Crypto investors have become accustomed to DeFi lending protocols over the years, but back in 2017 when Compound launched, the landscape was very different. Being one of the very few lending protocols in the space there was a lot of pressure on Compound to succeed and today it is home to $10B worth of deposited crypto supplied by 300,000 depositors. Even though it is only available on the Ethereum network, it has still gathered a lot of interest and users.
What Is Compound Finance? #
Compound is one of the oldest DeFi lending protocols in the cryptocurrency industry that connects borrowers with lenders and allows them to take full control over their crypto capital. In short, lenders can deposit crypto into the Compound protocol and borrowers can take out loans out of those pools if they have enough crypto to put down as collateral.
COMP is the native token of Compound Finance and holders can use it to vote on governance proposals since the protocol is managed and governed by the community.
How Does Compound Finance Work? #
As mentioned, Compound brings lenders and borrowers together on a single decentralized platform. From here, lenders can deposit their crypto into the corresponding pool and earn passive income just by holding it there. Borrowers also have to deposit some crypto before taking out a loan since every loan needs to be collateralized.
Every loan comes with a variable borrow rate which is distributed to lenders when a loan is repaid. Every depositor can become a borrower if they accept to use their deposited funds as collateral. Once a loan is taken out, it will generate interest until repaid or until the total sum doesn’t trigger a liquidation event.
Liquidations can vary because not every crypto is treated equally in the lending business. Some cryptocurrencies will allow you to take out loans up to 80% of their value while others will only allow you to take out 30%. Once the borrowed amount crosses these limits the protocol will sell the collateral, repay your loan and return any excess crypto to the borrower.
To keep track of all the deposits the protocol issues C tokens to every depositor. For example, if you deposit 1 ETH into Compound, the protocol will issue 1 cETH token to you. This token can be traded in the open markets, but it is only redeemable on the Compound platform.
What Is The COMP Token? #
Each action that you take on Compound is incentivized by the protocol. Both borrowers and lenders will receive a proportionate reward from the daily COMP distribution. Each day approximately 2300 COMP tokens are distributed to the users of Compound. According to their website, these rewards are split 50/50 between borrowers and lenders each day.
COMP is also used for protocol governance as holders can vote on proposals or delegate their votes to other members of the community.
The DeFi lending markets aren’t perfect yet, but with solutions like Compound crypto investors can unlock the full potential of their holdings. In situations when a token holder needs some cash on-hand but doesn’t want to sell their crypto position, lending protocols can give them the ability to take out a loan. Once they repay it, they can get the collateralized cryptocurrency back. A perfectly simple solution to a very common problem.