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Compound’s Pioneering Community-Led Governance Mechanism

Compound’s COMP token vastly decentralized the protocol’s governance, putting power back into the hands of the people.

By Cryptopedia Staff

Updated March 10, 20224 min read

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Summary

Decentralization is widely espoused as a core tenet of blockchain technology, and decentralized finance (DeFi) platforms help to make true decentralization a reality. Compound was one of the first and most notable DeFi projects to completely turn over protocol decisions to community governance through the release of the COMP token. COMP holders hold the power to propose and vote on new changes to the network’s protocol, cementing Compound’s status as a pioneer in decentralized governance on Ethereum.

Compound’s Admin Key

Like many crypto decentralized finance (DeFi) projects, Compound launched as a product furnished by a centralized organization with the intention of transitioning to a decentralized governance structure once the network hit a critical mass of users. As Compound’s permissionless money market protocol grew in value and usage, the future of the platform was discussed with increasing openness and transparency. One critique dominated: Could Compound — or any other DeFi application — actually become highly decentralized? Or were these projects really just centralized companies masquerading as decentralized protocols?

The major sticking point was what’s known as the admin key. Though smart contracts on Ethereum are inherently permissionless, trustless, and transparent, most projects use an administrative key as a fail-safe switch. If anything goes wrong — such as a bug or hack — an admin key can be used to shut the platform down, thereby protecting the protocol from further exploits or network disruptions. Projects that utilize an admin key also use it to authorize major changes and upgrades to the network’s protocols. Compound was no exception to the trend, and the platform’s admin key was originally controlled by a small group of insiders. According to critics, this meant that Compound was not a highly decentralized DeFi platform.

In June 2020, as part of its long-term plans for decentralization, the Compound team relinquished control of the network’s admin key. Since then, the project’s ownership has been distributed across the community, and decisions on when and how to change the network’s protocol are made collectively by holders of Compound’s COMP token. This was considered a watershed moment in decentralization and the DeFi sector in particular, and many projects have followed suit or have stated an intent to do so.

COMP and Yield Farming

In order to fairly distribute the COMP governance token — and with it, agency over the Compound protocol and platform — the team allocated tokens to the project’s users in proportion to on-chain activity in April 2020. The more you lent or borrowed on Compound, the more COMP tokens you were rewarded. Over 10,000,000 COMP were distributed in this allocation, with approximately half going to users and the other half to the founders, team members, and investors in Compound.

As a result of the COMP distribution, Compound usership skyrocketed and the project overtook MakerDAO for the first time ever within a matter of days — making it the top DeFi protocol in terms of locked value at the time. The COMP distribution mechanism launched the yield farming phenomenon, whereby DeFi users spread digital assets across different platforms and liquidity pools in order to obtain the most profitable returns. Yield farming is an example of how the structural interoperability created by the composability of DeFi platforms can bring value to users today.

COMP Governance Token

COMP is an ERC-20 governance token, which means it gives its holders special voting rights. COMP holders can propose and vote on any network decision, from the amount of COMP rewarded for network usage to the types of assets accepted by the platform. Even the framework for Compound’s governance model itself can be voted on and changed by COMP holders.

Anyone with 100,000 COMP tokens can create a new proposal. Additionally, through a process called the Compound Autonomous Proposal, anyone with 100 COMP tokens can also initiate the creation of a new proposal, but must first gather support from the community and have COMP tokens delegated to their proposal.

Well before a proposal is put to a vote, it is discussed through Compound’s official governance forum. All proposals and changes must be written as smart contract code and shared with the community before being voted on. That way, when a network change is proposed, there is no ambiguity about what will happen if the change is implemented. This process also gives the community a chance to analyze and review the proposed code changes. Under this system, governance is an iterative process. Code is written or revised, communication and feedback takes place, and the process repeats until the proposed code is accepted or rejected in full.

Decentralized Governance Voting

Once a proposal is active, anyone holding COMP can vote for or against it. Each COMP token equals one vote, meaning the more COMP someone has, the more weight their vote carries. COMP holders can also delegate their voting rights to select parties or known figures within the community. A large number of voting delegations have been allocated to Robert Leshner, Compound’s founder, and a16z, a venture capital firm and early investor in the protocol. This delegation process helps to balance decentralization with sound, informed decision making and allows casual COMP holders to delegate their voting rights — if they wish to —  to credible and incentivized entities who can make sound decisions on behalf of the platform and wider community.

UNI Token: Compound Governance in Action

In October 2020, COMP holders voted for Uniswap’s governance token, UNI, to be added as a new asset on Compound. The COMP community voted 537,376 to 1 in favor of adding UNI to the platform — and now you can borrow and lend UNI on the network. This decision was notable because it was enacted less than a month after UNI was launched, and the addition of UNI was also the first time a governance token other than COMP was added to Compound. Like COMP, UNI gives its holder special voting rights to its corresponding network. Compound creator Robert Leshner has stated that the goal of decentralization has always been “removing the largest single point of failure (our team), and creating an indestructible, open protocol that can evolve in entirely new ways.” The Compound platform, already a pioneer in DeFi, has proven itself a leader in the wider blockchain community by enacting its model of extraordinarily decentralized governance.

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