Heading towards decentralization, Compound issues governance token COMP

Compound has announced the issuance of governance tokens, initially distributed to shareholders for participating in governance proposals and voting, with plans to eventually open it up to users.

Compound Announces Issuance of Governance Token

Compound is one of the leading decentralized lending platforms in the market. According to DeFi Pulse, the total locked value on the Compound platform currently stands at a staggering $1.461 billion. Last fall, the startup raised $25 million from venture capital firms including a16z, Bain Capital Ventures, Polychain Capital, and Paradigm.

In a press release yesterday (27), Compound CEO Robert Leshner announced the issuance of a governance token, COMP, to create an indestructible open protocol and eliminate single points of failure. This move aims to establish a community organized by token holders, granting them the authority to propose, vote, and implement changes to the protocol, thereby replacing the current centralized governance by the development team.

Current Governance Mechanism and Single Point of Failure Issues

During the early stages of development, some DeFi projects have what is known as administrator keys in the protocol design, allowing the development team to efficiently optimize the protocol in case of updates or contract vulnerabilities. Currently, updates to the Compound protocol such as adding support for new assets or adjusting collateral parameters require administrator keys and a minimum 2-day waiting period for the upgrade to be completed.

Note: You can think of the waiting period as a time bomb that can be defused at any time until the deadline (measured in block height). Once the deadline is reached, the bomb will detonate, forcing the upgrade and activating the proposal.

However, holding administrator keys means having a backdoor to the protocol, requiring trust that the keys (development team) will ensure their security. If the keys are compromised, your funds are at risk, which is the single point of failure issue.

Note: Projects known to have administrator keys in their protocols include: bZx, Dharma, Token Sets, Synthetix, PoolTogether, Aave, dYdX, Compound.

To mitigate risks, as protocols mature, development teams transition governance rights to the community through governance tokens, aiming to achieve the long-term vision of decentralized finance.

Not all DeFi projects follow this transition method. For example, MakerDAO's protocol does not have administrator keys but issues governance tokens directly, allowing the community to participate in protocol governance, with any changes requiring approval through voting.

How COMP Will Be Released

The decision to issue a governance token by Compound marks a significant milestone as it enters the next phase. However, the primary concern is how the token will be released and whether there will be opportunities for private sales or ICOs, which seems unlikely based on yesterday's announcement. According to Robert Leshner:

“COMP is designed to enhance community governance and is not a fundraising mechanism or investment opportunity. COMP will not be open to the public until the decentralization process is completed.”

Additionally, during the initial sandbox period, a small portion of governance tokens will be allocated to Compound's shareholders, who can retain voting rights or delegate them to selected individuals. The majority of tokens will remain in team custody and will not participate in governance until the team considers the decentralized governance mechanism sufficiently refined to distribute the remaining tokens to Compound protocol users. The method of distributing tokens to protocol users has not been announced yet.

Decentralized Governance Process

Any holder of 1% of the total COMP circulation has the authority to propose governance proposals, including adding support for new assets, changing asset collateral ratios, adjusting market interest rate models, or any other parameters or variables that administrators can modify in the protocol. Robert Leshner further emphasizes that proposals refer to executable code, not just improvement suggestions to the team or foundation.

All proposals undergo a 3-day voting period, where any address with voting rights can vote in favor or against the proposal (with a minimum voting threshold of 4%). If the majority agrees, the proposal will queue in the time lock and be implemented after 2 days.

Concerns After Decentralized Governance

All decentralized applications must operate on the premise of "human nature is evil," as not everyone will abide by the rules for the long-term development of the protocol. Therefore, governance token economies generally require designs that raise the threshold for attackers. For example:

1. Honest token holders participating in network governance can receive rewards to increase the opportunity cost for attackers.
2. When the protocol operates normally, burning a portion of governance tokens allocated to governance helps reduce market circulation, providing long-term incentives for token holders, while increasing the cost for attackers.

Similarly, governance tokens like MKR incentivize honest token holders by burning tokens, increasing the cost for attackers as the token's market price rises (in case of major mishaps in the protocol, causing significant losses to governance token holders).

However, yesterday's article did not elaborate on COMP's details beyond protocol governance. With Compound's total locked assets valued at $1.461 billion, careful consideration is needed on how to defend against attackers to achieve the desired level of protocol decentralization.