Compound: Everything to Know
By Beluga Research July 17, 2023
- Compound is a lending platform that operates on the Ethereum blockchain as a decentralized autonomous organization (DAO)
- Compound uses smart contracts to automate lending processes, whicj eliminates the need for intermediaries to facilitate lending between users
Compound is a decentralized finance (DeFi) lending protocol that is governed by COMP token holders. Robert Leshner and Geoff Hayes launched Compound in 2018 to create an efficient and open financial system. The purpose of Compound is to enable person-to-person blockchain-based lending. Compound has become popular within the DeFi ecosystem because of its innovative approach. Compound's primary advantage over banks is that it offers users liquidity without the need for an intermediary to manage lending.
A Brief History
Leshner and Hayes launched Compound during the DeFi boom of 2017 and 2018. At this time, several projects were exploring the potential of blockchain technology to disrupt traditional financial systems. Leshner and Hayes recognized the need for a decentralized lending protocol that would make it possible for users to easily lend cryptocurrencies to one another. In June 2018, Compound began allowing users to lend and borrow Ethereum-based assets.
Compound garnered attention and quickly gained traction within the crypto community. In 2019, it raised $8.2 million in a seed funding round led by venture capital firms. The successful funding round enabled Compound to further develop its platform and expand its offerings. Compound launched its native coin, the COMP token, in June 2020.
- Connect a viable wallet. A user can connect a MetaMask wallet, Coinbase Wallet or an Ethereum wallet to the Compound platform.
- Acquire cryptocurrency to supply or borrow. The user should then specify the amount they want to supply or borrow and initiate a transaction.
- Observe cryptocurrency assets being used by borrowers. The borrowers provide collateral in another cryptocurrency and pay interest on the borrowed funds. The interest rates are determined by the supply and demand dynamics of each asset in the Compound protocol.
- Borrow assets. A user who wants to borrow cryptocurrency must provide collateral in the form of another cryptocurrency. The amount of assets that can be borrowed depends on the value of the collateral provided. The amount also depends on the specific collateral factor set for each asset. Borrowers must maintain a sufficient collateral-to-debt ratio to avoid liquidation of their collateral.
- Algorithmic interest rate model. Compound uses an algorithm that adjusts interest rates based on the supply and demand for each cryptocurrency. When the demand to borrow a particular asset increases, that cryptocurrency's interest rate goes up. This encourages more users to supply that asset and earn interest. The dynamic interest rate mechanism ensures that interest rates remain competitive and responsive to market conditions.
- Governance system. The protocol is governed by COMP, an ERC-20 token that enables holders to participate in the decision-making process. COMP token holders can propose and vote on changes to the protocol. This can include adjustments to interest rate models, collateral factors and other parameters. The decentralized governance model gives the community a voice in shaping the future of the protocol.
- Supports a wide range of cryptocurrencies. Such support allows users to supply and borrow various assets. The diversification of supported assets provides users with flexibility and options to utilize their holdings in a way that best suits their needs. Additionally, Compound's open architecture allows developers to build on top of the protocol. Developers can create innovative applications and services that further expand the ecosystem.
- Efficient interest rates . Compound adjusts interest rates dynamically based on supply and demand. This ensures that interest rates remain competitive and reflect current market conditions.
- Instant access to funds. Users can easily deposit and withdraw funds from Compound at any time. There are no restrictions or waiting periods. Users have instant liquidity.
- No credit checks . Unlike traditional lending systems, Compound does not require users to undergo credit checks or provide personal information. This allows individuals from all over the world to access lending and borrowing services without barriers.
- Decentralized governance . Compound's governance model allows users to participate in the decision-making process. Holders of the native COMP token can propose and vote on changes to the protocol. This feature ensures the Compound community has a say in its development.
- Diverse asset support. Compound supports a wide range of cryptocurrencies, including popular assets like ETH, DAI and USDC. This allows users to lend or borrow various cryptocurrencies based on their preferences and investment strategies.
- Volatility Risks. The cryptocurrency market is known for its volatility. Users that borrow or lend crypto assets on Compound are exposed to price fluctuations of the underlying assets. Losses can occur if the value of their collateral significantly decreases.
- Smart Contract Risks. Compound relies on smart contracts to facilitate lending and borrowing activities. While the protocol has undergone extensive audits, there is still a risk of vulnerabilities or bugs in the code. An exploit or security breach could result in the loss of funds.
- Centralization of Power . Despite its decentralized nature, Compound's governance model is heavily influenced by the holders of COMP tokens. This concentration of power in the hands of a few token holders may raise concerns regarding centralization. These users could manipulate the protocol's rules.
- Limited Control Over Interest Rates . Compound adjusts interest rates based on market conditions. Yet users have limited control over the rates. Users must rely on the algorithmic adjustments made by the protocol. These may not always align with individual preferences or expectations.
- Regulatory Uncertainty . As with any cryptocurrency-related project, Compound operates in a rapidly evolving regulatory landscape. Changes in regulations or legal interpretations could potentially impact the availability and functionality of the protocol in certain jurisdictions. This would impact the value of all users' holdings. It could also affect the viability of the ecosystem.