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    Home » What is Compound Finance? Decentralizing Lending Protocol
    what is compound finance
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    What is Compound Finance? Decentralizing Lending Protocol

    By Evan EzquerJanuary 14, 2021Updated:August 4, 2022No Comments6 Mins Read
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    Compound Finance is a crypto project that rose to the top of DeFi space in the last couple of months (June and July 2020).

    Decentralized finance (DeFi) has been growing strong since the beginning of 2020 and it appears to have no plans of slowing down. And Compound currently has the second-largest locked assets among DeFi protocols, next to Maker.

    Compound Finance enables users to earn money on the crypto assets that they hold. Instead of hodling tokens, you could choose to put them to work and earn passive income.

    Background

    Robert Leshner, founder of Compound Finance
    Robert Leshner, founder of Compound Finance

    Compound Finance is a San Francisco-headquartered company started by former economist Robert Leshner. The company was able to raise a seed round of $8.2 million in May 2018, and then another $25 million Series A funding in November 2019.

    Leading crypto VC firms such as Coinbase Ventures, Andreessen Horowitz, and Polychain Capital took part in financing the project.

    What is Compound Finance?

    Basically, Compound Finance is a DeFi platform that enables users to lend or borrow crypto-based assets without middlemen. Both parties will stand to benefit from it.

    Lenders earn interest while providing loans while borrowers deposit their assets so they can borrow capital without the hassle of traditional banking. The interest rates (paid or received) depend on the supply and demand of each crypto asset.

    Compound loans and locked assets can be paid and retrieved any time. As of August 2020, the protocol has over $770 million locked assets. It is currently the second-largest DeFi platform in Total Value Locked (TVL).

    How Compound Finance Works

    The Compound Protocol is a system of public smart contracts that provides money markets on the Ethereum blockchain. The lenders and borrowers directly interact with the protocol, which allows them to earn (or pay) a floating interest rate. Again, the floating interest rate is determined by the fluctuations of supply and demand.

    All assets in Compound are transparent, with all transaction records and historical interest rates available to the public. Most users utilize the platform to gain leverage, whether by accumulating interests via lending or by increasing exposure via a borrow position.

    How to Lend or Borrow on the Compound App.

    In order to use Compound, you need a Web3 wallet like MetaMask or Coinbase Wallet. Go over to their app portal and connect your wallet.

    You could interact on any of the assets whether you want to borrow or supply (lend) by clicking on them and then clicking enable.

    If you want to lend assets and generate income, simply choose an asset to enable and sign the transaction to approve the capital you wish to supply the platform with. Once done, you will receive cTokens proportional to the assets you supplied.

    Furthermore, your assets will instantly be added to the supply pool as interest gets tracked in real-time.

    If you want to borrow capital, simply click on any of the supported assets in the Borrow Markets section (right side). You will need to lock your assets in the system as collateral.

    Compound’s collateral ratio for both lenders and borrowers is currently 178%. For instance, if you want to borrow 100 cUSDC (cToken-based USDC), you’re gonna need to lock $178 worth of assets

    Native Tokens

    The Compound protocol has two native tokens: cTokens and COMP.

    cToken

    cTokens are the fuel of the Compound lending system. They are built on the ERC-20 standard, which means their transactions can be publicly viewed on Etherscan at any time.

    Furthermore, they are used as the unit of account to represent your balance in the platform.

    All supported assets have their own cTokens. For instance, if supply the system with ETH, you will receive a corresponding cETH. And cBAT for BAT, cDAI for DAI, and so on and so forth.

    The longer your cTokens are locked, the higher its value appreciates due to interest.

    cTokens are also usable and tradable outside Compound just like any other ERC-20 token. However, when you exchange your cTokens, you are also changing your corresponding stake in the Compound pool.

    COMP

    COMP is the governance token of the protocol. It is an ERC-20 token that gives holders voting rights to important protocol decisions. These decisions could range from changing interest rate models, collateral types, borrowing power, etc.

    However, only governors who hold more than 1% of COMP supply can create new proposals.

    This token serves as an effort for the protocol to transition into a fully decentralized system.

    Compound also allows token holders to delegate their tokens to other governors.

    Furthermore, COMP holds no economic value other than governance. Despite that, the value of the coin is currently at $158, which is about half its all-time high of $304.

    Is Compound Finance Safe?

    Like all DeFi platforms, safety is not a guarantee with Compound. That’s because these systems are still relatively new. There are two types of risks the platform faces: systemic risk and economic risk.

    Systemic Risk

    Systemic risk is basically the likelihood of a hacker exploiting a bug in the smart contracts and stealing user funds. This hasn’t happened with Compound but it has occurred several times with other DeFi platforms.

    With that being said, Compound Finance has been audited by OpenZeppelin.

    If you have a tech background, you could check Compounds’ code on Github, which can be freely audited by anyone.

    Economic Risk

    Economic risk happens when there is insolvency in the platform. This can come in the form of bank runs, which usually happen when a large number of users withdraw their assets simultaneously. It could come to the point that the locked assets may not be sufficient to cover withdrawals due to devaluation.

    This is why DeFi systems require high collateralization ratios in order to cushion the platforms from extreme market movements or flash crashes.

    With all things considered, Compound appears to have one of the best track records in all of DeFi. And, they have a small fund ready to cover losses of failed liquidations.

    Conclusion

    Like other DeFi protocol, Compound is here to grant everybody access to open financial systems. The goal is to empower the common individual to have control over the money they earn and save.

    The project has had some criticisms for its previous centralized model. But with the release of COMP governance token, the project is already leaning towards full decentralization. The Compound DAO will eventually have full authority over the protocol.


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    Evan Ezquer
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    Evan, the founder of Metaroids, is an OG crypto enthusiast and content creator who has explored the world of blockchain, AI, and other cutting-edge tech for nearly a decade. His ultimate goal is to build the best community on the Internet. Up until January 2023, Evan has been writing on Metaroids under the pseudonym Falkris.

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