What is auto-compounding?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 4 min
In short
Auto-compounding automatically reinvests the rewards a position earns, folding them back into the principal. It saves the gas and effort of doing it by hand, but compounding only works while rewards are actually being earned, and it does nothing to reduce the risk of losing principal.
Key points
- Rewards are reinvested automatically into the principal
- Fewer transactions than doing it manually, so lower cost
- If rewards stop, the compounding stops with them
- It does not reduce the risk to the principal
Definition
A mechanism that automatically harvests rewards, converts them and adds them back to the principal. Its real effect depends on how often it reinvests and what each reinvestment costs.
Doing it manually means claiming the reward, swapping it if necessary, and redepositing — a chain of transactions. On an expensive network, small rewards can cost more to reinvest than they are worth. An auto-compounder batches many users into one execution so they share that cost.
How often it runs is a design decision. Compounding frequently means more compounding events but more transaction costs; compounding rarely costs less but leaves rewards exposed to the reward token's price swings for longer. Which is better shifts with gas prices and the size of the rewards, so there is no single right answer.
The word 'compounding' misleadingly suggests safety. It only accumulates while rewards keep being distributed, and it stops dead when an emission programme ends. And if the principal sits in a liquidity pool, losses from a drifting price ratio accrue regardless of compounding. Rewards can pile up while the principal shrinks by more.
Watch out for
- · If a reward programme ends or is cut, the premise of the compounding disappears
- · Each reinvestment sells the reward token, so its price swings and thin liquidity feed into the result
- · If the underlying contract is exploited, the accumulated balance goes with the principal