The developers of Compound, a decentralized Ethereum-based lending protocol that forms part of the nearly $1 billion (at current valuations) DeFi ecosystem, had commissioned a stress test, which now reveals that the platform will be able to scale its total borrowed ETH value by 10x with a very slim chance of defaulting, even when the Ether price is experiencing record-levels of volatility.
The stress test was performed by Gauntlet, a blockchain-powered simulation network, which routinely subjected Compound’s DeFi protocol to several simulation-based stress tests that try to replicate how platform users will engage with the lending platform in a live setting. The tests aim to determine whether Compound’s lending protocol will be at risk of going into default, which can occur if the loans are consistently being under-collateralized, something that could happen under severe conditions.
On the Compound platform, loans are normally over-collateralized, which means that the value of the collateral users provide when taking out a loan is more than the value of the funds they borrow.
But due to certain market risks, like a significant decline in Ether’s value, these loans can become under-collateralized – which would then lead to liquidation, carried out by liquidators who are motivated by Compound’s lending mechanism to look for under-collateralized loans in the pool and liquidate them for financial gains.
Gauntlet’s research worked with several different slippage models, expected price trajectories for various crypto-assets, and liquidator and borrower strategies. The study allowed researchers to look at how all these variables interact with each other in a testing or simulated environment.
The simulation was performed to determine whether the protocol remains safe even when the outstanding debt is relatively high. It also checked whether the protocol would be safe under extremely volatile market conditions.
Moreover, the simulation checked what would happen if Compound wanted to add support for a new asset. In this case, the simulation aimed to answer the question: should one be setting the liquidation incentive and collateral factor so that the lending system will have an adequately large safety margin?
“Our conclusions show that the Compound protocol can scale to a larger size and handle high volatility scenarios for a variety of collateral types. In particular, we find statistically significant evidence that even when Ether (ETH) realizes its maximum historical volatility, the Compound system is able to grow total borrowed value by more than 10x while having a sub1% chance of default.”
In statements shared with The Block, Tarun Chitra, CEO at Gauntlet, said:
“Potential Compound users can view this report as defining a rigorous actuarial methodology for understanding potential risks, gains, and losses in a multi-agent decentralized system. As new collateral types are added, this can help guide whether their confidence in the choice of system parameters, given market conditions.”