Oanother great project in the world of decentralized finance (Decentralized Finance - DeFi), is Compound (COMP). This is a decentralized finance protocol that seeks to create a financing and loan ecosystem through credits to its users by applying interest on the assets they have within the system.
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The Compound protocol is currently capable of operating with Ether (ETH), 0x (ZRX), DAI (DAI), Basic Attention Token (BAT) and Augur (REP). The objective is to create investment pools that serve to give loans and that these make profitable both the platform and its liquidity providers, that is, the users who invest in the platform. And all this based on a series of powerful smart contracts or smart contracts on the Ethereum blockchain.
Yes, Compound is ultimately a lending platform where the COMP token is its governance currency and, alongside it, there are other internal tokens that allow it to function. But what does Compound really offer us? What is the objective of the platform? How do you make all this possible?
Compound, the origin
The history of Compound (COMP) takes us to San Francisco in 2017, at that time the company Compound Labs Inc. was founded, for Robert Leshner y Geoff Hayes. The company's goal was design a protocol that would allow the creation of financial exchange markets with interest rates based on their assets.
The idea was around and seeking support for a little over a year, attracting investors from companies such as Coinbase, Polychain Capital, Andreessen Horowitz, Bain Capital Ventures, Transmedia Capital, Abstract Ventures and Danhua Capital. That was how by 2018, Compound Labs Inc., managed to raise more than 8 million dollars and start its project.
Finally, the Compound protocol comes to light on September 26, 2018, and then begins its long evolution until today, where it has become one of the largest DeFi protocols in the crypto world.
Compound, a revolutionary protocol
Now, Compound (COMP) is a decentralized finance protocol (DeFi) whose purpose is; allow us to deposit and borrow cryptocurrencies, and at the same time earn interest while we do so.
An interesting idea, that although it was not new in the DeFi world, it attracts a lot of attention. However, Compound offered something that other alternatives did not, and this was what quickly made it a revolutionary protocol. This was Compound's ability to create liquid money markets for cryptocurrencies through the establishment of interest rates and the use of algorithms that adjust these values in real time and in a decentralized way. As a result, Compound is able to generate pools with a very wide liquidity, and offer its liquidity providers quite attractive interest rates.
Despite this, since its launch in September 2018, this protocol has hardly been used. It wasn't until June 2020 that the protocol garnered more attention and began its ascent to touch $ 912 million in locked value.
How does Compound work?
Compound's operation is similar to that of traditional banks, albeit with its nuances from the crypto world. First of all, you must make a cryptocurrency deposit in one of their pools. This will allow you to earn interest for that deposit.
As we told you, it is similar to what happens with a bank savings account, only in this case Compound offers much higher interest for your money. In addition, you do not need to go through an identification or KYC process, and they do not charge you exorbitant commissions. Additionally, Compound is a non-custodial protocol, so everything is handled by smart contracts and the Ethereum blockchain.
Now, what does Compound do with the money you inject into the platform? Where does the interest you receive come from? Well, Compound generates liquidity pools and money markets based on crypto assets, leaving your money in them. That is, it takes your money (for example, the DAI that you have deposited) and that of many others and places it in a smart contract.
That money is loaned to whoever wants to get credit with the interest that is there at that time, interest that will then be distributed to the liquidity providers.
The interest paid on the loan is what ultimately translates into the payment of interest for each person who has provided liquidity to the pool.
Put more simply, Compound takes your money (and that of the people who are within the protocol), makes loans to other people (loans with a 1: 1.5 ratio) and with the returns on those loans offers you profits for the money you invest.
The best of all? There is no type of time limit established for the cancellation or obtaining of a credit within the system, being entirely the responsibility of the commitment that each of the users has.
But what if the borrower does not pay it back?
These loans are made with a guarantee in between, a guarantee, which is usually more than what they lend you, usually 150% (for every $ 100 borrowed, you must put $ 150 as collateral). As we have said, to request a $ 100 loan, you must put $ 150 as collateral (collateral or endorsement). Once you return the $ 100 of the loan, and the interest, the $ 150 will be returned.
In turn, if the price of the token that you leave as collateral falls so much as to put the loan at risk, the contract is programmed to sell your cryptocurrencies, that is, the contract “liquidates” your position. This protects liquidity providers in case a person does not want to pay back the loan money.
What's the point of all this?
Surely you are thinking, What is the point of borrowing less than what you put as collateral? You must bear in mind that when in our example we mention values in dollars, we are talking about tokens worth that amount of dollars, not dollars properly.
That is, you can borrow Ether by putting collateral stablecoin DAI, wait for Ether to rise in price, return the Ether of the loan corresponding to $ 100 of DAI, and keep extra Ether. All this without also having sold and bought, only pawned, something that on the other hand has a different tax treatment than the purchase / sale.
cTokens, know the Compound tokens
One of the fundamental parts in the operation of Compound are the well-known cTokens. These are Tokens created by Compound to monitor and control the loans and interest generated within the platform. In a nutshell, cTokens are a unit of account within Compound.
For example, when a user injects funds into a group of loans, they are issued a corresponding balance in cTokens. This balance of cTokens is directly proportional to their participation in the loan group. Thus, each asset accepted by the platform has its pair in cToken. For example, DAI has its cDAI, and Ether has its cEther.
Additionally, these tokens work under the standard ERC-20 Therefore, they are tokens that we can store in our wallets and even exchange them without problems.
Now, what is its real function? To explain a little how it works, let's see an example:
Example of an investment in Compound
Daniel decided to invest 1000 DAI in Compound. These 1000 DAI will be transformed into 48477,3144168 cDAI, the reason is that the exchange rate between DAI and cDAI is currently: 0,02062820542. So we have to:
cDAI = DAI / Exchange rate
cDAI = 1000 DAI / 0,02062820542 = 48477,3144168
If months later, you decide it is time to withdraw your ICD from the protocol; but the exchange rate is now 0,022, then we will have the following:
DAI = cDAI * Exchange Rate
DAI = 48477,3144168 * 0,022 = 1066,50091717 DAI
It may seem like little profit, but the really positive in all this is: you will always make a profit. No matter how bad the cryptocurrency market goes, cTokens are built in such a way that Daniel always makes a profit for his creation, and all thanks to the interest earned.
Governance within Compound
Compound (COMP) started as a project with centralized control, where Compound Labs Inc., had absolute control over it. However, this began to change in May 2020, when Compound began its transition to community governance.
To achieve this, Compound created the COMP token. The token holders are those who have the power to make proposals and vote on decisions related to how the Compound will be developed or executed. In total, there can only be a total of 10 million COMP tokens, which are distributed as follows:
- 24% (2.396.307 COMP) for the shareholders of Compound Labs, Inc.
- 22.25% (2.226.037 COMP) for the founders.
- 3.72% (372.707 COMP) for future team members.
- 42.3% (4.229.949 COMP) for use of the protocol reservation.
- 7.75% (775.000 COMP) protocol governance reserve.
These tokens are generated automatically at a rate set by the community. Thus, currently, the generation rate is $ 0,176 in COMP for each block generated in Ethereum. This issuance policy allows Compound to be able to be financially self-sustaining, especially to cover developer fees, security audits, development of new financing features, incentives for voters to participate, and incentivize protocol liquidity. In short, the issuance of the COMP token allows not only to give power and rewards to the community that makes life within the protocol, but also helps it to sustain and evolve over time.
Now, surely you have realized at this point that Compound is a DeFi protocol that falls into two categories. On the one hand, it is a protocol of yield farming (allows you to get a return investing money). And at the same time, it is a protocol of liquidity mining (Your economic participation generates profits in the form of tokens that are mined and distributed among the community). In fact, it was precisely the transition to this community governance model that catapulted Compound to become one of the largest DeFi protocols in the world, as we can see in the DeFi Pulse graph.