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What Is Compound Finance?

9 mins
Updated by May Woods
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Everyone is familiar with the idea of borrowing and lending, whether in real money or mortgages, as it is one of the main sectors in the finance space. Lenders supply funds to borrowers with the expectation that the borrowed funds are returned with additional interest to provide instant access to funds. Conventionally, the process of matching borrowers with lenders is done by financial bodies such as banks that manage the rates. Thanks to Decentralized Finance (DeFi), the process is easier and allows a seamless connection.

DeFi protocols keep depositors’ assets and, in exchange, pay low (but safer) rewards. One notable DeFi platform in this space is Compound Finance. By allowing users to deposit into a pool that borrowers can then withdraw from without any third party. Here we explain everything you need to know about Compound Finance.

What is Compound Finance?

compound GRT Perp DeFi

Compound Finance is a decentralized protocol running on Ethereum, allowing users to lend and borrow crypto assets without any third party. It is an algorithmic money market protocol that offers users easy ways to earn interest from their savings. Just like the traditional savings account, you can earn APR from your crypto holdings with Compound Finance. Currently, the protocol has recorded more than 3 billion crypto assets gaining interest in 20 markets.

The platform was launched in 2018 by a team of professionals from different fields under the umbrella name known as Compound Labs. It primarily focuses on maximizing idle crypto assets locked in wallets to earn profits and get a steady passive income. This means anyone with a Web 3.0 wallet, such as MetaMask, can access this and start their earning journey. The Compound Protocol gives you access to earn from 20 Ethereum-based assets like ZRX and WBTC. It essentially started one of the most popular DeFi functions, yield farming. 

The concept favors both lenders and borrowers, as each side earns profits from their holdings. Lenders earn interest from their deposited funds, while borrowers have access to these funds without facing the stress of going to the bank. Likewise, the protocol uses a smart contract that automatically connects these two parties trustlessly. Lenders and borrowers don’t have to know each other, as they both interact with the smart contract, which handles the collateral and interest rates.

Compound Finance originally started as a tokenless protocol, where it implements cTokens. Subsequently, the Compound Labs teams made an update to further make the platform decentralized by implementing the COMP token used to govern the protocol. After several updates, Compound is now fully managed by COMP holders, with no remaining privileges held by Compound Labs.

What makes Compound unique?

On the surface, like any other DeFi lending protocol, Compound Finance allows users to earn interest from their crypto holdings. They get to deposit their funds into liquidity pools and exploit the best-performing strategy to maximize their profits. Additionally, compound interest is calculated algorithmically, and it offers a transparent and trustless finance banking system.

Compound interest

Compound interest rates run as decentralized functions that respond to market forces. This also extends to features like receiving loans or trading cryptocurrency on the Compound market. And in terms of collecting loans, there’s no exact time period to borrow assets from Compound Finance. You can return the borrowed funds at your convenience. However, the interest piles up per block on the Ethereum network.

It’s also worth noting that COMP tokens are given to lenders and borrowers to increase their participation in the network. COMP does not only offer users rewards for their participation. It also gives them access to the community’s governance. As a result, these token holders can vote, delegate, and make proposals that will affect the protocol’s future. These proposals include interest rates and other decisions that can change their future incentives.

Yield farming

In June 2020, Compound started incentivizing both lenders and borrowers that use the platform with their COMP token and subsequently triggered a trend that could well be the birth of yield farming. This concept allows users to increase their earnings via InstaDapp, which offers seamless access to multiple DeFi platforms from a single interface.

Eliminates the need for verification 

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In addition, the Gateway and Treasury feature improves users’ trading experience by offering them access to several money management tools. As a result, users get to easily access the crypto interest rates, excluding mechanical complexities like cybersecurity, interest rate volatility, and KYC compliance.

How does Compound Finance work?

COMP kava

As mentioned above, Compound Finance utilizes smart contracts to manage the funds deposited to the pools, with its algorithm determining interest rates. Since it’s a public platform on Ethereum, anyone can interact with the protocol once they have a crypto wallet and immediately start lending and borrowing. 

Likewise, borrowers can take loans in crypto assets supported by the platform by collateralizing their holdings without the need for Know-Your-Customer verification.

Now let’s explore how you can start lending and borrowing on the Compound Protocol.

How lending works

To start lending on Compound, consider it your regular savings account. With a savings account, you store money while the bank returns specific interest on the balance. This way, the bank can utilize the funds and issue loans to other clients in return. Similarly, to lend on Compound Finance, you need a reputable crypto wallet such as MetaMask. This wallet connects your funds to the decentralized Compound protocol.

The next step is to keep a small amount of Ether (ETH) as gas fees on the Ethereum blockchain to complete the transaction. To access the lending portal, you can visit here.

After completing the funding process, you get to earn the equivalent interest rate (APY), which varies with the market pool market fluctuations. Lenders earn COMP as rewards; the higher the interest rate, the more COMP tokens each market will receive.

After this, you can then take out your rewards at any time, and Compound even allows you to exchange them for other crypto assets. Likewise, your deposited funds can be used as collateral.

Borrowing on Compound Finance

As with any other DeFi protocol, borrowing on Compound Finance requires a crypto wallet and funds to serve as collateral. Basically, this concept employs overcollaterization, meaning the funds supplied as collateral must be higher than the proposed borrowed amount. Borrowers can only withdraw an equivalent amount up to their total capacity with the sum of the token balance multiplied by the collateral factor, which is a number 0-1 representing the portion users can borrow. 

Users can borrow up to, but not exceeding, their borrowing capacity, and they can take no action (e.g., borrow, transfer COMP collateral, or redeem COMP collateral) that would increase the total worth of borrowed assets above their borrowing capacity.

For instance, if the limit of an asset on a Compound is about 75%, users can borrow 75% of deposited collateral funds. So, if you deposited $100, you would be able to borrow a maximum of $75.

Overall, to borrow, users must first deposit crypto assets to the protocol, and regardless of the deposited asset, users can take out any other cryptocurrency asset.

How does Compound’s governance function?

Compound Finance has a comprehensive and easy governance framework that involves anyone with at least a COMP token to propose a governance action.

Other details regarding the governance actions include:

  • Proposals have a 3-day voting period.
  • Addresses with voting power can vote for or against the proposal.

All voting activities are expected to stay in Timelock for at least two days before implementation. This allows easy approval of qualified decisions without any mix-up. Additionally, you should note that if a certain proposal doesn’t receive at least 400,000 votes, it gets dropped.

Proposals can change and update the protocol parameters, provide a new interface, or add new features. Some of the proposed actions include:

  • Change the interest rate model of the market.
  • Update the oracle address.

The COMP token

compound (COMP)

Compound (COMP) is the native token of the Compound protocol, and it’s an ERC-20 asset that governs the community. Anyone holding a COMP token can vote, propose, and debate on future updates to the platform. The token has a circulating supply of about 7 million, and it’s currently trading at about $65.

How was the COMP token distributed?

COMP tokens were initially distributed to the team of Compound Labs, Inc., who explored token governance for a few months. After subsequent updates, the team started distributing the tokens to users, releasing the tokens consistently for a period of four years between lenders and borrowers of various pools based on the ratio of total interest paid out. 

This liquidity mining process gained attention in the DeFi space and contributed to the overall increase in the total value of crypto assets locked in DeFi from $100 million to over $600 million during the launching period.

Tokenomics

COMP token has a total maximum supply of 10 million tokens, and it was allocated as follows:

  • Compound Protocols users: 4 million COMP over a period of four years.
  • Shareholders: 2.3 million COMP go to the Shareholders of Compound Labs, Inc.
  • Founders and team: 2.2 million portions of the token over a period of four years.
  • Community Growth: 775,000 COMP also goes to the advancement of the community.
  • Future team members: 72,000 COMP tokens.

Token usage

The primary use of the COMP token is to govern the Compound Finance community. As a result, anyone holding the token can make proposals and vote on future community updates. The token also provides them with some claim on the funds flows of the network.

Governance

Compound Finance protocol is entirely governed on-chain by COMP tokens, where one token equals one vote. Token holders can vote directly or delegate their voting rights to other participants they deem fit for making decisions. All governance processes happen via the Governor Alpha, the module used to conduct these modifications.

How to buy COMP tokens

crypto buying Visa crypto payments increasing in Q1 2022 - beincrypto.com

The COMP token is pretty much popular, so it’s available on several centralized crypto exchanges such as Kraken, Binance, Coinbase, Kraken, and a lot more. 

You can also buy COMP and store it on your web3 wallets such as Trust wallet and MetaMask.

For this guide, let’s explore a detailed step-by-step guide on how to buy COMP.

Create an account

Before you can purchase COMP, you’ll typically need to have a wallet or an account with a cryptocurrency exchange. You can select Binance.

Complete verification 

Binance will wake you when you complete your verification to start buying coins. This helps limit your potential loss of funds or any security breach.

Choose how you want to buy the COMP token

Click on the “Buy Crypto” option official Binance web page, which will show the available options in your country. You can buy a stablecoin like USDT or BUSD first and then use it to buy Compound COMP.

There you go! You can store and hold the coins upon buying and probably participate in all the passive crypto-earning programs.

Should you invest in Compound Finance?

Compound Finance stands as one of the cornerstones of the DeFi market. It has proven itself to be one of the most active platforms, and there is no reason to think that that will change anytime soon. It also has a considerable reputation among users.

While the platform provides excellent features, it doesn’t mean that it automatically makes it a good investment. Do your own research, and never invest more than you can afford to lose.

Frequently asked questions

What is Compound Finance?

Is Compound Finance legit?

How do I join Compound Finance?

Can you lose money lending on Compound?

Is COMP a good crypto?

What is Compound crypto?

Does Compound pay you to borrow?

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Ayotomiwa Oladotun
Ayotomiwa is a tech writer and marketer focused on blockchain, crypto, DeFi, the metaverse, and NFTs. Ayotomiwa works with a number of emerging tech startups and crypto exchange platforms, including being the content manager for BeArt LLC. Ayotomiwa holds a Bachelor of Engineering from the Federal University of Technology, Akure.
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