we couldn't be more excited to see so many projects already building on it. Blockchain technologies are evolving fast, and development shouldn't be one-size-fits-all.

As a DAP developer, you need the tools that will allow your DAP to scale, grow, and evolve over time. The Cosmos SDK is a user-friendly, modular framework which allows you to customize your DAP to best suit your needs. It's powered by tenement core, an advanced implementation of the BFT Proof-State Protocol. all. Cosmos takes care of networking and consensus and allows you to focus on building your application in your language of choice. Ethereum smart contracts will be supported soon, and the SDK makes it simple for you to connect to other blockchains in the Cosmos network. If you have an idea for a Dab and would like to learn more about the Cosmos SDK, or if you'd like to connect your existing adapt to Cosmos, visit cosmos.network slash Epicenter. For Epicenter listeners, the Cosmos team will

reach out to answer your questions and help you get started. We'd like to thank Cosmos, for the supportive epicenter. There are two ways in which loaning money or tokens can in principle go wrong, right? So basically you need to collateralize those borrowers. This is something that we haven't talked about yet. So you need to put up

in excess of 100% of the thing that you're bought, 100% of the value of the thing you're borrowing in some other token. So what actually happens if this falls below a certain threshold is my first part of the question. The second part being,

if I actually lend out my money on compound, so if I'm a supplier, am I always guaranteed that I can get back my tokens at any point in time? That's a great question. So there's really two pieces there. The first one is, is there the risk of a borrower defaulting?

So the way the compound protocol works is you have to maintain excess collateral in order to borrow from the protocol. Anyone who's going to borrow from the protocol, puts up a multiple of what they're borrowing. It's similar to how make or die, BACs, make it out BACs die. It's similar to how a lot of other systems work.

And that creates a significant risk buffer to prevent users from at any point having borrowed more assets than they have collateral in the system. Compound V1 ran from September of 2018 to present and didn't have any events where a user defaulted on their borrowing. The excess collateralization, at least over the past year, was enough of a cushion

such that even if the value of what someone has borrowed has gone up or if the value of their collateral has gone down, the system itself is still completely safe. There's always the risk that the market doesn't liquidate them fast enough. We've created an incentive mechanism where the community is incentivized to rapidly liquidate users if they have, once they have less collateralization and is required. And that system works relatively effectively. We've seen a variety of bots and software packages and different users participating in liquidation process, but it's incentive driven. It's not a guarantee. And it's worked flawlessly for the past year, but it's not a guarantee that it always works in the future.

And the second piece of your question was, is there the ability to always get my assets back? So that goes to liquidity. So the compound protocol incentivizes but also does not guarantee liquidity. So it's possible theoretically for every single token in a market to be borrowed. And when you want to withdraw your supply, every single token has already been borrowed. That's theoretically possible. What the protocol does to prevent this is it use. is this interest rate model. And the interest rate model says the less liquidity there is,

the higher the interest rate is. And the more liquidity there is, the lower the interest rate is. And when liquidity becomes scarce, interest rates go up, attracting new supply and incentivizing the repayment of borrowed assets. And we've seen this play out again and again and again in the markets from V1 to present. Whenever there begins to be a scarcity of assets, interest rates go up and it attracts new assets. I mean, it's a really elegant and beautiful process to watch. When there's a short-term spike due to borrowing demand, over time, the interest rate returns right back down to the equilibrium where it is intended. Is there a flaw in the cap for the interest rate?

There is. So the interest rate model does have a minimum and a maximum parameter to it. And it's basically a straight line between the two. And there is a cap, so a smart contract can lead on chain exactly how the interest rate model works. And it is defined, you know, in smart contracts. And at any point in the middle, it's defined by the liquidity and utilization of the market. What's the floor and what's the cap? So it varies by assets. So right now for Dai, the interest rate to borrow ranges from 5% to 17%.

And for Ether, it ranges from, I believe it's 2% to 30%. And all of the other tokens are 2% to 3%. 30%, with the exception of USDC, which is much closer to the die interest rate model. So how do you set these minimum and maximum interest rates? And what's the rationale behind that? So long term, the process is going to be handed off to the community. Our goal is for each community to govern its own interest rate model. So, you know, in compound version two, we've created this concept called C tokens. We haven't gone into what are C tokens and how do they work yet. But The very simple story is when you supply an asset to compound, you actually get back a token that denotes your balance.

And these are also going to be governance tokens. So over time, all of the different suppliers of any given asset are going to be able to govern the interest rate model for their markets. All of the suppliers are ether are going to be able to set the ether interest rate model. And all of the suppliers of die are going to be able to set the die interest rate model. We're planning to start to deploy this system closer to the end of the year. But until then, they are essentially centrally set by our team. They're designed to be relatively immutable. We're not changing the model.

We basically set it at the launch compound V2, and now it basically runs on autopilot until decentralization. But the model was designed by the developers. And I looked at compound as a supplier, and this was a while back. It was very attractive to supply dye, but not so attractive to supply auger or bat. why do particular assets behave that way?

Why does that usually attract a greater interest rate, but other assets don't? That's a great question. And it's one that we've been constantly asking ourselves, and we've started to do a little bit of data analysis on this. It turns out that stable coins are fundamentally the most desirable assets to borrow. They look the closest to money, and if you're going to borrow something, you want to be able to borrow something where you know how much you're going to owe, a year. If you borrow ether, if you borrow auger, if you borrow a token of volatile value,

it's uncertain how much you're going to owe in a year. And so stable coins are just much more attractive to borrow than other assets are. And it also goes to the use cases. People are borrowing dye and USDC in order to make purchases, make purchases of other crypto, make purchases of real world assets, just make purchases. Whereas borrowing a token, the primary use case is right now to short sell the token. So you haven't seen too many people borrowing auger to create prediction markets that they wouldn't otherwise be able to afford to create. You're seeing it mostly for very limited short sale use cases.

So in a way, when you buy dye and in a way it's short sell die, you're going long ether, right? So I mean, basically it's, is that a sign of the bull market or did you see that in the bear market as well? So we actually saw that there's some interesting correlations between borrowing demand on compound and the price of assets. When, you know, and it goes to sentiment a lot, you know, when people think that it's a good time to buy borrowing spikes and when people think that, you know, it's, and by, I mean, it's a good time to spend the borrowed asset. It's a good time to spend die or spend U.S.D coin. You see borrowing demand go up. It's the same thing for when an asset seems overvalued.

If, for example, zero X seems overvalied, you'll see people borrowing zero X and sending it off to Coinbase for their favorite exchange to sell it. It's when people think something is overvalued, they borrow it, knowing that the liability goes down in the future relative to other things. And so it's the same thing for a stable coin. When everything else looks cheap, the stable coin looks expensive.

And that's when you see borrowing demand start to spike. super interesting. So what was the rationale between not actually putting the base rate at zero? So, I mean, why is there a couple of percentage floor implemented? Because it sounds like you guys are big believers in the markets. And this seems like something that in principle the market should be able to fix, no? Yeah, you would think that the model should theoretically start at 0%. But we know that the model the end of the day is designed to find an equilibrium. And the model doesn't have to start at zero. The model can start at 2% for most assets, knowing that there should be some non-zero cost to borrow the asset.

Otherwise, incentives actually start to break down a little bit the other way. If it's too easy to borrow an asset, eventually it creates perverse incentives. And so we wanted there to be some floor in general for borrowing costs, just because we think at least we're a healthier model. But when the community takes over the interest rate models, we'll see people potentially set the floor at zero. That'll be exciting to watch. Yeah, that'll be super interesting. So, I mean, if you look at the legacy banking world, currently at least here in Germany, if you take out a loan against a house, you're actually, you're looking at an interest rate on the order of 1% fixed for 10 to 15 years or so. So why are the interest rates you see on compound larger than what you see in the legacy world?

That's a great question. I think it comes down to the fact that compound fundamentally allows you to borrow assets using other crypto assets as collateral. And this opens users up to non-bank lending. And it really is a great service for people who aren't currently a part of the normal banking world who don't have access to 1% mortgages to borrow. houses are very known and understood high-quality collateral. Crypto is not considered to be that high-quality. So the interest rates are going to be higher.

And it's also because it's open to users who otherwise wouldn't even be able to borrow, if not for the crypto that they have. That's a great pitch. But do you think that is informed by the people who are currently using compound? Are those people who wouldn't be able to get a mortgage on a house? Well, it's people who wouldn't be able to take out a mortgage on crypto. If you're buying a house, then yes. You know, it's very easy to finance a house because a house has, you know, a very predictable value.

But crypto's not there yet. And so it's people who are using crypto to be able to purchase, to borrow assets to purchase other assets with. And so it's a much higher velocity borrowing. You're not locked into a 10-year mortgage. It's extremely short-term. and it's based on the value of your crypto. And so I think it's definitely a different user base and a different use case than formages.

Let's get into these C tokens. So what are these compound tokens and why did you implement such a feature? Great question. So C tokens are really a tokenized, fungible representation of the balance that you've provided to compound. So when you supply an asset, let's just call it, die to the protocol,

you receive a C token that represents your balance, C-dye. And the interest that you earn is actually represented by the C-token increasing in price relative to the underlying asset. So when you supply dye to compound, we give you C-dye. And over time, that C-dye that you hold in your wallet becomes worth a slightly larger amount of dye. And, you know, over time, whether it's a block, an hour, a day, a week, a month, 7.4 hours, that C-Dai is convertible into more underlying die.

This also unlocks tons of other use cases. So it allows us to have a governance token for each market right out of the gate. So that C-Di is also going to be the governance token to control the interest rate model for die. And it's also a transferable asset. The example we like to use is it allows you to take your balance and do more with it. In the original version of compound, you know, once you supply it an asset to the protocol, that's it. You couldn't do anything else. You just sat there.

You had a hot wallet connected to the internet, and you just had to, you know, keep it that way. With DC tokens, it unlocks more use cases. One is you can actually send them to cold storage. So this is my personal favorite use case. You can basically interact with a smart contract, you know, supply an asset to a market where it can earn interest, and then take that representation of your balance and send it to a cold. cold storage offline address that's never interacted with the internet before. And you can fundamentally be earning interest from cold storage.

And that's super powerful. It unlocks more programmability from other smart contracts and other applications. Other smart contracts can control compound balances, which they couldn't do in version one. And it just opens up like this entirely new basket of opportunities that we haven't even conceived of yet. We think this is the biggest upgrade from V1 to V2. So basically in the traditional world, when you loan out something, the thing that you're loaning out is gone, right? So someone else has it. And now on compound, when you get back, you know, compound whatever you lend out, you actually have a fungible token that you can still use.

So it's like you only lend out part of what you had because basically the C-di or C-Ether or whatever you have now is still transferable. and is worse something, and that to me sounds like a fundamental game changer. Do you feel the same way? And if so, what do you think will be the effects of this? Well, we do think it's a game changer. I think it's so early. We only launched compound V2 less than a month ago. I think it's actually almost a month to the day, actually.

And we're just starting to see developers experimenting with seed tokens. I think in a couple months we're going to start to see fabulous new applications built that we couldn't even conceive of today and I'm just eagerly awaiting watching where the community goes with this. To me, personally it seems that we are almost going to this internet of composable risks

almost. So you know, when I have ether, I can put the ether up into maker and I'll get a derivative asset which is the dye. Now, of course, the dye has some additional risk on top of the ether because now this dye is now dependent on the maker system, on the well-functioning of the maker system.

Now, I have this dye. I can put it into compound, and I can get compound dye out of it. But now, compound dye is exposed to the risks inherent in maker as well as compound. Right. And now maybe imagine like this future version of Truebit or some system like that, where I want to, let's say, run a verifier, some kind of node, and I put compound dye as my stake in that node,

and then I run that node. And that node makes me some interest in a system like in an off-chain system. And so when I do that, I could issue the third asset, which is like staked compound dye. So now if you think of staked compound die, it's like this composite asset with three risks, the four risks almost. Like the risk of ether, risk of maker,

the risk of compound and the risk of whatever staking solution you are using to stake compound die. So you have like, you know, like composed four risks together. You have like, and you have like multiplied those four risks into an asset and you're earning in like returns on all of those four assets at the same time. But you're also exposed to the risk of all of those four assets. So it almost feels like we are moving into this world where risk, effortlessly composed together and create like synthetics that represent all of those risks as a bundle and all of those returns as a bundle? Absolutely. I mean, I think that each of these layers

when composed together can either add or remove risk, right? So you're adding the risk of each platform individually. When you create the system that you described, you have the risk of Maker and there's risks associated with Maker. You have the risk of compounds. And there's risk associated and there's risks associated with compound. There's the risks of TrueBet and there's, you know, associated ones. But they can also offset each other in interesting ways, where it's possible that two layers in conjunction are actually a better asset with less risk than either of them individually.

A great example would be, you know, if there's a layer that's just buying insurance, it's possible that that insurance is a waste of money. And, you know, the event never occurs. But by combining it with compound, there's income that offsets the cost of insurance. It's possible the net product of those two layers is less risk and more upside. And I think all of this is in such an early chapter that we're going to see, you know,

a thousand new experiments composing different layers together and experimenting with the use cases that come up with systems that are fundamentally creating value. And that's going to be really exciting to watch. Do you think this will change the concept of what money is? because basically to us money is something that's fungible, right? Something that has no inherent value, but something that you can exchange for a lot of other things. But now that you can actually lend against anything for anything else, more or less,

or at least I guess that's the future vision, do you think this somehow makes money as a fungible thing obsolete? I don't think it makes it obsolete. I definitely think that, you know, we still think of money as this sort of like base unit, right? where we still think in terms of euros and dollars fundamentally. And even if we're like using crypto assets to exchange value, I think in the back of our minds, you know, we still go back to euros and dollars. And so it definitely creates, you know, more money-like properties for every crypto asset.

You know, eventually, you know, augur tokens are a little bit closer to money than they were, you know, a few months ago. But I don't think it truly puts them on the same footing as money. It definitely just makes everything a little bit more fluid and liquid and, you know, easier to use. Many things are indeed much more fluid than previously. So basically, if you borrow against something, you run the risk that the interest rate on that actually changes substantially. So am I warned in any way if I borrow an asset and the interest that I'm being charged just increases by a large amount? So the base protocol is just a series of smart contracts. And what's great about having an open protocol is that anyone can build new experiences on top.

What you just described is an awesome product idea. And I hope that someone in the community out there builds an application to interact with the compound protocol that does exactly that. That builds in offline communication systems with you, maybe through text message or email alerts, that does something like this. You know, the base protocol doesn't. It doesn't have this sophistication of product. It's really just fertile ground for developers in the community to build experiences like that. It starts off as a very simple series of smart contracts and eventually will be, you know, a beautiful series of applications like you just described. If you're holding a significant portion of your net worth in crypto, you're probably waiting for your portfolio to moon at any time. But holding crypto doesn't mean you should be irresponsible in the face of volatility risk. That's where Voltauro comes in. Voltauro is the leading gold hedging solution for the crypto community. And as a stable asset, trusted for millennia, gold is the perfect long-term hedging solution. And at Epicenter, we've been using Volturo since 2014 to protect a portion of our company's assets against

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Yeah. So in terms of real raw numbers, you know, we host a dashboard at compound. dot finance slash markets with all of the real-time information in the protocol. And one of the best parts of a transparent series of smart contracts is that you can use this information on chain, you can audit the information, you can inspect it, manipulate the data in any way you want, because everything's available for you. Since launching a month ago, the markets have grown in size.

There's currently, as of this Monday morning, $42.3 million of assets in the protocol. that have been supplied, and there's about $10.1 million of assets in the protocol that are actively being borrowed. The largest market is Ether, by far. Ether is most frequently used as collateral, and the most popular borrowing assets are Dai and USD coin. Last night when I checked this, you could borrow Dai for 13.5%, right? It's probably still similar. If you actually take out a CDP on Maker, you'd charge 16.5%. 5% stability fee. Why would anyone actually go to Maker? Why don't people just borrow this on compound? Well, the advantage that Maker has is that Maker has a community of stakeholders, the MKR token holders,

that are incentivized to use Maker and to grow the ecosystem and to shepherd it along. If you're an MKR tokenholder, you would probably rather use Maker than compound. I know a lot of Maker tokenholders love using compound. But, you know, I think there's a economic incentive to use Maker and pay a higher interest rate than something like compound at the end of the day. And I think there's always going to be users who prefer to use the Maker ecosystem. They're the ones fundamentally creating die. And for a lot of users, you know, a small difference in interest doesn't matter. They don't have to be a complete interest rate parity between the two systems. You know, Maker could still be a little bit more expensive and I think the system still works.

What we have seen is that the interest rates on compound and the maker's stability feed do move relatively in lockstep. It's not a perfect correlation, but they're definitely positively correlated. Yeah, interesting. So currently you allow borrowing against six tokens, right? So ether die, USC, basic attention token, auger, and zero X. And basically the soundness of the operation. depends on these tokens. So basically if these tokens are of such a nature that they crush in price unpredictably,

or for instance, if you list some sort of shit coin that is artificially inflated and borrowed against, and then the market collapses and the borrower defaults, and I mean, that would be a bad situation, right? So basically we saw this recently on Poloniacs. there was a token listed called Clam, and Clam was clearly pumped and borrowed against, and then the market collapsed, and the Bitcoin holders pool took a severe loss on that one.

So how do you, what's your governance solution for deciding which markets are valid and which ones to support, in essence, on compound? Yeah, so there's really two pieces to this. The first one is that in compound v2, there's no longer a global standard collateral factor, which represents how useful collateral is. In the very first version of the protocol for simplicity, and to be able to ship the protocol, one of the things we did is we said all assets were the same. You can borrow against any asset in a similar fashion. Everything is equally useful as collateral. And this was a simplifying assumption, which we knew was a starting point. And so we only listed five of the largest and most liquid assets that were least likely to be pumped and then dumped. In compound V2, we actually broke that simplifying assumption. And what we did is we said that each asset has its own collateral factor that represents how useful it is as collateral based on the liquidity and the volatility of the asset.

Large liquid assets like Ether are great collateral and clams, which are extremely thinly traded low market-caf assets are terrible. But in compound V2, the protocol can actually support assets that aren't just the absolute largest and most liquid. They'll just have a lower collateral factor. So, you know, with Ether, you can borrow 75% of its value. One day, the protocol might be able to support something like clams, and you might be only able to borrow 5% of its value because it's thinly traded.

The protocol can support every asset because of this very very. usefulness of collateral factors. And the second piece of this is, you know, we're actually allowing the community to select which assets the protocol supports. So we like to call this semi-centralized governance. At the end of the day, you know, the developers still control the multi-sig address, which serves as the admin of the protocol. But the important decisions of what occurs, what assets are supported, when and how, we like

to give to the community to vote on. So, you know, we initially held a vote for which stable coins will list. You know, Dye came in first place. USDC came in second place by just a hair and everything else lost dramatically. You know, and we basically, like, allowed the community to express its views on what to support. The same process is going to hold going forward. You know, if the community thinks that we should list clams for some reason, I'll think they're crazy. But, you know, that's a very strong signal.

But it doesn't mean that it has to be useful as collateral. And, you know, an asset can even be supported without it being collateral at all. We can create a market for clams. You just can't use it as collateral. You can borrow it. There can be an interest rate. You can theoretically actually have the Poloniac-style market, but without the risk. And that's something we're really excited about.

So that's super interesting. So what's the current governance model? So how does the community actually voice their opinion on which token should be listed or not listed? So we actually have a page on compound. It's slash vote. We're going to be bringing it back. shortly. Basically, what we're going to do is we're going to freeze at a certain point in time, a list of addresses that were users of the protocol. So when we start to vote, we'll say these,

you know, 3,000 addresses are able to vote. And then each one gets one vote. And we basically allow them to vote on a list of assets, you know, similar to how some exchanges have let people vote for which asset to list. And it's a very similar process. People sign a transaction with their key, basically saying, you know, I vote for this asset. But the whole thing is product. in a very simple web interface where you just click a button and it signs the message. And it says, I vote for Maker to be the next asset. In many of the governance questions around compound, the emphasis should is to have users vote. Like the holders of C tokens can vote and do something or the users of compound can vote to list assets.

Why push these decisions on the users rather than, let's say, create a compound? token and have the holders of that token be responsible for these decisions? Are users actually the best class of people to be making these decisions? I mean, that's a fantastic question. The answer is we're not sure yet. I mean, it's still so early in governance. I think Maker is the first example of a widely held governance token that gets used by the community. And we're just watching this really unfold. I'm extremely excited by it. maker and that governance token. But we don't want to rush into determining the long-term shape and form of the protocol until we have a lot of conviction on what it should look like. In some ways, yeah, maybe the system

would run better if there was a token. But we haven't made that determination yet. So basically, Maker is a formidable protocol. But it's well known that there are a small number of maker whales who have a lot of sway in where the ecosystem and maker in the ecosystem are going to navigate, right?

Is your way of implementing this user voting, a way of safeguarding against that? And do you hope that this will translate into network effects for compound? Right.

So I definitely think that it helps prevent against a concentration of power. But it's also, you know, more advantageous because it allows us to actually change how we allow the community to express itself before deciding on any specific path. You know, once you have a governance token, you know, its distribution, its ownership, the concentration of power is relatively permanent. And you can't go back from that. You know, we'd like to start off with a much more set series of lightweight approaches that we know can evolve, that we know can change, so that we don't wind up with something that's permanent. You know, the last thing you want to do is, you know, like, distribute something of value or wealth

and power and have to change the model later. We'd rather, you know, conduct a series of experiments, transparently, you know, hand-in-hand with the community, figure out what works, and then eventually slowly begin to enshrine that in product and economics. So currently, one of the big governance acts that need to be done is, you know, is the setting of the interest rate parameters, right? And this is done by your firm. Like the firm presumably controls some multi-signature account

and that is able to set these interest rate parameters that are used by the protocol. Yes, that's right. So we've designed the interest rate models that the protocol uses at launch. these are going to be relatively rigid models until we hand off control to the community. I would like by the end of the year

to be very close to having each C token control its own interest rate model. And so how does that work? So you have a group of ever-changing token holders and they need to set essentially two parameters on the interest rate model which let's say is like the floor and the ceiling of the interest rate

for approximation. How does a group of ever-changing token holders decide on these two important parameters? It seems like an unsolved governance problem. It is. That's why we want to be careful with it. The thing that gives me confidence is that the incentives are in place for the C-token holders to set the correct interest rate model, assuming that they're selfish. You know, if you're a supplier of capital, you want the highest return.

impossible. And the highest return possible comes from the most amount of usage times the highest interest rate. If the interest rate is too high, people won't use the product. If it's too low, you don't make enough money. And there's actually, you know, an equilibrium, even for the C token holders, that they're incentivized to do this correctly. I think the model can be simplified a little bit where they just have to express a single number. What's the, you know, slope of the curve, so to speak? We can create it where there's just a single parameter that they have to vote on. And from there, it could be as simple as a median. It could be something more complicated.

But I think we can boil it down to a relatively usable experience. And it can start off with just one market being governed by the community. We might say Auger has an interest rate model set by the suppliers of the token and continue to have the other markets using a semi-central. set interest rate model. Can you envisage a situation where basically there are different pools with different business logics as to which collateral to allow for lending out a certain asset? And I mean, basically the interest rate will inform itself from that, basically from knowing

what the quality of the asset is that is permissible. Do you think there will be different pools with different substantially different interest rates that allow different collaterals? Well, we actually want to take it one step further. So really long-term in the governance, what we'd like to do is allow the C-token holders themselves

to say what's acceptable collateral to borrow from their market. So instead of having globally recognized collateral factors, each market is going to be able to express what's acceptable collateral to borrow that asset. And they're very incentivized to handle that correctly. And so a great

example of this is, you know, other stable coins could be even better collateral for borrowing die than ether is just because there's more price volatility between ether and die. It might be that USC is, you know, hyper good collateral to borrow die and other assets less so. And so when you actually allow the community to express this granularity, I actually think you get a more efficient system because each market knows how it works. And they can set their own risk parameters. and they're incentivized not to accept clams as collateral. And so I think long-term this goes hands in hand

with just completely decentralizing new governance and allowing each market to really control its own destiny. I think there's a larger question here of whether people, by and large, care enough to make these decisions or whether it's fair to have this be a democratic process. because for financial decisions, it always seems to be the case that there are a few people who care a lot and then a lot of people who don't really care. Yep.

Oh, I agree. And it's possible that we also take the lessons of other governance approaches and have a delegated proof of state type model where people just vote for who they want the chief economist in their market to date, where the dieholders elect a chief economist on a sort of majority rules. way and then that address gets to set the model. Maybe one day we'll see, you know, public elections held for the chief economist of each market. There's going to be someone who's an expert at Auger. There's going to be someone who's an expert at die. And you're going to see, you know, experts start to control the models, you know,

through a delegation of the C token holders. Maybe it'll be exciting like that. We'll see. Wow, that sounds great. So there's one last thing we haven't talked about yet in terms of the the protocol itself. So there has to be a price feed, right, that actually informs the decision of whether liquidation can be forced or not. How do you actually,

how do you obtain this price feed? And is there a way to manipulate it? So basically, I mean, this is seen even in legacy markets that, you know, you have pump and dump schemes to force liquidation through margin calls. And I mean, even, even

in legacy markets, that are highly regulated, we see this constantly. So what's your take on this? Is this a bug or feature and has compounded a way of handling this? In the short term, the price feed is relatively simple. It takes a average of prices across Coinbase, Polonex, BitTrex, and Binance, and posted on chain, and there's some safety mechanisms hard-coded into the smart contracts to prevent extreme deviations in price in the short term, unless there's human manual

override and approval. It's a relatively simple system. It still requires there to be an organization, which is ours, that maintains a system. But long term, you know, our goal is to move to a truly robust, decentralized, perpetual on-chain system that's not susceptible to really any real-world flaws. And, you know, in the next couple months, we're going to be announcing the next generation of how we handle price feeds on-chain. We think that, that this is a great area for improvement, because what we want at the end of the day is for us, the developers,

to be able to disappear entirely, and the system works. It's perpetual, it's robust, and it doesn't need any involvement whatsoever from any of our developers. Any comments on how this new price article system will work? We're not going to reveal it yet, but just I will pre-announce it here

that something new and dig is coming soon. So how is Compound currently financed? So far, Compound is a venture-backed business. We look like a very traditional Silicon Valley tech company in that there's venture capital firms that are providing us capital to develop this platform. We have not gone the route of creating a token who are conducting an ICO, and we're following a very boring path so far. And I'm actually curious about sort of the network effects around the

compound protocol. So are there any network effects and what is the nature of those network effects? Well, I think it's very early in the story of compound. I think, you know, it might take a number of years for us to truly be able to answer that question. It looks like there's network effects. The bigger the markets, the more stable the interest rates. The more stable the interest rates, the easier it is to use. You know, we'll see. I think the biggest network effect is going to come into play when, you know, we have more markets and there's more utility that gets created by having different pairs of assets that you can use. I think if there's 20 assets and the system works, it'll have more of a network effect than if there's six assets.

And so I think it's early. You know, I'd love to come back to this question in the year and we'll, you know, compare and contrast today to them. So what's currently your business model? So right now our business model is to develop extremely widely used infrastructure for decentralized finance and figure out the business model later. You know, one of the things we are really focused on is creating widely used, dependable, safe financial infrastructure with the Compop Protocol. And, you know, our vision is that if, you know, this can power a trillion dollars of economic activity, there will be a very big business model. and it doesn't make sense to worry about it until we get there. But my understanding is that the compound protocol does charge a spread

between the lenders and borrowers, and that is what already constitutes a business model today. Yes, that was the case in V1. So in V2, there's still a spread. It's a percent of interest that's set aside into a reserve, but this reserve is to further decrease the liquidity risks of a liquidation. It's basically a reserve that's just held by the protocol. So there's still a spread there, but that's not necessarily the business model.

There's other lending protocols such as DYDX and DAMA. How would you say it does compound compare to them? Well, it's interesting because all of them are cousins. All of us are exploring decentralized finance together. All three products are fundamentally different. You know, one is a peer-to-peer lending protocol. that all of the order matching is handled by an organization. One is a margin trading protocol that uses pooled borrowing and lending facilities, very similar to compound,

but it's the foundation for a margin trading exchange. And then there's compound, which is probably the simplest of all three. Simplicity can be an advantage or a disadvantage. We'll see. But all it is is a pooled approach without exchange capabilities. So I think all three are very different products, taking very different approaches. I think compound is really exciting because it's so simple. I think it makes it easier to integrate into other smart contracts.

But we'll see what this looks like in a year or two. Have you ever had the pressure to be for any of your interest rates to be competitive against the other protocols? For example, DYDX might be offering a slightly high interest rate than compound and then you need to change your parameters to accommodate that? So our models are relatively, you know, stable. We're not like, you know, pulling the lever every time, you know, something happens on another market. You know, it's an interest rate model that sets the interest rates, not a bunch of people.

And so, you know, we actually don't look at other projects on a day-to-day basis. That's just not how we think about it. You know, they might look to compound as sort of like the base rate because it's by far the largest market and sort of plan around. compound, but compound doesn't plan around other projects. You said earlier that you would like for compound to be something that other companies build on top of. Are there companies already building on top of compound right now? There's a few.

And we're starting to see more and more developers building on top of the protocol every week. We've seen a series of projects launched sort of in tandem with compound. Over the past couple of weeks, we've seen compound protocol integrated into a project called Open, which is doing a decentralized exchange. We've seen CDP saver integrate compounds as well as instadap, being able to interact the compound alongside Maker in both cases. We've seen a project called Xerion build a really beautiful web interface around the protocol. We're starting to see more and more integrations of compound into Uri-Syrored. other applications and systems.

I think, you know, give it a year and you're going to see, you know, a pretty vibrant ecosystem spring up around compound. At least that's our goal. Our goal is to help any developer who wants to build with compound. You know, we try to be, you know, very supportive of other developers

with, you know, engineering resources, mentorship, design, and just, you know, anything we can do to help developers, we will. Cool. So what to you would be the key metrics for success for, say, the next year or the five years or, you know, all of compound, all of compounds future?

That's a great question. We actually measure success in terms of the number of applications that we enable. You know, I think at the end of the day, you know, compound long term isn't going to be used by users going directly to the compound protocol. I think over time, the compound protocol is going to be a base layer for other applications to be created. And users aren't going to have to, you know, fiddle around with the compound protocol. They'll just go to other applications.

And so for us, the success metric is the number of experiences that we enable to get built. You know, pretty soon we're going to start to, you know, really start to reframe how we show off compounds to not be compound, but the project's built on compound. And that's how we think about success. Very interesting. So compound will sort of recede into the background over time. That's the goal. I mean, I think success really.

looks like compound being a part of many other applications, but on its own, not being something that you have to use directly, being able to use compound through other services. And so what are some of the cool features apart from the price article that your team

is working on? So we're working on a longer term, we'd like to think of it as more decentralized oracle system. After that, I think we're going to be really focused on building out, as you might I call them SDKs and APIs for other developers.

It's less about changing what happens on-chain and more about enabling new use cases. And we'll be doing that in parallel with transitioning governance towards the C-Token holders. So at the end of the day, we become less and less important and the community becomes more important. That's maybe a lovely note to end on. Thank you so much, Robert, for coming on the show.

It's been super interesting. and I look forward to seeing what compound will be out to. Thank you, Friedrich. It's been such a pleasure to join you on EFISCenter. I can't wait for you in the rest of the community to follow Compound's progress, and it's been great to be on the show. Thanks a time for taking on the time. Likewise. Thank you.

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