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.
Compound Strengths
- One of the most tenured and successful DeFi applications to date with ~$10 billion in total value locked (TVL)
- The team has taken demonstratable steps to remove their authority and influence over the protocol, helping to further decentralize the project including the issuance of the COMP governance token
- Proven security track record compared to many of the newer DeFi projects
Compound Weaknesses
- General regulatory uncertainty around DeFi, stablecoins, and KYC laws all affect Compound greatly
- Stiff competition, among DeFi and centralized counterparts, have made Compound's APY rates less attractive to users
- Compound lists fewer assets (13) than other borrow and lending platforms
Compound Links
- Website
- Whitepaper
- Discord
- Governance Forums
- Newsletter
- Blog
- Wallets - Ledger and TREZOR
- Where to buy? Coinbase and Gemini
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.
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.
Technology
Compound's protocol is built on top of Ethereum’s blockchain, which, as of the time of writing, still uses a Proof of Work (PoW) consensus mechanism. Since the Compound protocol is a dApp built on Ethereum, the consensus is also Proof of Work. Ethereum’s development team is planning to fully implement Serenity, a Proof of Stake (PoS) consensus, along with many improvements to scalability, efficiency, and security by the year 2022. In the meantime, the Compound protocol has to deal with the limitations of a PoW consensus. One of the challenges of a PoW consensus is the limit on scalability, which has to do with the block frequency and block size within a blockchain. Any attempt to increase the block time or block size consequently results in trade-offs to the security of the blockchain.
Since the Ethereum blockchain is working with a PoW mechanism, the Compound finance protocol will also have to work within these constraints until the Ethereum blockchain switches to a PoS consensus mechanism. In an effort to reduce the high processing fees that are embedded within the Ethereum blockchain, Compound labs member Maxcwolff posted on May 11, 2021, to their forum that they are in “the process of developing patches to the Comptroller and ctoken in order to improve gas efficiency and security.”
Compound operates as a liquidity pool within Ethereum where users supply assets to the liquidity pool to earn interest. On the other side of the trade, borrowers take out loans from the liquidity pool and pay interest on their debt. Compound brings together lenders and borrowers in a trustless ecosystem, allowing users to interact with a liquidity pool and algorithm rather than a bank. This peer-to-smart contract interaction reduces friction and is more inclusive than traditional lending companies/banks.
The interest rates, calculated in Annual Percentage Yield (APY), differ for each asset on the protocol based on their liquidity, volatility, and demand via an internal algorithm.
In comparison with competitor AAVE’s lending protocol, the Compound protocol offers different benefits. Compound’s use of the governance token, COMP, allows for users that hold over 10,000 COMP to offer proposals. AAVE does have the largest asset diversity and promotes a use case called flash loans. These loans allow for uncollateralized loans while Compound does not. Compound has variable interest rates, but AAVE offers fixed-rate borrowing where “users can commit to a higher interest rate, in exchange for a predictable rate.”
Network Effect
Compound Labs went through two stages of funding from several venture capital firms. The seed round in May of 2018 raised $8.2 million with a total of 10 investors, including Bain Capital Ventures, Andreessen Horowitz, Polychain Capital, and Coinbase Ventures. The November 2019 Series A raised $25 million with Andreessen Horowitz being the lead investor. Compound raised a total of $33 million via funding in order to expand the protocol’s horizon to all. It is important to point out that the addresses with the largest voting weights are some of the venture capital firms that contributed to Compound’s funding. Andressen Horrowitz’s address named “a16za17z” has the most voting weight with 13.14%. Polychain Capital has the second-largest voting weight of all addresses, which is 11.65%. It is sufficient to say that these venture capital companies have significant clout in every governance proposal.
In the social media aspect, Compound ranks as the 5th most followed Twitter profile within the DeFi community, as of Q3 2021. Twitter handle, @compoundfinance, has ~163K followers with a frequent activity of updates on new proposals and team goals. Compound Finance has over 7,000 subscribers to their devoted subreddit. For the month of July 2021, Compound.finance.com experienced 541,720 visits and, earlier, in April of 2021, had 1.15 million searches. The graph below compares Compound’s web traffic with other leading DeFi lending protocol, AAVE’s, over the last 6 months:
Source: SimilarWeb
Since Compound releases governance proposals quite consistently, the active addresses are well known and even on display. An important note is that active addresses are ranked in vote number and voting weight on the Compound website, not by the amount of COMP tokens held. Recall, COMP token holders are able to delegate votes to the addresses of their choice.
Source: Dune Analytics
The COMP token is listed on 68 different digital asset exchanges, among the most globally popular cryptocurrency exchanges: Binance, OKex, Coinbase Pro, DigiFinex, Huobi Global, BitMart, FTX, Kraken, and Kucoin. BINANCE is the exchange with the largest 24-hour trade volume of COMP token: $42.72 million. The 24-hour trading volume of the COMP token across all exchanges is $237,139,326 as of July 21, 2021.
Compound has created a revolutionary protocol, but their work has not stopped there. They recently launched a multi-chain lending protocol called Gateway that allows users to lend a broader range of crypto assets with a cross-chain interest rate. Compound Labs, creators of Compound, also announced another project named Treasury with the partnership of digital asset custody Fireblocks. This project expands Compound protocol’s functionality and aims to provide a treasury in which native or non-native crypto businesses can earn a high yield-interest rate in a frictionless manner.
