The following report was written by Messari Hub Analyst(s) and commissioned by the Compound Grants committee, a member of Messari Hub. For additional information, please see the disclaimers following the article.

Introduction to Compound Launched in September 2018, Compound is a leading interest rate protocol built on Ethereum that enables users to permissionlessly borrow and lend assets from a pool of collateral. It sets interest rates for those assets algorithmically using an interest rate model based on the proportion of assets lent out, which it calls the utilization ratio. Compound launched its V2 protocol in May 2019, which introduced additional assets, individual risk models, and smart contract gateways for each asset, among other features. In April 2020, Compound replaced the administrator of the protocol with community governance, empowering COMP token holders to take control of the protocol. In June 2020, Compound began distributing COMP to users via a pioneering liquidity mining program reserving 42% of the total COMP supply to be distributed to users over the next four years.

Compound Markets - Macro Overview

Fueled by strong overall market conditions that saw two all-time high breakouts from Bitcoin in Q4, Compound closed the quarter with quarter-ending highs in several key categories - namely outstanding loans and outstanding deposits.

Strictly looking at quarter-ending figures, outstanding loans and outstanding deposits saw modest growth at 7.5% and 1.0%, respectively. Net income grew over 19% as market conditions dramatically improved from Q3, which attracted new borrowing demand, driving increases in interest income (+11%) and liquidation income (+27%).

Plaguing the quarter-ending figures, however, are two key periods worth noting. On the quarterly close date of Q3, the COMP distribution bug caused roughly $3B worth of closed loans and withdrawn deposits. As a result, Q3 quarter-ending figures drastically underrepresent the state of usage of Compound at the time. Comparison of the underrepresented Q3 figures to quarter-ending Q4 figures masquerades modest declines in usage as modest growth.

Upon resolution of the COMP distribution bug in mid-October, capital quickly reestablished prior levels of usage at approximately $18B of deposits and over $7B of outstanding loans. Capital levels remained at these levels until late November when broader crypto markets began to sell off causing leverage demand and collateral deposits to wane going into the last month of the quarter. As such, Q4 quarter-ending figures represent a state of a slow decline of usage as opposed to the modest growth reflected in the quarter-to-quarter figures.

Outstanding Loans, while up 7.5% on the quarter, are down 23% from the highs established in early December. Loans remain predominantly in stables (USDC and DAI) as borrowers overwhelmingly favor stable forms of debt over volatile debts. During the contraction in borrow demand across December, DAI exhibited less overall loan contraction (-23%) than the more favorable borrowed USDC (-30%). As a result, DAI surpassed USDC as the most heavily borrowed asset on Compound to end the quarter.

Read the full quarterly report on Compound Finance from Dustin Teander and Sami Kassab: State of Compound: Q4 2021