Crypto Asset Statement - Compound
About this Statement
Coinsquare Capital Markets Inc. (“Coinsquare”) is offering crypto contracts to purchase and sell Compound in reliance on a prospectus exemption granted by the Canadian Securities Administrators (CSA) in the exemptive relief decision dated October 12, 2022. The statutory rights of action for damages and the right of rescission in section 130.1 of the Securities Act (Ontario) and similar legislation in the other CSA jurisdictions do not apply in respect of a misrepresentation in this statement to the extent that a crypto contract is distributed under the above-noted prospectus relief.
No securities regulatory authority in Canada or any other jurisdiction has expressed an opinion about any of the crypto assets (or crypto contracts) that are available through Coinsquare’s platform, including an opinion that the crypto assets are not themselves securities and/or derivatives.
Coinsquare has compiled the information contained in this Crypto Asset Statement to the best of its ability based on publicly available information.
Compound was founded in 2017 and is headquartered in San Francisco, California. It is an Ethereum project that focuses on allowing borrowers to take out loans and lenders to provide loans by locking their assets into the protocol. COMP is the native token of the Compound protocol. As an organization, Compound aims to incentivize users with interest and rewards for lending their COMP and contributing to a decentralized money market.
As with all assets, investing in Compound is not without some general risks. Many of these risks are identified and explained in our Risk Statement.
The relevant sections in the Risk Statement are as follows:
Platform Risk, Short History Risk, Price Volatility, Potential Decrease in Global Demand for Digital Assets, Potential for Illiquid Markets, Transfers of Digital Assets are Irreversible, Concentration Risks, Uncertainty in Regulation, Financial Institutions May Refuse to Support Transactions Involving Digital Assets, Digital Assets’ Blockchain May Temporarily or Permanently Fork and/or Split, Cyber-Security Risk, Airdrops, Issues with Cryptography Underlying Digital Asset Networks, Internet Risk, Open Loop System, Risk if Entity Gains a 51% Share of Digital Asset Network, Possible Increase in Transaction Fees, Possible Increase in Service Fees, Limited Canadian Investor Protection Fund Account, No Voting Rights, Custody of Digital Assets, Custody Risk Insurance, Threats to Coinsquare’s Physical Assets, Covid-19 Outbreak, Use of Leverage, Halting, Suspending, and Discontinuing Digital Assets.
In addition to the general risks, we outline some risks that are specific to Compound below. While we make an effort to identify every source of risk, we encourage you to do your own research and ensure you are comfortable investing in Compound.
Liquidity Risk or “Bank Run” Risk in Compound
Since Compound is a lending protocol that operates using liquidity pools, it is susceptible to potential situations of illiquidity. Suppliers contribute their assets to liquidity pools from which borrowers borrow assets. Each loan reduces the liquidity in the pool. Similarly, when a supplier withdraws their assets, this reduces the liquidity in the pool.
This presents the opportunity for illiquidity, which happens when withdrawals or borrows fail because they exceed the amount of liquidity available in the pool. The creators of Compound anticipated this risk and created an algorithm that modifies dynamic interest rates as liquidity changes. In short, suppliers are incentivized to supply liquidity, and borrowers are incentivized to repay loans when liquidity is low, and the opposite occurs when liquidity is high.
The risk of a “bank run” occurs when liquidity is low and suppliers suddenly and simultaneously attempt to withdraw liquidity from the pool. In this case, multiple withdrawals may fail, causing distrust in the system and panic from suppliers. In a one-off illiquidity event a large supplier may be affected, but in “bank run” scenarios multiple suppliers, often with small amounts, are left unable to withdraw their assets. In centralized banking systems, government may intervene to mitigate or prevent a bank run, however in DeFi platforms, intervention is not typically possible.2 Instead, onus is placed on the algorithm in the smart contract, which controls the dynamic interest rates, to incentivize suppliers enough to prevent uncontrollable illiquidity situations.
In the past, Compound has experienced multiple near-illiquidity events, and multiple confirmed illiquidity events. The interest rate algorithm has successfully prevented any “bank run” event to date. However, investors should be aware that this risk exists, and consider this when investing in COMP.1
Uncertain regulatory status of DeFi lending platforms
To date, Canadian financial regulators have not taken a firm position on centralized or decentralized crypto lending platforms/protocols.3 Additionally, many governments have not yet determined if or how they will attempt to regulate this new financial technology. As the regulatory landscape develops, scrutiny from various governing bodies could have an impact on the market capitalization of Compound.
Compound reliance on Ethereum
As Compound is an ERC-20 token on the Ethereum network, it is highly dependent on the continued stability of that network. Any fundamental issues in the Ethereum network may impact COMP’s smart contract or token value. Investors should consider this dependency when evaluating Compound.
Coinsquare’s Due Diligence for Digital Assets
To be made available for trading on Coinsquare’s platform, a digital asset must pass the following due diligence reviews:
- Coinsquare Securities Law Assessment
- Coinsquare Digital Asset Security Audit
- New Digital Asset Business Case
Coinsquare undertakes these three levels of due diligence in order to determine whether the digital asset is compliant with our legal and regulatory obligations, is secure, and has historical data supporting a beneficial business case. Coinsquare’s New Product Committee must provide final approval for a new digital asset to be made available on the platform.
- Alethio. “Illiquidity and Bank Run Risk in Defi.” Medium.com. December 8, 2019. https://medium.com/alethio/overlooked-risk-illiquidity-and-bank-runs-on-compound-finance-5d6fc3922d0d
- Federal Deposit Insurance Corpoation. “Failed Bank Information” September 11, 2020. https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/wamu.html
- Rene Sorell, Lori Stein, Ana Badour, Laure Fouin. “Regulatory Uncertainty Regarding Crypto Asset Lending in Canada.” McCarthy Tetrault. June 1, 2022. https://www.mccarthy.ca/en/insights/blogs/techlex/regulatory-uncertainty-regarding-crypto-asset-lending-canada
Published Date: Feb 5 2024