In 2020, decentralized finance (DeFi) has taken the crypto market by surprise by introducing alternative ways to save, borrow, and trade funds.
In other terms, DeFi made financial solutions more democratic, decentralized, and accessible for anyone with a working internet connection.
What Is Compound Finance?
Created by Robert Leshner and Geoffrey Hayes, Compound Finance is a DeFi lending protocol that has been in development since 2018.
After Compound v2 went live in May 2019, it quickly became a top decentralized finance application after the DeFi boom in 2020.
According to DeFi Pulse, Compound ranks as the 5th top decentralized finance protocol on Ethereum with a total value locked (TVL) of nearly $11 billion.
Unlike banks where you have to go through a tedious process to apply for a loan, borrowers can instantly access extra capital in stablecoins and other cryptocurrencies on Compound without any credit checks.
On the other hand, lenders can generate a much better passive income than traditional savings products by lending out their coins to borrowers on the platform.
How Does Crypto Lending and Borrowing Work on Compound?
As part of a non-custodial solution, users can borrow funds on Compound by depositing cryptocurrency into a smart contract, which they have to lock up as collateral.
Like most DeFi protocols, Compound utilizes overcollateralized loans, which means you can borrow less funds than your collateral (e.g., you can get $70 USDC after your $100 BTC).
While this allows borrowers to access extra capital without liquidating their digital asset holdings, lenders are protected against non-paying borrowers and defaults.
Interestingly, Compound tokenizes the assets in the form of cTokens, which are ERC-20 coins representing the cryptocurrency holdings you have locked in the protocol along with the interest you have earned on them.
Based on the dynamic interest rates on the platform, users accumulate funds with cTokens over time. And, if lenders want to take profit, they have to redeem their cTokens and withdraw their coins from Compound.
In the opposite case, borrowers have to deposit coins to the platform and lock them up in a smart contract to access extra capital. Upon repaying the principal amount along with interest, the contract will release their collateral, which they are free to use after.
Alternatively, users can move their cTokens to other DeFi protocols to maximize their gains or generate extra revenue.
What Is COMP?
COMP is the native ERC-20 token of the Compound protocol that features a maximum supply of 10 million coins.
In addition to allowing holders to participate in community governance decisions, COMP’s primary utility is to incentivize lenders and borrowers to utilize the protocol by distributing daily rewards based on their activity.
Compound: Disrupting How Lending Works in Finance
As one of the first DeFi lending protocols, Compound Finance introduced a new way for users to save and borrow money without the oversight or permission of banks.
And, by utilizing cTokens to represent locked funds on the protocol, Compound offers the ability for users to combine the benefits of multiple DeFi apps by moving the assets back and forth between numerous decentralized finance solutions.