The decentralized finance (DeFi) lending landscape continues to evolve, with innovation driving efficiency, security, and cross-chain interoperability. At the forefront of this transformation is Compound III, the next evolution of one of DeFi’s most influential lending protocols. This article explores the core upgrades in Compound III and features an exclusive interview with Jared Flatow, Engineering Vice President at Compound Labs, offering insights into the protocol’s design philosophy, risk management, and future roadmap.
The State of DeFi Lending in 2025
According to data from DeFi Llama, while Arbitrum’s lending TVL rebounded by 35% after a 76% drop over two weeks, and Ethereum’s total chain TVL increased by $4.5 billion, lending still accounts for only 27% of total DeFi TVL. This highlights both the resilience and untapped potential of DeFi lending markets.
Amid this shifting environment, Compound Labs has taken a strategic step forward with the open-sourcing of its codebase to support a multi-chain deployment strategy. Though earlier forks of Compound existed on BSC, Avalanche, Tron, and Polygon, the new approach focuses on deploying on chains with lower fees than Ethereum—without relying on the previously anticipated Gateway (CASH) project.
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Key Innovations in Compound III
Single Underlying Asset Markets
One of the most significant changes in Compound III (Comet) is the shift to single underlying asset markets. Each market supports only one borrowable asset—such as USDC or WETH—while allowing multiple collateral types.
This design separates users into two clear roles:
- Lenders: Supply the base asset to earn yield.
- Borrowers: Deposit eligible collateral to borrow the base asset and pay interest.
Only the base asset accrues interest; collateral assets no longer earn APR. This simplifies risk modeling and enhances capital efficiency by isolating exposure.
Dual Collateral Factors
Compound III introduces two distinct collateral factors:
- Borrow Collateral Factor (BCF): The maximum percentage of collateral value that can be borrowed.
- Liquidation Collateral Factor (LCF): The threshold at which a position becomes eligible for liquidation—always higher than BCF.
This creates a “buffer zone” between borrowing and liquidation, giving borrowers time to adjust positions without immediate risk. As Adam Bavosa from Compound Labs explained, this mechanism improves user experience and reduces panic-driven de-leveraging.
Supply Caps for Risk Management
Governance can now set supply caps per asset in each market. This limits overexposure to volatile or less-trusted assets—especially important when deploying on L2s or alternative Layer 1s. By controlling supply, governance enhances protocol safety without sacrificing flexibility.
Upgraded Liquidation Mechanism
The new two-step liquidation process works as follows:
- Debt Absorption: A liquidator “absorbs” the defaulted debt, which is transferred to the protocol’s reserve.
- Collateral Sale: Once reserves accumulate a certain threshold of seized collateral, it’s auctioned off at a discount.
This decoupling offers key benefits:
- Reduces pressure on DEX liquidity during market downturns.
- Transfers bad debt risk from lenders to the protocol reserve, funded by borrower reserve fees.
- Enables smoother, more predictable liquidations.
Notably, liquidation calls are incentivized via gas rebate points, which are later redeemed for token rewards—encouraging timely participation.
Interview with Jared Flatow: Engineering Vision Behind Compound III
We spoke with Jared Flatow, VP of Engineering at Compound Labs, to better understand the strategic decisions shaping Compound III.
Q1: What drives Comet’s multi-chain strategy, especially after bear market setbacks?
"Comet contracts are designed as modular building blocks—simple, composable, and secure. Features like supply caps, dual collateral factors, and single underlying assets allow governance to safely deploy on various chains. We don’t expect Ethereum’s high fees to last forever, but users deserve faster, cheaper alternatives today. Multi-chain deployment meets real demand."
He emphasized that single underlying assets enable cross-chain liquidity pooling—for example, USDC markets across chains could eventually merge into a unified liquidity layer via bridges.
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Q2: How does the Business Source License (BSL) affect community deployments?
"Special-use grants require explicit governance approval and aren’t directly managed by the DAO. While we’re open to flexible use cases in the future, we want communities to take ownership of their deployments. Right now, our focus is demonstrating Comet’s value on major networks."
This suggests a cautious approach: empowering communities while maintaining protocol integrity.
Q3: Why adopt single borrowable assets? How does it improve risk management?
"With one borrowable asset per market, risk is directly tied to that asset’s price behavior. This allows for more precise collateral factor tuning. For stablecoins like USDC, price risk is fully borne by the collateral—making risk modeling clearer and safer."
He added that supporting multiple collaterals increases composability with other DeFi protocols without compromising control.
Q4: How does the new liquidation mechanism address low DEX liquidity?
"We split liquidation into two phases: debt absorption and collateral sale. When a position is under-collateralized, anyone can absorb its debt into the protocol. The protocol then pays back lenders using reserves and holds the collateral. Later, when thresholds are met, the collateral is sold at a discount."
This model acts as a shock absorber during volatility and protects lenders from cascading failures.
Q5: What new possibilities do account management tools unlock?
"Users can now delegate position management to smart contracts or external addresses. This enables powerful integrations—like batch transactions through our 'bulker' contract, which lets users supply and borrow in one go, or wrap ETH into WETH seamlessly."
The removal of reliance on msg.sender opens doors for off-chain management and L2-based account abstraction.
Q6: What’s the difference between Gateway (CASH) and Compound III? Is Gateway still active?
"When we started developing Gateway, the multi-chain landscape was less mature. Now, with so many EVM-compatible chains and bridges, we’ve distilled those learnings into Comet—a portable, standalone protocol. Gateway and CASH are currently on hold as we focus on helping communities launch Comet across chains."
He noted that future work might reconnect Comet deployments using a Gateway-like layer for shared liquidity—but that’s not an immediate priority.
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Frequently Asked Questions (FAQ)
Q: What is the main difference between Compound II and Compound III?
A: The biggest change is the shift to single underlying asset markets, where only one asset can be borrowed per market. This simplifies risk management, introduces supply caps, dual collateral factors, and a new two-phase liquidation system.
Q: Why remove multi-asset borrowing?
A: Isolating borrowing to one asset per market allows for more precise risk modeling. It reduces systemic risk from correlated asset failures and makes governance more effective in managing exposure.
Q: Can I still use multiple collaterals in Compound III?
A: Yes. While only one asset can be borrowed, users can deposit various approved tokens as collateral—increasing flexibility without compromising safety.
Q: How does the new liquidation system protect lenders?
A: By absorbing bad debt into the protocol reserve (funded by borrower fees), lenders are shielded from immediate losses. Collateral is sold later under controlled conditions, reducing fire-sale risks.
Q: Is Gateway still part of Compound’s roadmap?
A: Not currently. Gateway (CASH) has been paused as Compound Labs focuses on deploying Comet across chains. Future versions may reintroduce cross-chain liquidity sharing concepts.
Q: How does Compound III support cross-chain use?
A: Because each market uses a single base asset (e.g., USDC), these markets can potentially be bridged across chains to form unified liquidity pools—enabling seamless borrowing and lending regardless of chain.
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