Compound Use Case

What is Compound?

Compound is a DeFi and smart contract blockchain platform built onto the Ethereum network. It allows users to borrow assets or earn interest by lending their cryptocurrencies. It is designed to provide a decentralized alternative to borrowing from traditional banking institutions and to allow users to generate income by providing the liquidity needed to offer loans. It supports the borrowing and lending of several well-known cryptocurrencies already including Ethereum, Wrapped Bitcoin, Tether, USD Coin, BAT and DAI.

Compound was one of the first blockchains to offer liquidity mining. This is where users can lend their cryptocurrency to earn interest and receive tokens as a reward. Liquidity mining has become a widely adopted method for DeFi blockchains and users are able to maximize profits by lending their tokens to the network. 

Compound uses smart contracts to allow borrowers to take out loans and lenders to provide the assets for the loans. The lenders receive interest based on the tokens supplied and the demand for the crypto asset. Lenders can withdraw their tokens at any time. 

In traditional banking institutions, cash deposited by users in savings accounts is used to provide liquidity and loans to others. However the user who deposits this cash receives very little direct benefit other than a small amount of interest from the savings account and the bank receives the larger loan interest. Compound provides an alternative where the user can generate income by providing the funds for loans. 

What is COMP?

Compound has a native token, COMP, that is used to incentivize participation in the network. Users who use the network for borrowing or lending receive COMP tokens in return. COMP is used as a governance token for the platform as well and holders can vote on proposals for the chain. 

There is a maximum supply of 10 million COMP tokens. At the initial rounds of investing, 24% of tokens went to shareholders in Compound Labs (the company behind the blockchain), 22% went to the staff and founders. 

New COMP tokens are issued daily by the network as rewards. 2,880 tokens are given out as rewards to lenders and borrowers daily spending on the amount lent to the network or the collateral provided. This will stop in 2024 when the cryptocurrency reaches its cap.

Compound Background

Compound Labs was founded in 2017 by entrepreneurs Geoff Hayes and Robert Leshner (co-founders of Safe Shepard, Britches and more). In 2018 the network went live and held a funding round that raised $8.2 million from investors including Andreessen Horowitz, Polychain Capital and Bain Capital Ventures.

In 2019 they held a second round of funding that raised $25 million. The token COMP was launched in June 2020 to facilitate liquidity mining and peaked initially at $337. Since then it has varied depending on market speculation. During 2020 they reached a milestone of having over $1 billion worth of cryptocurrency assets locked into the Compound network.

Compound experienced a smart contract bug in October 2021 which accidentally overpaid $90 million in rewards to users. The founders were forced to ask the users to return it with no mechanism available to reclaim it. This shook confidence in the platform slightly and the market value of COMP fell but it has been regaining its value since.

Compound Use Case: Lending

Compound provides an option for cryptocurrency holders to lend their tokens to the network and generate income in both COMP tokens and the token that they have provided. 

To lend tokens, a user can send or deposit their tokens into a lending pool controlled by Compound. Once the user makes a deposit, Compound will send the user cTokens in return. These are custom ERC-20 tokens within the Compound network that represent the deposit made.

For example, if a user sends 100 ETH they will receive 100 cETH to their wallet as a representative of their deposit. These tokens can be exchanged for the equivalent ETH at any time. Other examples of cTokens are cBAT, cWBTC and cDAI. 

The cTokens can be traded on the network with other users but can only be redeemed for the deposited tokens.

Rewards and Interest

Any Compound user who provides collateral to the lending pools receives a reward and a portion of the interest from the loan. The interest rate is based on the supply of tokens for the specific asset and the demand for the token

So, if there is only a small lending pool of Ethereum tokens and a high demand for ETH loans, the lender will receive a high interest rate. The lender will receive the interest in ETH tokens. 

The interest is compounded. This means that users who lend their tokens for a longer period of time can expect to see much larger returns. 

They will also receive COMP tokens anytime they lend, borrow or withdraw tokens from the pools. This is designed to incentivize user participation and increase activity on the network.

Compound Use Case: Borrowing

Once a user has provided collateral they can also borrow from Compound. A user who lends tokens to the network can also take out a loan in another coin offered on the Compound platform. 

The loan can be up to the equivalent value of the tokens lent originally depending on the accepted rate of borrowing for the collateralized asset. So, if a user lends ETH with a value of $500 and the borrowing rate is 75%, they can borrow $375 worth of another token. 

If the asset they borrow increases in value to be more than the collateral provided, the loan is liquidated by a smart contract instantly. This is so that the amount of collateral provided is always greater than the amount borrowed. 

Anyone who takes out a loan pays interest in the form of the borrowed asset. This goes back to the users who deposited into the lending pool. 

Borrowers also receive COMP tokens for both borrowing tokens and repaying their loan. Again, the COMP token is used to incentivize a high rate of user activity and participation.

Compound Use Case: Governance

Compound uses the COMP token as a governance token in the network and any COMP holder can take part in making decisions about the platform by voting. These voting rights include changes to interest rates, blockchain structure, security upgrades and more. 

Traditionally, blockchain governance is carried out by a team of developers or a foundation who made all the decisions on the roadmap for the blockchain. The community has little say in the platform. A major drawback of this is that hard forks can occur when the community disagrees with the roadmap or decisions made for the blockchain.

A hard fork is when the community splits in two directions and the blockchain separates into two separate blockchains with different code. Bitcoin has seen this happen several times with the creation of separate blockchains such as Bitcoin Classic and Bitcoin Cash.

This can cause a dilution of the value of the coin and cause unrest in the market. Many investors and individuals are wary of investing in a cryptocurrency that can suffer these hard forks. 

With Compound, governance is carried out on-chain and proposals are designed as code that can be implemented automatically once a consensus is reached. Compound originally had a certain level of centralization with the Compound team managing the protocol but over time they have moved to a fully decentralized governance method with an interim period where the Compound team had veto power.

Compound has set up a Decentralized Autonomous Organization (DAO) to manage the blockchain, treasury and token reserves. Compound was one of the first blockchains to successfully implement a DAO for governing their blockchain.

Proposals and Voting in Compound

Any COMP token holder who holds 1% of total COMP tokens (100,000 COMP) can suggest a proposal to the community. These have to be in the form of executable code and can govern many things such as interest rates, adding new supported assets or protocol changes. 

Once suggested, the proposal has a 3 day voting period and any COMP token holder can vote on it. After 3 days if over 400,000 votes have been cast and a majority is reached the proposal is accepted and enacted within 2 days.

Voting power is given proportionally to the amount of COMP tokens held. One COMP token is equivalent to one vote. COMP holders can delegate their votes to others including legal experts if necessary. 

This system allows every COMP token holder to help choose the direction that the Compound platform will take. To earn more COMP tokens and have a greater say, users simply have to take part in borrowing and lending tokens to the network. This helps promote a robust and active platform.

Why Compound is a Successful DeFi Provider

Compound has created a successful decentralized cryptocurrency lending platform that works in tandem with the Ethereum blockchain underpinning it. It provides loans for many successful tokens on the network and has an active community.

The token at the heart of Compound, COMP, is primarily a governance token but has proven itself to be a successful coin as many passionate users enjoy being a part of the decision making process. Although the network has seen some bugs with the development of the platform, most COMP token holders have remained hopeful and invested in the future of Compound.