Created by:
Ayhan Güler & Kaan Alp
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Compound (COMP) vs Maker (MKR)
Part III
– Blockchain Technologies in Finance –
Risks
There are many risks to DeFi products because they are basically all pieces of code written by humans and there are many unforeseen negative scenarios as it is such a new field yet. We would like to start my evaluation by stating that the two projects we compared in this section have similar risks, just like with other DeFi products.
Compound
The biggest problem with DeFi projects like Compound is liquidity. To solve this problem, Compound has revealed the governance token named COMP, which we mentioned frequently. The purpose of this token, which was distributed to the creditors of the system, was to ensure that Compound spread to large masses. Because if there is no user, there is no liquidity, and if there is no liquidity, there is no user. With the release of the COMP token, the value of the cryptocurrency connected to the Compound system increased fivefold within two weeks, and at that time Compound was ahead of MKR.
Another problem is the possibility of a change in the supply of COMP after the decisions to be made by the COMP owners in the future. Although it is said that it will be produced in limited numbers for now, people with power in the administration may have the authority to change this rule and distribute new tokens to users. This may mean sacrificing the price advantage of limited supply.
The fact that cryptocurrencies are volatile assets creates serious problems in DeFi products as well as in all products related to cryptocurrencies. The collateral deposited by the users to get a loan may be corrupted by the system with a sudden price drop, which may lead to unexpected large losses for the users.
The last problem we want to talk about for other DeFi products like Compound is the rapidly developing new products and trends. With the blockchain technology, the freedom of data and transaction now passes to the user side. Switching from one system to another now takes seconds and very low transaction fees can suffice. With a single wallet, users can benefit from many different products and services as they wish. For this reason, systems need to constantly improve themselves and offer new services that will satisfy users. Projects that cannot renew themselves in an environment where hundreds of new projects emerge every day are doomed to disappear.
MakerDAO
The volatility of cryptocurrencies is very risky for DeFi products. It is not possible to avoid problems in the MakerDAO system, where DAI is received by depositing a cryptocurrency collateral such as ETH. Let’s examine the Black Thursday Crisis in March 2020 together. ETH price fell 53% on March 12 (Figure 7).
Figure 7
For this reason, many users’ collateral has been broken, and in such a case, the thing to do is to put extra ETH in the system or return some of the created DAIs and increase the collateral back above 150%. However, due to the huge increase in ETH gas fees and systemic problems that day, many users could not complete their collaterals and recover their loans. The outstanding loans were auctioned and many contracts were sold at zero value due to a systemic error. Nearly $5 million worth of contracts were affected. The MakerDAO executives at that time submitted a proposal to the votes of the MKR holders regarding the losses, thus correcting the status of some contracts. You can find the value of the MKR token that day in Figure 8.
Figure 8
Apart from sudden price changes, the complete decentralization of the MakerDAO system also has several risks. There are not enough examples in front of them as there are not many projects that are governed completely decentralized yet. We will see together how the MKR owners’ different expectations of interests, different wishes and power to influence decisions will lead the project.
We will not write again about a risk we wrote for Compound, but like other DeFi products, MakerDAO needs to constantly improve and change its technology and services in order to survive. Otherwise, it will inevitably be lost among many innovative projects.
Future of DeFi Products
DeFi projects are just at the beginning and many promising projects are emerging. We can see that people are slowly starting to prefer DeFi products instead of cumbersome banking methods where they deal with a lot of paperwork, identity verification, and transaction fees. In this direction, I can say that DeFi products should be a little easier to use in order to reach more people and be more accessible. Apart from this, the volatility of cryptocurrencies, which I mentioned in the risks section, seems to be a problem for DeFi products for a while. However, especially the new generation and many innovative companies are aware of the benefits of blockchain technology and are preparing for the future. Every challenge faced by today’s projects is a great lesson for future projects. Thanks to many pioneering projects that have learned from mistakes, I think it will take a shorter time than we expected to see projects where human errors in smart contracts are minimized, reaching full decentralization and progressing smoothly. We look forward to taking part in this exciting future and following the developments.
