How is DAI on the Compound platform 2.7 times the total circulation?

DAI is a stablecoin pegged to the US dollar issued by the decentralized protocol Maker. According to data from DAI Stats, the total circulating supply of DAI in the market is approximately 148 million. However, the total locked assets of DAI displayed on the Compound website are as high as 401 million DAI, which is 2.7 times the total circulating supply. What is the reason behind this?

Leveraging Mining

Is there a problem with the Maker protocol? Or are there counterfeit DAIs in the market? In fact, the situation is closely related to Compound's liquidity mining. According to previous reports, participating in Compound's liquidity mining by just providing loans does not yield high returns. Therefore, many people maximize their mining profits by simultaneously participating in both "lending" and "borrowing." The operation is as follows:

1. Transfer 100 USDC to Instadapp and deposit it into Compound
2. Use the 100 USDC in Compound as collateral to borrow up to 75 USDT (based on the collateral ratio)
3. Exchange the borrowed 73 USDT for 73 USDC. (Slightly below 75 USDT in this example to avoid liquidation risk)
4. Transfer the 73 USDC back to Instadapp and repeat the above steps.
5. By cycling through multiple collateralizations and borrowings, one can maximize the use of funds and maximize the COMP shares through accumulating borrowings.

From the above example, after one round of such operations, our total locked assets in the Compound protocol will increase from the original 100 USDC to 173 USDC, achieving a leverage effect. This is why the total locked assets of DAI in the Compound protocol exceed the market circulation. Ken Deeter of Electric Capital pointed out in a media interview:

"Please note that this is actually how banks handle dollars. Suppose I deposit 100 dollars in a bank, and then the bank gives 90 dollars to A, A pays this 90 dollars to B, and then B deposits it back in the bank. In this way, even though there are only 100 dollars in reality, the bank's account will show 190 dollars."

Adjustment of Distribution Mechanism is the Main Reason

Why did liquidity mining take so long and DAI suddenly showed significant growth on Compound recently? The reason may be related to the latest governance proposal of Compound. According to previous reports, Compound governance proposal 011 has been officially passed. The new proposal not only restricts users from obtaining COMP through "flash loans," but also adjusts the distribution mechanism of COMP. The original distribution mechanism allocated COMP based on the interest rates in the borrowing market. In other words, the higher the interest rate in the borrowing market, the higher the COMP allocation.

After the update, COMP will be distributed based on the "asset scale" of the borrowing market to avoid extreme interest rates in a single market. For example, the borrowing annual interest rate of the Brave (BAT) token in the previous Compound market once reached as high as 33%. This proposal will take effect this Friday.

After the proposal is passed, there has been a significant rotation in the interest rates and fund sizes in the Compound borrowing market. The borrowing and lending rates for DAI are around 4%, and DAI has the largest locked asset size in Compound currently. In other words, the DAI borrowing market can allocate the most COMP, attracting a large number of participants in liquidity mining to choose DAI as the target for operating Compound liquidity mining.

However, the MakerDAO community is concerned about this "alternative demand." Cyrus Younessi of the MakerDAO Risk Team wrote:

"We have the opportunity (and it's quite likely) to see unprecedented demand for DAI. However, most of the circulating DAI may be locked in the COMP protocol, weakening the sell-side depth of the trading market."