Compound is a decentralized finance (DeFi) protocol that allows users to lend and borrow cryptocurrencies. Built on the Ethereum blockchain, Compound enables users to deposit cryptocurrencies into liquidity pools to earn interest or to borrow assets by providing collateral. The protocol is governed by a decentralized community of COMP token holders, who propose and vote on changes to the protocol.
History of Compound
Compound was founded in 2017 by Robert Leshner and Geoffrey Hayes. The project was initially incubated by the venture capital firm Andreessen Horowitz, which was instrumental in its early development. The Compound protocol was launched on the Ethereum mainnet in September 2018. Since its launch, Compound has become one of the leading DeFi protocols, contributing significantly to the growth and popularity of decentralized lending and borrowing.
In June 2020, Compound introduced its native governance token, COMP, which marked a significant milestone for the protocol. The introduction of the COMP token enabled the decentralization of governance, allowing token holders to propose and vote on protocol changes and improvements.
How Compound works
Lending and borrowing
Compound operates as an algorithmic, autonomous interest rate protocol. Users can supply assets to the Compound protocol and earn interest, or they can borrow assets by providing collateral. The interest rates for lending and borrowing are determined algorithmically based on the supply and demand dynamics of each asset in the protocol's liquidity pools.
When a user supplies an asset to the protocol, they receive cTokens in return. cTokens represent the user's claim to the supplied assets and the interest earned on them. For example, if a user supplies Ether (ETH) to the protocol, they will receive cETH in return. These cTokens can be redeemed for the underlying asset at any time.
Borrowers can access liquidity by locking up collateral in the form of supported cryptocurrencies. The amount a user can borrow is determined by the collateral factor assigned to each asset, which dictates the maximum loan-to-value ratio. If the value of the collateral falls below a certain threshold, the user's position may be subject to liquidation to maintain the protocol's solvency.
Governance
Compound's governance is decentralized and driven by the community through the COMP token. COMP holders have the ability to propose and vote on changes to the protocol, such as adjustments to interest rate models, the addition of new assets, or changes to collateral factors. Each COMP token represents one vote in the decision-making process, and proposals that receive a majority of votes are implemented.
The governance process is designed to be transparent and open, allowing COMP holders to actively participate in shaping the future of the protocol. This decentralized approach ensures that the protocol can adapt and evolve based on the needs and preferences of its users.
Key features of Compound
Decentralization and transparency
Compound is fully decentralized, with all transactions and operations conducted on the Ethereum blockchain. This provides transparency and security, as all interactions with the protocol can be audited and verified on the blockchain. The use of smart contracts ensures that the protocol operates autonomously, without the need for intermediaries.
Permissionless access
Compound allows anyone with an Ethereum wallet to interact with the protocol. Users can supply or borrow assets without the need for approval or verification, making the protocol accessible to a global audience. This permissionless nature is a key aspect of DeFi, enabling financial services to be available to anyone with internet access.
Automated interest rates
Interest rates on Compound are determined algorithmically based on the supply and demand for each asset. This dynamic rate adjustment ensures that interest rates reflect the current market conditions, providing competitive returns for suppliers and reasonable borrowing costs for borrowers. The automated nature of interest rates eliminates the need for manual intervention, allowing the protocol to function efficiently and autonomously.
Use cases and applications
Earning interest
One of the primary use cases for Compound is earning interest on idle cryptocurrency holdings. Users can supply their assets to the protocol's liquidity pools and earn interest in the form of additional tokens. This allows users to generate passive income from their crypto assets without needing to sell them.
Accessing liquidity
Compound provides users with the ability to access liquidity without selling their assets. By using their crypto holdings as collateral, users can borrow against their assets to obtain additional funds. This can be useful for various purposes, such as investing in other opportunities, covering expenses, or managing risk.
Leveraging assets
Sophisticated users can leverage their assets by borrowing additional assets to reinvest back into the protocol or other DeFi opportunities. This strategy can amplify returns, though it also increases the risk of liquidation if the value of the collateral decreases significantly.