What is Compound (COMP)? The Decentralised Lending Platform
Take a closer look and learn all about Compound (COMP), how it works, and what innovations it brings to the crypto space.
Banking in the crypto realm may seem like a complicated matter. On the contrary, Compound Finance makes it easy to do.
Set on the Ethereum blockchain, the decentralised application allows stablecoin holders to lend their assets in exchange for fair interest returns.
On the other side of the deal, stablecoin borrowers can simply borrow any amount of stablecoins given that they’ve deposited one of the preferred crypto assets (like ETH, DAI, USDC, and WBTC) as collateral, against which they borrow.
The interest rates are set automatically, based on the relative supply and demand of crypto assets from both sides of the transaction.
All of this is made possible through a series of smart contract workflows, making Compound Finance not only a breeze to use, but also entirely self-custodial.
Read more if you’d like to know more about Compound Finance and its utility token, COMP.
What is Compound (COMP)?
Compound is a type of protocol known as a decentralised money market.
In this market, anyone who requires immediate access to capital can do so by borrowing stablecoins against their crypto assets.
The great thing about this model is that the borrower doesn’t have to sell (or liquidate) their crypto holdings to benefit from the additional capital injection.
As long as their crypto collateral continues to grow in value, the borrower can benefit from both the liquidity they get from the borrowed stablecoins as well as capital gains from their crypto collateral.
However, if a borrower’s crypto collateral loses its value under a certain threshold, the collateral is immediately liquidated by Compound’s smart contracts.
In that case, the borrower would no longer have access to their crypto collateral, and could keep their stablecoins indefinitely.
The chances of this happening is usually pretty slim, as the protocol demands that borrowed stablecoins must be over-collateralised.
Documentation: Read Compound’s official Whitepaper.
How does Compound’s over-collateralised loans work?
On Compound, different stablecoins (and even non-stablecoins) have their own collateral ratio, which ranges somewhere between 60% to 80%. If, for example, borrowing USDT requires a 60% collateral on ETH, the borrower must deposit $100 of ETH for every $80 of USDT borrowed.
That being said, if the price of ETH falls 20%, the value of the collateral would effectively be equal to the value of the borrowed USDT.
Through a series of self-executing smart contracts, Compound will make sure to sell the ETH collateral before its value is less than that of the borrowed asset.
This is a time-tested mechanism that all decentralised peer-to-peer lending platforms share, like Aave, another Ethereum-based platform. The mechanism ensures that lenders (or depositors a.k.a. liquidity providers) don’t get the worse end of the deal.
On the other hand, if the collateral maintains its value, the borrower can rest assured that their collateral is safe. They could return their borrowed assets whenever they want, pay interest and network fees, and release their collateral.
How does Compound keep track of collateral value?
The lending platform connects to an independent network called Chainlink.
Chainlink is a network in which computers keep track of events around the world. From geographical conditions like weather and traffic, to asset prices on various public markets like the New York stock exchange and crypto exchanges.
An army of automatic reporters collaborate to form a database of truth (with very small margins of error). This source of truth is used by Compound and many other decentralised protocols to determine the average market price of any asset, around the world, 24/7.
Who controls or owns Compound Finance?
All decentralised finance applications are never controlled or owned by a single company, even though Compound was founded by one.
The protocol is governed by holders of the COMP token, an ERC-20 token that circulates in the Ethereum network (as well as layer-2 networks like Polygon).
What are ERC20 tokens?
In short, these are simply tokens that are used on the Ethereum blockchain and act as assets that facilitate the various utilities and functions on the network. Learn more with our guide.
COMP token can represent a share of the protocol, meaning that holders would receive a proportional share of revenue by all interests paid. It also means that token holders have the right to vote on upgrades or changes to the platform.
Of course, the voting power is also proportional to the amount of COMP tokens owned.
Changes to the protocol may directly or indirectly impact parameters such as the interest rate and collateral ratios, which would then impact the risks tolerances and future revenue of all COMP token holders.
COMP token distribution
COMP tokens were initially introduced to provide incentives to Compound users, in addition to being a proxy for crowdfunding via an initial coin offering (ICO) in June 2020. The maximum supply of COMP tokens were set at 10 million COMP.
The following is the distribution statistic:
- 2.4 million COMP were allocated to shareholders of Compound Labs, Inc. for development funding.
- 2.2 million COMP were initially allocated to the company founders and have a 4-year vesting schedule. This means the tokens couldn’t be sold by them until some time in 2024.
- 332,000 were reserved to be distributed to future team members.
When Compound transitioned to a community-owned protocol, 775,000 COMP were allocated to incentivising community governance.
The remaining token supply, approximately 4.2 million, would be distributed to Compound users over around 4 years.
The issuance rate of COMP could change via community governance, so the exact schedule for when all COMP tokens have been issued is unknown.
History of Compound Finance
Compound was founded in 2018 by Geoffrey Hayes, now CTO of Compound, and former derivatives trader Robert Leshner, now CEO of Compound, at the time of writing.
Compound Labs, Inc. was funded by notable venture capital firms, including Andreessen Horowitz, Polychain and Paradigm Capital.
In its early years, Compound received at least $33.2 million in VC funding. Then the COMP tokens became an integral part of the Compound ecosystem, for raising even more funding from public investors as well as incentivising users.
Users who lend, borrow, deposit or withdraw assets on the platform receive extra COMP tokens on top of revenue generated from the protocol, denominated in the native token itself.
Compound Protocol and its governance token, COMP, have emerged as important players in the DeFi space.
By providing a decentralised and self-governed money market protocol, Compound offers a transparent and cost-effective solution to lending and borrowing.
COMP token incentivizes participation in governance and provides an attractive investment opportunity for those who believe in the future of DeFi.
As Compound and DeFi continue to grow, we can expect to see even more innovative solutions emerge from this space.
Further reading: Explore more topics on all things crypto.
How to buy Compound (COMP)?
With all that said, what are your own thoughts on Compound Protocol?
If you’re feeling bullish on the innovations and technology brought by Compound Finance, consider adding the COMP token to your crypto portfolio.
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Invest in Compound Protocol: Buy COMP tokens with Easy Crypto.
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Disclaimer: Information is current as at the date of publication. This is general information only and is not intended to be advice. Crypto is volatile, carries risk and the value can go up and down. Past performance is not an indicator of future returns. Please do your own research.
Last updated May 5, 2023