LD Capital: New Narrative of Blue Chip DeFi, Review of Aave & Compound

Original Author: Jill, LD Capital

Preface

Recently, the founder of Compound, Robert, announced the establishment of a new company focusing on the on-chain of U.S. debt, which detonated the RWA (Real World Asset Tokenization) narrative, and the price of the Compound token COMP also skyrocketed. In addition, the token prices of MakerDAO, the leader in RWA, and Aave, the leader in lending, have all risen sharply recently.

The product forms of Compound and Aave are more similar, and we have released MakerDAO-related business data before, so this article mainly reviews the fundamental data of Aave and Compound from three directions: lending business, token emission, and agreement revenue and expenditure.

Summarize

Aave’s capital volume is 2.6 times that of Compound, and it is currently the largest agreement in the field of DeFi lending. Although Compound is the first agreement to propose a fund pool model for lending, its follow-up development is weak due to the relatively conservative team and lagging business expansion. Aave has seized the opportunity of multi-chain development, the team has a sense of innovation and the latecomers prevail.

The security of the DeFi protocol is the foundation of project development, and reducing the potential risks of the protocol is the most important task of the team. Both Aave and Compound have risk isolation measures in their product design, but Compound’s current approach is more radical, directly reducing the complexity of the protocol, and isolating each asset pool according to the different underlying assets, which also means that Compound has given up some of the market share of altcoins as underlying assets. Aave is more inclined to build a large and comprehensive general-purpose lending agreement to seize more market share, isolate new assets from the core asset pool, and reduce the potential risk of new assets as collateral.

From the perspective of risk control measures, both have introduced reserves as a means of remedial measures when the agreement suffers from debt losses. In addition, Aave has a built-in security module, and the token pledger is responsible for the security of the entire protocol, which not only empowers the protocol tokens, but also locks the liquidity of some tokens to reduce market inflation.

From the perspective of token emissions, the current emissions of both are relatively low, and token selling pressure has little impact on the price of the secondary market. Aave is an earlier protocol, with a token circulation of 90.5%, but the security module locks the liquidity of some tokens. Compound pioneered liquidity mining, but the liquidity brought by this method will immediately sell tokens when participants obtain considerable benefits, which has a greater impact on the protocol. Therefore, Compound has changed the liquidity incentives and distributed tokens to real users. The current token circulation has reached 68.6%.

Both the prices of COMP and AAVE tokens have risen significantly due to the recent RWA narrative, but in fact the new company of the founder of Compound is still in the application stage, and the RWA fund size of Aave is only 7.65 million US dollars, which is only 0.3% of the capital volume of RWA leader Maker.

From the perspective of protocol income and expenditure, Aave’s income sources are relatively diversified, and the interest on the loan of the stable currency GHO is also owned by the treasury. From the treasury income trend, we can see that since the last round of bull market, the income of Aave protocol has dropped sharply, but the current agreement income can cover the agreement expenditure, and Compound still needs to be rewarded and subsidized by COMP tokens. Compound has a relatively single source of income, and the income of the Aave protocol is about 4 times that of Compound.

1. Product fundamentals

1. Product version

The initial version of Aave is peer-to-peer lending, which was later revised due to the low efficiency of loan matching, and provides high liquidity by drawing on the Compound fund pool lending model. Aave is currently in version V3, which aims to provide higher capital efficiency, higher security and cross-chain lending functions.

Higher capital efficiency refers to the efficient mode (eMode), which classifies assets and sets risk parameters according to asset types. When the collateral of the borrower is of the same type as the loaned assets, a higher loan amount can be obtained. Higher security refers to the isolation mode, that is, new loan assets that are voted on the chain will first enter the isolation mode. Assets in this model will set a debt ceiling, and when the asset is used as collateral, only licensed stablecoins are allowed to be lent. The purpose is to allow more long-tail assets to be listed on the agreement while ensuring the security of the agreement.

The above functions are currently available on V3, and the cross-chain lending (Portal) function has reached a deployable state as early as March 2022 when the V3 version was launched. However, due to security considerations, the team’s launch of this function is more cautious and has not been officially deployed yet. Because Aave’s cross-chain lending is not controlled by the Aave protocol itself, but a third-party cross-chain bridge protocol is introduced.

Compound is the first DeFi protocol to propose fund pool lending, allowing mainstream encrypted assets to borrow and lend each other. However, the V3 version changes the previous general lending and isolates each asset pool according to the difference of the underlying assets.

Specifically, in Compound V 2, the protocol allows users to freely deposit (mortgage) or lend assets supported by the protocol. Mortgage assets are well understood, and the basic assets are the assets lent by users. There will only be unique underlying assets in each pool in Compound V 3, but unlimited collateral assets. At present, the first basic asset pool launched by V 3 is USDC, which allows users to pledge mainstream encrypted assets to lend stable currency USDC.

2. Lending business

When users choose a lending agreement, the first factor to consider is the security of assets. Under the premise of fund security, users usually prefer agreements with larger funds, because larger funds usually mean better liquidity. In addition, which side has more advantages in interest rates, more asset types supported, lending incentives, etc., we will compare the two agreement products from the above dimensions.

The TVL data comes from defillama.com. Since the last round of bull market, the overall scale of DeFi protocols has experienced a large retracement. Compound and Aave are the leading protocols in the field of DeFi lending. At present, Aave’s capital volume is 2.6 times that of Compound, making it the largest protocol in the lending field.

Both Aave and Compound have been deployed on multiple chains. The difference is that Aave has entered Polygon and other chains as early as 21 years ago, and is basically in the leading position on other chains, occupying more market share. Compound only started to deploy on other chains this year. However, the Ethereum chain is still the most important place for lending. Aave supports more types of copycats. However, due to the potential risks of some tokens, they are frozen, so the number supported by the Compound V 2 version is almost the same. And Aave has supported stETH as collateral in February 2022, but Compound did not start listing wstETH and cbETH until January this year. From this point of view, Compound is progressing slowly in multi-chain development, while Aave is more aggressive in business development, so Aave has gradually opened up the gap.

Both use dynamic interest rate lending, with the block of Ethereum as the interest calculation unit, which was first proposed by Compound. The core of the interest rate model is the utilization rate of funds, which is based on market lending demand and calculated through algorithms, with little difference. When the capital utilization rate is high, the interest rate will be higher, and both introduce the optimal interest rate, that is, when the capital utilization rate reaches a certain threshold, the lending interest rate will increase sharply, so as to limit borrowing and prevent liquidity from drying up. The capital utilization efficiency of stablecoins and altcoins in Aave is higher than that of Compound.

From the perspective of the fund pool model, both have risk isolation measures, but Aave’s fund pool is still a full-pool risk model, but for the sake of protocol security, newly launched assets will first enter the isolation mode, and set specific risk parameters and specific underlying assets to reduce the risk of such assets as collateral. The Compound V3 version isolates each asset pool according to the difference of the underlying assets, and isolates risks from the system architecture level, but it also means that Compound has given up some of the market share of altcoins as the underlying assets.

In order to deal with potential risks that may occur in the system, Compound introduces the concept of “reserve fund”. The system will use the loan interest part as a reserve fund according to the reserve fund coefficient to deal with the loss of the agreement. In addition to collecting reserves, Aave also adopts a security module as the backstop of the protocol, that is, AAVE token pledgers will bear up to 30% of the security risk of the entire protocol. In return, the pledgers can receive AAVE token rewards and protocol income dividends.

Compound is the protocol that pioneered the concept of liquidity mining. COMP tokens are used as rewards, and the amount of rewards is currently being gradually reduced. The Aave protocol was launched relatively early, and the tokens are basically in a state of full circulation. At present, they can only cooperate with other project parties to stimulate liquidity. For example, in June 2021, they will cooperate with Polygon to provide token rewards exceeding 85 million US dollars for liquidity mining in the Aave Polygon market.

3. Other business

Stablecoin: Aave’s stablecoin GHO was launched on the mainnet on July 15th. The 1.5% borrowing rate makes it more competitive than other stablecoins. GHO’s interest income will all go to the treasury. In two days since its launch, GHO has borrowed a total of 2.21 million pieces. The large-scale casting of GHO should pay attention to the team’s subsequent measures to promote liquidity. Compound has no plans to issue stablecoins for the time being.

RWA: Aave is the second DeFi protocol that introduces RWA assets after Maker. In cooperation with Centrifuge Tinlake, the RWA market and the Aave lending market operate independently. The current capital scale is about 7.65 million US dollars, which is far behind Maker’s 2.3 billion US dollars. At present, only the USDC market can provide deposit and loan APY, and other markets no longer provide it. Users who have successfully passed KYC only need to deposit USDC in the USDC market to obtain a basic annualized return of 2.83% and a wCFG liquidity mining return of 4.09%.

On June 29, the founder of Compound announced that it has submitted documents to the US securities regulators to establish Superstate’s bond fund company, but it is still in the application stage.

Source: Aave official website

From the perspective of the development of the lending business, although Compound pioneered the capital pool lending agreement, but because the team is relatively Buddhist, the follow-up development is weak, and business expansion is lagging behind. Aave has seized the opportunity of multi-chain development, and the team has a sense of innovation. Gradually widen the gap with Compound, and the latecomers are ahead.

2. Token demand and emission

Aave released a new version of the economic model in July 2020, replacing the original token LEND with AAVE at a ratio of 100:1, and the LEND token is in full circulation. The total amount of AAVE tokens is 16 million, of which 13 million can be replaced by the original LEND tokens, and the remaining 3 million are additionally issued by the protocol for Aave’s ecological reserve.

The main use cases of AAVE in the protocol are governance and staking. The Aave protocol has a built-in safety module (SM, Safety Module) component, and token holders can pledge funds in it, with the purpose of covering up when there is a debt gap in the Aave protocol. In return, stakers can receive AAVE token incentives and share protocol revenue.

From the pledge interface on the official website, we can see that the current daily emission of AAVE tokens is 1,100. Based on Coingecko’s July 15 price of $80.56, the value is about 886,000 U.S. dollars. The current circulation of AAVE tokens has reached 90.52%.

Source: Aave official website pledge interface

The Compound token is COMP, which was officially launched in June 2020, with a total of 10 million. COMP, as the governance token in the Compound protocol, is mainly used to participate in protocol governance (proposal voting) and as a liquidity incentive in the lending market. The initial distribution scheme of COMP is as follows:

At present, the continuous unlocking pressure of tokens mainly comes from the founders and the team and the part allocated to users. The plan for the part allocated to the founders and the team is not clear, and the part allocated to users is mainly an incentive for lending activities.

According to the proposal passed on July 15, 2023, the user incentives for participating in USDC and DAI deposits and loans in the V 2 market will be reduced from 161.2 COMP to 111.2 COMP, and the total reward for lending in the V 2 market will be 111.2* 4 = 444.8 COMP/day (the deposit/borrow market rewards are 0.015 COMP/block respectively). The simultaneous proposal lowered the borrowing reward in the V 3 lending market from 481.41 COMP to 381.41 COMP, and raised the supply reward from 0 to 100 COMP/day, transferring the borrowing incentive part to the supply market, so the total reward in the V 3 market is still 481.41 COMP.

According to the above proposal, the current deterministic daily emission of COMP is 926.21 coins. Based on the Coingecko price of $74 on July 15, the value is about 685,000 US dollars. The circulation of COMP tokens currently reaches 68.56%.

As DeFi protocols launched relatively early, Compound and Aave currently have relatively small token emissions, and token selling pressure has little impact on the price of the secondary market. The two protocol tokens are mainly used for governance and incentives for protocol users. The difference is that Compound distributes tokens to users who actually participate in lending activities to attract liquidity; Aave is a pledge incentive for token holders. On the one hand, it can cover the debt of the agreement, and on the other hand, it can reduce token inflation. Because there are currently about 4.68 million tokens pledged in the security module, the actual circulation of AAVE is about 61.3%.

3. Agreement revenue and expenditure

The Aave treasury is composed of system reserves and treasury collectors. Aave protocol income sources: 1) Deposit and loan spreads, which vary according to different lending market interest rates; 2) Lightning loan fees, usually 0.09% of the borrowed amount, 30% of which will go to the agreement treasury, and the other 70% will be distributed to depositors; 3) GHO minting income; Both have not been activated.

The Aave Vault currently has a cumulative value of $130M, of which $91.5M (1.2M) is in the form of AAVE tokens as an ecosystem reserve and the remaining $25.8M is in stablecoins.

Source: llama.xyz

The above data comes from llama.xyz, which is officially recognized by Aave, but the data statistics on this website start from January 2022. Taking the income and expenditure in June 2023 as an example, the monthly consumption (token incentive) is 1.5 million US dollars, the monthly income is 2.4 million US dollars, and the surplus is 900,000 US dollars. This data is consistent with the Token Terminal data.

The only source of income for the Compound protocol is the interest rate difference between deposits and loans. Because there is no official statistical website, in order to maintain a unified caliber, the Token Terminal data is used as a reference.

Source: Token Terminal

In the calculation of Token Terminal, protocol revenue (Revenue) = borrowing fee (Fees) - deposit interest (Supply-side fees), and Earnings is protocol revenue - liquidity incentive.

Aave protocol income has gradually increased since May 2021, and the revenue peak period is from September to November 2021. After that, the income has gradually declined, and the income has dropped sharply in April 2022. The monthly income is 1.9 million US dollars. By October 2022, the monthly income is only 860,000 US dollars, which is 12.6% of the peak period = (86/680)* 100% , and continued to decline. Beginning in March 2023, the revenue of the agreement will pick up, and the monthly revenue will reach 1.3 million US dollars.

Earings are related to the token price and the number of tokens issued, the higher the token price, the lower the Earings. By December 2022, the income of the agreement has been able to cover the token incentive expenditure. The main influencing factor is the decline in the price of AAVE tokens. So far, by December 2022, the agreement has begun to be in surplus.

Source: token terminal

From January 2021, the revenue of the Compound protocol has gradually increased, with the peak period from March to April 2021, and the monthly revenue is around 5 million US dollars. Since February 2022, Compound’s revenue has fallen sharply, with monthly revenue maintained at around US$1 million, and by May 2022, the revenue has dropped to US$460,000, and it has been declining all the way.

Compound pioneered the loan-to-mining model, and the token incentives are relatively strong, so the Earnings are lower. After April 2022, Compound changed the token incentive model to gradually reduce COMP rewards, and the price of COMP tokens also fell sharply, and Earings gradually picked up. However, the current protocol revenue is far from covering token incentive spending.

Source: token terminal

Source: token terminal

According to LinkedIn data, Aave currently has 98 employees and Compound has 18 employees. The number of Aave employees is five times that of Compound, and the personnel expenditure may be much greater than Compound.

From the agreement income of the two, we can see that Aave’s income sources are more diversified, while Compound’s is relatively simple. If we look at the agreement income alone, using June’s income as a reference, Aave’s monthly income is 4.4 = (105/24.5) times that of Compound. Aave protocol income is currently able to cover token incentive expenditures, while Compound is still subsidized by COMP tokens.