Despite the sobering takeaways around Compound III’s design, there are still plenty of paths forward for the protocol.

On the existing protocol, one approach would be to have isolated comets with one collateral asset per comet in an extreme case or a group of LRT/LSTs as collateral assets all for the same comet asset. The existing WETH comet would have a risk profile that is more conducive to raising CFs if less correlated collateral assets, like WBTC, were placed in separate comets. Currently, these assets share a store front price factor with ETH LRTs, but their optimal values in isolation are likely quite different.

For an LRT like ezETH, where the largest day over day drawdown over the last 90 days for the Compound III oracle was <20 bps, raising CFs in an isolated setting seems reasonable.

While coming at the cost of liquidity fragmentation, separating collateral across comets reduces the risk profile for base asset lenders. To see this with a more concrete example, if a WETH comet enables weETH, ezETH and ezETH as collateral, a WETH lender is exposed to insolvency risk across all the assets, especially from toxic loans being opened in slash events. The adverse selection here could be particularly bad if there is temporal correlation in slashes that provide leading indicators before the oracle update.

If lenders are interested in a specific particular opportunity e.g. lending to recursive ezETH borrowers, then this approach could enable a more capital-efficient bilateral market without introducing additional risk to the rest of the protocol.

After disabling the UAV, Compound V2 may be a better choice for isolated LRT markets from a design perspective. V2 can use the same staking rate oracles as V3 but has a liquidation mechanism that closely resembles Aave's and has a close factor. Compared to V3, this would reduce liquidation costs for borrowers while maintaining a stronger insolvency buffer for the protocol.

Proposals like this suggested collaboration with Morpho on Polygon could allow Compound to better compete without requiring new smart contract development. Morpho has isolated markets and has curators such as Gauntlet dynamically optimize risk adjusted yield for lenders by continuously reallocating liquidity across high demand markets.

Will only give a few suggestions since the list of new features to add to the protocol is extensive, with a lot to prioritize in terms of expected impact vs development cost.

• The store front price factor is set for the entire comet but having it be set on a per asset basis allows for better risk parameterizations that enable more capital efficiency

• A close factor would increase the insolvency buffer and reduce borrower liquidation costs

• Soft liquidations where the close factor is dynamic based on collateralization should have a similar effect and have worked well on Euler in the past, especially in driving down user costs without compromising much on insolvency risk

• Having conservative valuations for collateral and aggressive valuations for debt at loan origination protects against adversarial attacks as noted here following the Compound V2 UAV incident

  • Generally the gap between these two valuations should be small but the gap becoming large is indicative of attack possibility

  • The confidence intervals from Pyth oracles can be utilized to implement this like on Synonym

• CAPO and killswitch are both good features for mitigating tail risk which allows the protocol to safely offer more leverage

Despite the sobering takeaways around Compound III’s design, there are still plenty of paths forward for the protocol.

On the existing protocol, one approach would be to have isolated comets with one collateral asset per comet in an extreme case or a group of LRT/LSTs as collateral assets all for the same comet asset. The existing WETH comet would have a risk profile that is more conducive to raising CFs if less correlated collateral assets, like WBTC, were placed in separate comets. Currently, these assets share a store front price factor with ETH LRTs, but their optimal values in isolation are likely quite different.

For an LRT like ezETH, where the largest day over day drawdown over the last 90 days for the Compound III oracle was <20 bps, raising CFs in an isolated setting seems reasonable.

While coming at the cost of liquidity fragmentation, separating collateral across comets reduces the risk profile for base asset lenders. To see this with a more concrete example, if a WETH comet enables weETH, ezETH and ezETH as collateral, a WETH lender is exposed to insolvency risk across all the assets, especially from toxic loans being opened in slash events. The adverse selection here could be particularly bad if there is temporal correlation in slashes that provide leading indicators before the oracle update.

If lenders are interested in a specific particular opportunity e.g. lending to recursive ezETH borrowers, then this approach could enable a more capital-efficient bilateral market without introducing additional risk to the rest of the protocol.

After disabling the UAV, Compound V2 may be a better choice for isolated LRT markets from a design perspective. V2 can use the same staking rate oracles as V3 but has a liquidation mechanism that closely resembles Aave's and has a close factor. Compared to V3, this would reduce liquidation costs for borrowers while maintaining a stronger insolvency buffer for the protocol.

Proposals like this suggested collaboration with Morpho on Polygon could allow Compound to better compete without requiring new smart contract development. Morpho has isolated markets and has curators such as Gauntlet dynamically optimize risk adjusted yield for lenders by continuously reallocating liquidity across high demand markets.

Will only give a few suggestions since the list of new features to add to the protocol is extensive, with a lot to prioritize in terms of expected impact vs development cost.

• The store front price factor is set for the entire comet but having it be set on a per asset basis allows for better risk parameterizations that enable more capital efficiency

• A close factor would increase the insolvency buffer and reduce borrower liquidation costs

• Soft liquidations where the close factor is dynamic based on collateralization should have a similar effect and have worked well on Euler in the past, especially in driving down user costs without compromising much on insolvency risk

• Having conservative valuations for collateral and aggressive valuations for debt at loan origination protects against adversarial attacks as noted here following the Compound V2 UAV incident

  • Generally the gap between these two valuations should be small but the gap becoming large is indicative of attack possibility

  • The confidence intervals from Pyth oracles can be utilized to implement this like on Synonym

• CAPO and killswitch are both good features for mitigating tail risk which allows the protocol to safely offer more leverage