Comparison of DeFi Lending Protocol Mechanisms: Euler, Compound, Aave and Rari Capital

One of the biggest features of DeFi is its composability, an open blockchain protocol without permission, allowing assets to flow freely between protocols. The loan agreement is one of the important infrastructures of the DeFi ecosystem. It provides depositors with interest income and borrowers with the assets they need. With such basic services, users can make more complex transactions in the DeFi ecosystem, including leverage , short selling, arbitrage and other operations.

In the Ethereum ecosystem, the largest lending agreements are Compound and Aave. The asset deposits on the platform still exceed $15 billion, of which the asset utilization rate on the Compound platform is 25%, and the asset utilization rate on the Aave platform is 32%. After these two platforms laid the foundation and business model of DeFi lending, many projects that forked their codes appeared in the market, but so far no other lending project has surpassed Compound and Aave in terms of asset size.

At the end of last year, the Ethereum lending project Euler Finance, which was developed for one and a half years, was launched in a low-key manner. The core concept incorporates many innovative designs. In order to keep up with changes in the market, the code of the Euler protocol is all self-developed, coupled with a strong team lineup, it has obtained investment from top institutions such as Paradigm.

Euler has been running on the Ethereum mainnet for 6 months so far, and the platform data continues to climb. What is the difference between Euler and Compound and Aave, and what are its advantages compared with other newly launched lending agreements? This article disassembles and analyzes them from 8 angles.

Self-created lending market

Compound and Aave have been running for so many years, and currently support about 20 and 30 assets for lending, almost all of which are top 100 blue-chip assets by market value. It can be said that these two platforms are designed for blue-chip assets.

Euler has supported 60 assets in 6 months of operation, among which there are not only blue-chip assets but also some High-risk assets and long-tail assets. The reason why Euler can quickly support asset types is that anyone can create a new lending market on the platform, and the process is fully automated. If Compound and Aave want to support new assets, they need to be decided through governance voting. Even if the vote is passed, the next link still needs manual input, including the access of Chainlink oracle machines.

A lending market that can create new assets by itself , no need for governance voting and manual intervention

Oracle rating prevents manipulation by big players

One of the reasons why Euler can enable users to independently create a lending market is because the system uses the Uniswap V3 price oracle to obtain the time-weighted average price (TWAP) with a time interval of 30 minutes, which can effectively prevent snapshot manipulation. Uniswap is currently the deepest decentralized trading platform in the Ethereum ecosystem. As long as it is an asset with a deep trading depth on Uniswap, users can create a lending market on the Euler platform.

Although the Uniswap V3 price oracle is used, the quality of each oracle is not the same. It is related to the depth of the transaction, and Euler is also aware of this. In order to provide users with more detailed information, Euler pioneered the price oracle quality score in the industry. In each lending market, the quality of the oracle is displayed, divided into three levels: high, medium, and low. The price that needs to be paid, such as: how much money will be spent to make the price rise by 20%, and how much assets will be sold to make the price fall by 20%. This information is of great value to users, because in the trading market, there will always be big players trying to manipulate prices, and this is no exception in the blockchain industry. On top of this, Euler's mechanism goes a step further by providing users with an oracle attack simulator, which simulates the impact of capital inflows and outflows on asset prices based on the transaction depth of Uniswap.

Uniswap V3 price oracle rating three

In this regard, both Compound and Aave use Chainlink oracles as the mainstay, and Chainlink also uses Uniswap V2 A price confirmation process has been made, compared with Euler's solution, which is more in-depth and mature.

With grades for oracle quality, the next step is to grade assets.

Asset layering to avoid quick liquidation

Compound and Aave platforms mainly serve blue-chip assets. There is no concept of classification, or assets that belong to the same echelon. Aave has made a simple classification, one is mortgageable assets, and the other is non-mortgageable assets.

Because it supports more diverse assets, in order to ensure the stable operation of the system, Euler adopts an asset layering mechanism. Divide assets into three levels according to risk and transaction depth. The assets in the Isolation Tier are the most risky. The borrower provides the asset to obtain interest, but the lender must provide an independent mortgage asset for this asset before the asset can be loaned out. The assets in the isolation layer cannot be used for mortgages, because their prices fluctuate too much and are not suitable as collaterals, so as to avoid liquidation due to the rapid decline in the value of mortgaged assets.

Assets with the lowest risk, such as WBTC, WETH, USDC, and DAI, are all Collateral Tier assets. Only such assets can be used as collateral, reducing the chances of borrowers being liquidated due to the shrinking value of mortgage assets. Between the isolation layer and the mortgage layer, there are also cross-tier (Cross Tier) assets. The risk of this type of asset is medium risk. Like the isolation layer assets, they cannot be used for mortgages, but the advantage over cross-tier assets is that borrowers do not Mortgage assets need to be configured separately for each cross-layer asset lent, which means that users can lend multiple cross-layer assets after putting in mortgage assets at one time.

Classifying assets according to market risk is one of the steps in risk management. Euler also made a more systematic risk management develop.

Borrowing double coefficient calculation control risk

The common risk management mechanism of the lending platform is to require users to over-collateralize, which means that the value of the mortgaged assets must exceed the loaned assets. Compound uses the Collateral Factor to give corresponding discounts according to the quality of the collateral assets (the higher the quality of the collateral assets, the higher the collateral factor), so as to ensure the stable operation of the Compound platform.

However, the assets on the Euler platform are different from Compound, and there are various assets with different risk levels, in addition to the mortgage In addition to the quality of the assets, the quality of the lent assets must also be taken into consideration. Therefore, Euler not only used the mortgage factor to calculate the risk-adjusted value of the mortgage assets, but also increased the borrowing factor (Borrow Factor), which is based on the quality of the loaned assets. Corresponding discounts (the higher the quality of the loaned asset, the higher the lending coefficient), the quality of the mortgaged asset and the loaned asset are considered at the same time, and then the calculation of how much assets the user can eventually lend, this design is more comprehensive.

In order to allow users to intuitively grasp the loan dynamics, Euler provides detailed mortgage assets and loan assets on the user interface The market value, as well as the risk-adjusted value, also shows the health of the account and how long it is expected to take to liquidate. This information will help users operate more confidently.

User risk management interface

Transaction package tool saves handling fee

In At the operational level, Euler, Compound, and Aave all have basic deposit and borrow operations. For users on Ethereum, Euler has developed a user-friendly transaction packaging tool (Transaction Builder), which can save transaction fees. This function is similar to Furucombo's platform push function. But the difference is that Furucombo is a series of transactions between multiple DeFi protocols, and the savings in handling fees are relatively limited. Euler’s transaction packaging tool is aimed at transactions on its own platform, such as packaging the five types of assets lent into one Transactions, packaged transactions only need to confirm the price of these 5 assets once (5 times if the price is not packaged), so the savings in handling fees are considerable. This tool works with the Defer Liquidity function, and can also be used for flash loans.

Transaction packaging tool interface

A liquidation mechanism similar to a Dutch auction

Liquidation is the last thing users want to face, so on Compound and Aave platforms, users mostly choose to over-collateralize in order to avoid liquidation. Overcollateralization creates another problem, which is that it reduces the efficient use of assets. Therefore, users of Compound and Aave have to make a trade-off between the probability of liquidation and the efficiency of asset use, because as a borrower, the cost of liquidation is too high, which is about 5% to 10% of the loan amount. You may think that this fee is reasonable, but for large investors, the assets they may lend are worth tens of millions of dollars, and the liquidation reward is like a big gift bag falling from the sky to the liquidation party. Execute liquidation at the first time and earn liquidation rewards. When the situation evolves into a robot-to-robot competition, whoever has the highest handling fee will win. In this case, the miners on Ethereum will also enter the market chasing profits, and take advantage of the miners’ advantages to take away this part of the liquidation reward. This is The so-called "miner extractable value" (Miner Extractable Value, MEV).

Clearers are valuable to the platform, they assist the stable operation of the platform and remove potential bad debts, the problem is How much reward is reasonable? Is there a better liquidation process that can make the system stronger?

Euler used a mechanism similar to a Dutch auction in the liquidation process, and the liquidation rewards started from low and gradually increased , this design will test the cost strength of the liquidator. Assume that liquidator A can only make a profit when the liquidation reward reaches 4%, while liquidator B can make a profit when the liquidation reward reaches 3.5%. In this case, A has not yet B has the right to liquidate the position before making a move.

Generally, when clearing positions, the clearing party needs to obtain liquidity in the market outside the platform, and use the liquidity outside the platform to A potential problem of liquidation within the platform is that the same asset will have different prices in different trading markets, which brings price uncertainty to the liquidation party. In extreme cases, the external market does not have enough Liquidity may lead to liquidation failure. In response to this problem, Euler developed the Stability Pool function, allowing the lender to provide the assets required for liquidation, which realizes the use of liquidity within the platform to complete liquidation, and the asset prices used for liquidation are consistent of.

Reuse of idle funds

Reserve funds are a line of defense for the platform system, which can maintain the stable operation of the platform. Euler borrowed from Compound's model and put part of the interest paid by lenders into reserve funds.

Euler also borrowed Aave’s Safety Module (Safety Module) mechanism to allow users to deposit platform tokens as a reserve Funds, earning rewards can be obtained during the deposit period. Different from Aave's model, the deposited platform tokens are idle on the Aave platform, but on the Euler platform, these tokens will be invested in the system itself to earn income, so the income will grow exponentially, and the income space bigger.

Comparison of new generation lending platforms

In order to support a wider range of asset lending, Euler seems to have redesigned the entire lending system. Is this necessary? The codes of Compound and Aave have been verified by the market. In addition to supporting mainstream assets, can it also increase support for assets with higher risks?

“Create a new lending market without permission” Aiming at this market vacancy, in addition to Euler, Rari Capital also has a similar design, they Fuse's flagship product supports users to create their own lending market, and each Fuse pool is equivalent to a fork of the Compound protocol. So Fuse uses the battle-tested Compound code to allow users to borrow any asset.

We see that Rari Capital was hacked in 2021 and lost $11 million, shortly after April 2022 Hacked again and lost $80 million. Between these two major security incidents, there is another incident, that is, in January 2022, in Fuse No. 90 pool, the attacker maliciously controlled the price of FLOAT/USDC, causing the price of FLOAT to skyrocket in a short period of time. At this time, FLOAT assets are used for collateral, and a large number of other valuable assets are borrowed from the pool. This incident reflects the value of asset classification, and high-risk assets that are prone to price manipulation are not suitable for mortgage assets.

If Compound and Aave are previous-generation lending protocols, Euler and Rari Capital are both new-generation lending protocols. There are obvious differences in the route. Rari Capital is based on Compound to achieve lending support for any asset. Euler designed the system from scratch and wrote original code. The platform asset deposits exceeded 300 million US dollars within 6 months of its launch. From the perspective of asset utilization, Compound and Aave are no more than 35%, and Euler is 70%.

However, the new generation of lending agreements still need time and a longer-term market test to stabilize, and the value of the platform It will rise over time, and finally see if the generational change in the lending market can be achieved.

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