DeFi Drama: Revenue, Governance or Both

The cryptocurrency market had its share of drama last week with several significant developments. In this edition of the Crypto Market Monitor, we'll cover these latest updates including the events affecting the decentralised finance (DeFi) lending protocol Compound Finance, the new fee switch proposal on Aave’s governance forum and the challenge of decentralization that DAOs face in crypto. Additionally, we'll discuss some positive news from the US SEC that pleasantly surprised the crypto market??

The Compound Finance Drama?

Earlier last month, DeFi platform Compound Finance experienced a significant security breach affecting its official website. The domain was hijacked and redirected to a phishing site. However, the protocol’s security advisor quickly clarified that while the website was compromised, the Compound protocol itself remained secure and all smart contract funds were safe.??

Just a few days later, Compound’s governance faced an attack orchestrated by the notorious DeFi whale known as Humpy (@Titanium_32 on X). Before diving into the details of the attack, it's important to understand Humpy’s background.?

In the past, Humpy clashed with the decentralised automated market making platform, Balancer by accumulating a significant number of its veBAL governance tokens and using that power to push liquidity pool emission incentives towards questionable, low-liquidity pools, profiting in the process. After months of conflict, the DAO reached a peace agreement with him. Earlier this year, Humpy bought into the token of Sushi DEX (SUSHI) and participated in its governance. With the help of a few collaborators, he attempted to inflate the emission of SUSHI tokens to low-liquidity pools, similar to his actions with Balancer.?

Now, let's discuss the attack on Compound’s governance. In late July, Humpy and his team of collaborators (aka the Golden Boys) attempted a similar strategy to their past exploits by setting up a proposal to direct COMP emissions to some low-liquidity pools. The proposal requested a transfer of 499K COMP tokens (about $24 million) to the team’s own goldCOMP vault. He argued that this was to provide additional yield for COMP holders through a wrapped token called goldCOMP.

However, the proposal gave the Golden Boys multisig significant control over these funds. The proposal passed by a narrow margin: 682K votes for and 633K against. (Notably, only 57 addresses participated in the vote, highlighting concerns about voter engagement and concentration of power.) The protocol’s security advisor warned this could be considered a governance attack to take funds from the protocol. Soon, Compound Finance and its community scrambled to respond and mitigate potential risks. Ultimately, after negotiations, the Compound team and Humpy reached a compromise. They agreed that in exchange for withdrawing the proposal, a staking product for COMP token holders would be created to generate yield. As a result, COMP is now an interest-bearing token. Shortly after the news of the negotiated terms hit the market, the price of the COMP token rose by 13%, crossing the $52 mark and the current market capitalisation of the token is around $447 million.?

30% of revenues and 30% of the treasury will together make up 100% of the total yield paid out to COMP stakers. This yield will be distributed proportionally based on the percentage of COMP each staker holds relative to the total staked COMP. For context, the protocol generated $5.68 million in revenue in 2023. As of July this year, revenue has reached $8.9 million. Additionally, the treasury (excluding unallocated COMP tokens) currently totals $17.63 million. Based on these figures, nearly $7.95 million would be allocated towards yield payouts to stakers if the fee switch was activated immediately.??

The Achilles Heel for DAOs?

This recent incident within Compound Finance brings the focus on the opportunity for protocol tokens to offer more than just governance utility. As the cryptocurrency market has matured, DAO-native tokens can provide additional value and the simplest way to achieve this is by offering governance token stakers a share of the protocol’s revenues.?

While Compound introduced this as part of negotiations with Humpy and his team, some protocols have been working on similar initiatives for a while. Aave, the largest lending market protocol in crypto, recently saw a proposal on its governance forum that aligns with this trend. On July 25, a temperature check on the forum proposed a “buy and distribute” program, using Aave's fee revenue to buy back the AAVE token on the secondary market. Following the release of this proposal, AAVE’s price rose by 10% and the token’s market cap is currently at $1.6 billion. The immediate rise in price reflects the market’s enthusiasm for its potential implementation.?

Figure 1: AAVE and COMP token prices rose on their respective fee switch announcements in late-July

This kind of fee switch is highly beneficial for DAOs in crypto, as it attracts more token holders through revenue sharing. However, implementing such changes is not always straightforward. For instance, Uniswap’s governance has been deliberating over a similar proposal for months without success. The largest decentralized exchange (DEX) in crypto has seen multiple proposals suggesting a fee switch but voters remain divided. Concerns include the risk of driving liquidity providers away from the DEX and potential tax and securities law implications, as the fee switch would essentially pay a revenue-based dividend to token holders. These complexities highlight the challenges that DAOs face in decision-making and governance.??

Another challenge with DAOs is that many voters aren't very involved in the decision-making process. This might be because there's not enough incentive for people to follow the discussions and participate. To tackle this, DAOs need to find creative and sustainable ways to make participation more appealing and engaging for everyone.?

Additionally, another more fundamental issue persists most decentralized autonomous organizations (DAOs) are not truly decentralized. A case in point is last year’s Uniswap governance proposal to launch the DEX on BNB Chain. In February 2023, the vote centered on selecting a technical partner to act as a cross-chain bridge. Venture capital firm a16z, a major UNI holder, opposed the proposal. At the time, a16z had delegated most of its UNI tokens to other parties. If a16z had directly controlled all its tokens, it could have single-handedly rejected the proposal. This scenario is a possibility for all DAOs with governance tokens.?

Token utility and the need for decentralizing token supply are crucial for the long-term well-being of a DAO and its token holders. By providing additional value through revenue sharing and ensuring that no single entity holds excessive control, DAOs can enhance their appeal and resilience. This balance helps maintain trust and engagement within the community, ultimately supporting the sustainable growth of both the DAO and its token.?

Good News from the US SEC?

On July 30, the US SEC announced it would no longer ask a court to declare the tokens named in its lawsuit against crypto exchange Binance as securities. These tokens include BNB, Solana, Binance USD, Cardano, Polygon, Cosmos, The Sandbox, Decentraland, Axie Infinity, and Coti.?

While this development is positive news for the crypto community, the market views it as a politically motivated step, coinciding with presidential candidates' attempts to win over pro-crypto US voters. Former US President and Republican Party candidate Donald Trump has promised pro-crypto reforms as part of his election campaign. He also stated that if elected, he would replace the current SEC Chair Gary Gensler and appoint a crypto and Bitcoin presidential advisory council. Meanwhile, the Democratic Party is also showing a friendlier stance towards crypto. On July 27, Democratic Party members of the US House of Representatives signed a letter urging the party to adopt a forward-looking approach to blockchain and digital assets. Additionally, Vice President Kamala Harris contacted crypto companies to mend the party’s ties to the crypto industry.?

However, some crypto companies continue to face legal battles. For instance, Ethereum software development firm Consensys is fighting allegations of engaging in the unregistered offer and sale of securities through its MetaMask product (a wallet and staking software). Similar allegations have been made against other crypto exchanges, and the case against Coinbase is still ongoing. Uniswap Labs is also battling a case with similar allegations against it.?

Bitcoin dominance and a possible return of altcoins?

As of now, BTC dominance continues to climb from its post-FTX low, indicating more potential growth for BTC before altcoins catch up. Bitcoin's dominance currently hovers around 56%, up roughly 1% over the week.

Figure 2: Bitcoin dominance continues to climb higher week-on-week as investors have fled to BTC away from alts over the past couple of months

This increase comes as a surprise, given the market's expectation that ETH dominance would rise following the asset’s US spot ETF listing. However, this has not been the case.?

Looking ahead, the rise in BTC dominance brings us closer to a phase of capital rotation into altcoins. Factors contributing to a potential resurgence in interest in altcoins include the SEC's decision to no longer target some major altcoins as securities, as previously discussed. Additionally, the approval of Ethereum ETFs will further legitimize the market, boost investor confidence, and accelerate the adoption of Ethereum-based applications. Consequently, established protocols with proven resilience and revenue generation are likely to attract significant investor attention in the coming months.

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