Compound is an open-source, decentralized application (dApp) built atop the Ethereum blockchain that creates permissionless money markets with algorithmically set interest rates based upon supply and demand. It enables users to lend and borrow various digital assets with no maturity dates or restrictions while interacting with a smart contract rather than a company. COMP is the native ERC-20 governance token for the Compound protocol. Holders of COMP may debate, propose and vote on all changes to the Compound protocol
Use Case
Compound is a DeFi project which aims to provide financial services like lending and borrowing without an intermediary like a brokerage or bank. The goal of Compound is to create a decentralized, robust money market. Though money markets already exist in the world of traditional finance, they continue to be an innovative addition to the world of DeFi.
In contrast to the traditional legacy companies which determine the creditworthiness of an applicant through credit history, job status, etc., Compound does not require any identifying information. In this way, Compound (and DeFi in general) democratize access to loans and remove the need for trusted third parties.
The risk(s) behind a centralized exchange include a potential hack or seizure of funds. Compound presents a solution in which users can deposit the asset(s) of their choosing into a decentralized liquidity pool, held by a smart contract as opposed to a centralized third-party, that borrowers can then withdraw if they provide sufficient collateral.
Compound also allows users to earn interest on their owned assets (through the minting cTokens when a user lends a supported token), short assets, and acquire assets by providing enough collateral to borrow them. Users interact in a peer-to-pool fashion meaning lenders deposit similar assets into a common pool where borrowers can then deposit collateral and directly borrow. This approach enables each party can immediately earn interest or receive funds. However, the terms of the loan are subject to variable interest rates based on supply and demand, rather than a fixed interest rate.
For example, if a borrower wants to acquire ETH tokens then they are able to borrow 80% of what has been deposited as collateral. The protocol erases some of the outdated practices of traditional financial institutions, such as checking a user’s credit score, creating an interest rate, and centralized regulations that govern our current financial system. Compound’s borrowing and lending protocol are built on top of the Ethereum blockchain. In Compound’s whitepaper, Robert Leshner (CEO and Co-Founder) and Geoffrey Hayes (CTO and Co-Founder) explain that each money market is uniquely attached to an Ethereum asset such as an Ether, Dai, or an ERC-20 utility token. This allows for a transparent and public LEDGER with a record of all the transactions made and previous interest rates established. Compound calculates the interest rate with an algorithm of supply and demand economics within the platform, so it fluctuates quickly over a period of time. The suppliers and borrowers of any asset interact directly with the protocol by earning or paying an interest rate, without the intermediary step of negotiating terms, “such as maturity, interest rate, or collateral with a counterparty”. Compound uses smart contracts in order to fulfill these processes. The three primary use cases for dApp consumers, traders, and developers are explicitly listed in the Compound Whitepaper:
- Without having to wait for an order to fill, or requiring off-chain behavior, dApps can borrow tokens to use in the Ethereum ecosystem, such as to purchase computing power on the Golem network.
- Traders can finance new ICO investments by borrowing Ether, using their existing portfolio as collateral.
- Traders looking to short a token can borrow it, send it to an exchange and sell the token, profiting from declines in overvalued tokens.
These capabilities allow for a decentralized system in which frictionless borrowing of Ethereum tokens can create a safe and vibrant community for storing assets.
Along with the Compound protocol, the team released the Compound token (COMP) in 2020. Whenever a user interacts with the Compound protocol, whether it is borrowing or lending, they earn COMP tokens. The token allows users to engage with the protocol by voting on future proposals or delegating votes to the user who they choose, which is discussed in greater detail in the Governance section. The growth of DeFi projects has grown exponentially and as of Q3 2021 ~$10 billion in assets were deposited into Compound’s liquidity pools.
Economics
As of Q3 2021, there are 13 different tokens available on the Compound Platform:
- 0x (ZRX);
- Basic Attention Token (BAT);
- Compound (COMP);
- Dai (DAI);
- Ether (ETH);
- USD Coin (USDC);
- Tether (USDT);
- Uniswap (UNI); and
- Wrapped Bitcoin (WBTC)
- Maker (MKR)
- AAVE (AAVE)
- Sushiswap (SUSHI)
- Yearn.finance (YFI).
Compound takes 10% of what lenders earn in interest for themselves. The interest comes from other users that borrow funds and pay interest for the loans. The interest rate on Compound is dependent on the supply and demand of that asset within the protocol. Therefore, if a large amount of a particular asset is being borrowed, the Compound smart contract will increase the interest rate to attract lenders and make it more expensive to get a loan.
Unique to Compound (when compared to traditional finance and banks), is the fact that when funds are deposited into the protocol, Compound issues new tokens called cTokens. For example, if a user deposits ETH, an equivalent value of cETH is generated and given to the user. The cETH can then be used as collateral for a loan, meaning that, effectively, the funds can be spent while they’re earning interest.
For borrowers on Compound, there is a liquidation clause in order to assure that users do not overborrow.
According to icodrops.com, the Compound (COMP) token had an initial coin offering of 34 USD for 1 unit of COMP. From the initial coin release on June 15th of 2020 until the time of writing, the token has experienced a 9.16x USD return and increased in value to over $300. The entire Compound platform was released on mainnet in September of 2018. As of Q3 2021, the token has a market cap of ~$2.6 Billion USD.
Compound generates daily fees of ~$800,000, positioning it in the top 10 productive blockchain projects. In comparison, Ethereum’s blockchain accumulates approximately a daily amount of $19.6 million in fees and ~$20 million being the weekly average. As of Q3 2021, the circulating supply of the Compound token is roughly 5.4 million with a max supply of 10 million tokens, meaning that only 52.86% tokens are in circulation. Most COMP tokens are traded via the BINANCE exchange, with Coinbase, Huobi, and the decentralized exchange, Uniswap, being the other top trading venues.
Compound does not explicitly mention a token burn feature for COMP tokens in their whitepaper or on their website. In a Bankless podcast during May 2017, Robert Leshner explained that the COMP token’s purpose is to represent a user’s delegation or voting power and should not be a coin to be speculated on.
The COMP token, which is the native governance token behind the Compound lending protocol, has a total supply of 10,000,000 COMP tokens. As of the time of writing, the circulation is divided into 42.3% reserved for protocol usage, 24% for shareholders of Compound Labs Inc., 22.25% to founders of Compound, 3.72% for future team members, and 7.75% for future governance participation incentives. COMP tokens are created every time a user uses the Compound Finance platform to supply or borrow supported assets. Then, the protocol distributes the token to each market such as ETH, DAI, USDC, or 0x, depending on the interest rate that is set through the supply and demand of each market.
4,229,949 COMP were placed into a Reservoir contract, which transfers 0.50 COMP per Ethereum block into the protocol for distribution The total amount of distributed COMP tokens is ~1,000,000 with a remaining amount of 3,300,000. Each day, ~2,300 COMP tokens are distributed to users of the protocol, depending on the interest rate of each market. Once the user interacts with a market, Ether, DAI, Chainlink, etc, they are able to claim the COMP tokens but will have to pay a transaction fee for that action. Within each market, half of the distribution is earned by suppliers, and the other half by borrowers.
The market distribution can be viewed via a dashboard on the Compound website. While subject to change, as of the time of writing, the market distribution is below.
??A comparison of Compound’s interest rates to other leading DeFi projects is below. Compound typically does not offer the highest APY but the stability and longevity of the project are unmatched in the DeFi space.
