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What Is Compound?
Compound is a decentralized and automated lending and borrowing application that runs on the Ethereum blockchain. With it, people can earn interest on their cryptocurrencies or take collateralized crypto loans with them. Essentially, it is a bank that is not controlled by one single entity but instead by its users. It supports a growing number of cryptocurrencies, including DAI, ETH, USDC, ZRX, USDT, WBTC, BAT, UNI, and COMP.
Lending on Compound
If you want to earn interest on your crypto like you would on the money in a savings account, you can send your coins from a browser wallet like MetaMask to a smart contract that is part of Compound. Once you deposit your cryptocurrencies, you receive an equivalent amount of c-tokens and begin to earn interest on them.
For example, if you have 1 ETH and lend it on Compound, then you would receive 1 cETH and begin to earn interest on it. You can then swap your cETH back for ETH whenever you want at a 1-1 ratio.
The interest for lending and borrowing is calculated automatically by the protocol based by the supply and demand for a cryptocurrency. If many people take a loan for a certain crypto, but few people lend it to Compound, then the interest for lending it will rise to incentivize people to lend it.
Borrowing on Compound
Compound only gives out collateral loans, which means that borrowers first have to deposit cryptocurrencies before they are able to take out loans. Additionally, borrowers can only borrow an amount of crypto valued less than or equal to what they have deposited.
You are probably wondering why anyone would even take a loan if they already have more crypto than what they could borrow. Someone might do this because such a loan provides liquidity without the need to sell your asset. If you have ETH and don't want to sell it because you believe that it will rise in value, but you need cash, then you can lend your ETH to Compound and get a loan in stablecoins.
Should the value of your collateral fall beneath what you are allowed to borrow with it, the Compound protocol will sell some of it with a 5% discount. This is done to incentivize borrowers to pay their loans back quickly.
On Compound, you stay anonymous and don't have to get your loan approved by anyone. You only have to connect a browser wallet with the app and deposit collateral. Non-collateral loans are not currently supported by Compound because it is nearly impossible to evaluate whether someone is trustworthy to pay back a loan without collateral in a decentralized and automated way.
There are many alternatives for earning interest on your crypto holdings. There are crypto banks like Nexo and Celsius, where you can earn a high APY on your crypto holdings. However, such centralized institutions have custody over your cryptocurrencies. This can be an advantage if you don't trust yourself to take care of your crypto, but it can be a disadvantage if you don't want to depend on a third party.
One big competitor to Compound within the decentralized finance sector is Aave, another lending and borrowing protocol on Ethereum that works in a similar way to Compound and is also very popular in the DeFi space.
The COMP Token
COMP is the governance token of the Compound protocol. It gives its holders voting rights for possible changes. Such changes could be anything from adding a new asset that can be lent and borrowed to changing how interest rates are calculated.
COMP has a circulating supply of 5.4 Million COMP coins as of mid-July 2021 and a max supply of 10 Million. 2,880 COMP tokens are distributed daily to users, so anyone who lends or borrows earns a share of that.
Anyone who has 100,000 COMP, either by themself or delegated from other holders, can submit a proposal. There is then a three-day voting period where at least 400,000 COMP must have been used to vote. If the majority of the votes support the proposal, it will be implemented after a two-day waiting period. Such proposals are finished and executable code and not just suggestions for developers to be implemented.
The price of the COMP token depends on how much money is in the protocol. If the demand for cryptocurrencies and decentralized finance grows, then so will the COMP token thanks to its limited supply. The only real threats to COMP come from its competitors like Aave, which does the same thing as Compound but has more users.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2021 Krypton Currency