What is Compound?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 6 min
In short
Compound is a lending protocol where you can deposit crypto to earn interest and borrow against collateral. Rates are not set by an operator but adjusted algorithmically according to how much of each pool is in use. COMP, the governance token it began distributing in 2020, became the template for incentive design across DeFi.
Key points
- Users do not match with each other; they supply to and borrow from per-asset pools
- Interest rates are derived automatically from utilisation (borrowed divided by supplied)
- Borrowing is always over-collateralised, and positions are liquidated below the threshold
- The 2020 COMP distribution popularised handing out tokens in proportion to protocol usage
Definition
A lending protocol on Ethereum where supplying assets to per-asset pools earns interest and posting collateral lets you borrow other assets.
Compound challenged the assumption that lending crypto requires an intermediary. Previously a company held your funds and you relied on its solvency. In Compound, funds sit in smart contract pools and supply, borrowing, interest accrual and liquidation are all executed in code.
Rate-setting is the distinctive part. The more of a pool that is borrowed, the higher both the borrow rate and the supply rate climb. When capital sits idle, rates fall and attract borrowers. Nobody sets the number by judgement; supply and demand are the rate.
Supplying mints cTokens, a receipt whose exchange rate rises over time, which is how interest is expressed. Borrowing is always limited to less than the value of your collateral, and if prices move against you, third parties can liquidate the position by buying the collateral at a discount. That incentive is what keeps the pools solvent.
In June 2020 Compound began distributing its governance token, COMP, to users. Because both suppliers and borrowers received it, activity surged, and the launch is generally credited with starting 'DeFi summer'. Protocol decisions have since been made by COMP holder votes. The newer Compound III accepts several collateral assets while restricting borrowing to a single asset per market.
Watch out for
- · Bugs and mis-set parameters have caused real losses, including a 2021 incident where a faulty upgrade distributed excess COMP
- · A sharp fall in collateral value triggers liquidation, and part of the collateral is sold at a discount
- · Displayed rates are not fixed; they change continuously as utilisation moves
Frequently asked questions
Is my principal guaranteed, like a bank deposit?
No. There is no deposit insurance. Contract bugs, bad debt or oracle failures can all mean funds are not returned. Earning interest and keeping your principal are separate questions.