What is Compound?
Compound Finance is a decentralized landing protocol in which interest rates are formed algorithmically based on the ratio of supply and demand. It can be thought of as an open money market where users place crypto assets as well as borrow funds.
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Who created Compound Finance?
The creator of the Compound Finance protocol and CEO of Compound Labs is a web developer and financial markets analyst Robert Leshner.
The co-founder and CTO of Compound Labs is programmer Jeff Hayes.
How did Compound Finance come about and evolve?
Graduates of the University of Pennsylvania Leschner and Hayes collaborated for several years on various projects (Britches, Postmates and others). In 2013, Leschner, who worked as a certified auditor, investment portfolio manager and banker, became interested in cryptocurrencies.
On August 28, 2017, Leschner and Hayes registered Compound Labs, Inc., headquartered in San Francisco.
On January 31, 2018, Leschner published an article on the development of the Compound protocol.
On May 7, 2018, the company attracted seed investments of $ 8.2 million The round involved Bain Capital Ventures, Andreessen Horowitz, Polychain Capital, Transmedia Capital, Compound Ventures, Abstract Ventures, Danhua Capital and Coinbase Ventures.
In September 2018, Compound Labs introduced the first version of the protocol, allowing you to borrow five crypto assets – ETH, TUSD, ZRX, BAT and REP.
In February 2019, a white paper of the project was published. On May 23, 2019, Compound Labs released the second version of the protocol with the release of cTokentokens representing the rights to the underlying assets of the money markets in Compound Finance.
In November 2019, Compound Labs raised $25 million in a Series A funding round led by Andreessen Horowitz. Also participating in the round were Bain Capital Ventures, Polychain Capital and Paradigm.
Even in the early stages, Robert Leshner announced his intention to gradually decentralize the protocol, depriving compound Labs developers of administrative privileges in favor of the community.
In February 2020, Compound Labs issued COMPmanagement tokens designed to encourage community participation in the project.
On April 16, 2020, management issues on Compound were transferred from administrators to holders of COMP tokens, who were able to change the list of supported coins, influence risk parameters, interest rate curves, etc.
How does Compound work?
Compound works similarly to a bank: the user deposits various cryptocurrencies and receives interest income. However, unlike the bank, Compound does not store deposits: funds are placed in smart contracts, with which the user interacts directly.
Lenders and borrowers do not need to negotiate terms. The parties interact directly within the framework of the protocol that controls the size of the interest rate and collateral. There are no counterparties withholding funds.
Access to the platform can be obtained by any owner of a Web3 wallet like MetaMask.
After confirming the request to interact with the Web3 Wallet, the user has access to a dashboard that displays the supported assets. To deposit or borrow an asset, you need to click on the page of this asset and unblock it.
After unlocking an asset that involves allowing the smart contract to interact with funds, the user can lend it at a predetermined annual interest rate (APR). Each asset has an individual annual percentage return(APY).
To borrow an asset, the user must first place funds on the platform and receive the so-called borrowing power. This metric represents the amount that can be borrowed. It increases with the increase in collateral provided.
This is what the balance of the user depositing the funds looks like after the transaction is processed:
After placing assets on the platform, so-called c-tokens appear in the user’s wallet – in this case, Compound Dai (cDai).
To withdraw the placed assets with accumulated interest income, you need to click on the Withdraw button.
The function of obtaining a loan on the platform
The process of obtaining a loan is as simple as the deposit process. Provided that the user has already obtained the right to borrow, he can borrow assets using the appropriate panel.
Compound must obtain permission from the Web3 wallet to interact with smart contracts. The resolution is obtained once. This will require an on-chain transaction involving the payment of a commission on the Ethereum network.
By selecting a supported asset on the right side of the panel, the user can assign the amount they wish to borrow. The Safe Max value represents the maximum amount of borrowed funds with a low risk of liquidation when the price of the underlying asset decreases.
After the transaction is initiated, the asset received on credit (in this example, ETH) is deposited in the Web3 wallet.
Interest on the loan is accumulated in accordance with the preset interest rate. The debt can be paid at any time by clicking the Repay button.
How does the system of two types of Compound tokens work?
cToken
Tokens represent the balances of users interacting with the Compound liquidity pool. The underlying asset presented by cToken allows you to receive interest income and serves as collateral.
These tokens are assets of the ERC-20 standard – they can be viewed in the Etherscan blockchain browser, stored in the wallet and sent to other users. Compound currently supports 14 crypto assets.
Example. The user places 1000 BAT in the liquidity pool, while the exchange rate is 0.02. In this scenario, the user receives 50,000 (1000/0.02) cBATs. If, after a few weeks, when the exchange rate becomes equal to 0.021, the user withdraws funds, 50,000 cBAT will be equal to 1050 BAT (50,000 * 0.021).
Features of cTokens:
- You can borrow up to 50-75% of the value of cTokens, depending on the market characteristics of the underlying asset. You can add or withdraw tokens at any time.
- If the collateral coverage of the user’s debt is not enough, the debt position may be liquidated.
- Liquidators receive 5% of the liquidated assets.
- cTokens are available for viewing in Etherscan.
How do I get cEther?
The method of obtaining cETH is different from that of cBAT or cDAI.
When a user deposits ETH, the app sends the tokens directly to the paid cEther contract creation feature. After activating the option, cEther appears in the wallet.
As a result, thanks to the request (invocation), the cToken contract withdraws the specified amount in the base tokens from the sender’s address.
COMP
Another asset in the Compound ecosystem is the native COMP management token.
Features of the COMP token:
- The total volume of the COMP offer is 10 million 55.71% of them are to be distributed among the project team members, founders, investors and partners. The remaining 42.29% will go to users within four years.
- The dynamics of coin accrual depends on the interest rates set by the market. For example, if USDT has the highest rates, then those who deposit and borrow in a stablecoin from Tether will be credited with more COMP tokens.
- In each asset market, the number of COMP tokens is divided equally between lenders and borrowers.
- Users can see the interest rate on the User Distributionpage.
- COMP holders can earn additional native COMP tokens by voting on system management issues.
- COMP tokens are available on many exchanges, including Coinbase and FTX.
How is the Compound interest rate formed?
- The size of the interest rate depends on the liquidityavailable in a particular market.
- The rate fluctuates depending on real-time supply and demand.
- When liquidity is high, the interest rate is small.
- When liquidity is low, the interest rate rises.
How is the interest rate calculated?
Each asset in the Compound markets has its own annual interest rate (APR) of lending and deposit, set on the basis of the ratio of supply and demand. Interest income is generated by mining a new Ethereum block, approximately every 15 seconds.
Excess liquidity can exist only if the number of assets placed on the platform exceeds the amount of borrowed funds. If the number of lenders in the market exceeds the number of borrowers, the interest income of lenders decreases. The utilization rate of an asset determines the level of income.
How is the secured loan rate calculated?
The user’s borrowing power directly correlates with the amount of collateral. Each asset has its own collateral factor, determined by its volatility.
For example, a Basic Attention Token (BAT) whose collateral factor is 50% has less borrowing power than the Dai stablecoin. The latter has a higher collateral factor of 75%, since it is a less risky asset. Thus, the placement of BAT tokens on the platform for $ 100 will give the right to borrow for $ 50, while the placement of DAI for $ 100 will give the right to borrow for $ 75.
When calculating the collateral loan rate, the collateral factors of all assets placed on the platform are taken into account. A base rate is set for the maximum amount of funds that can be borrowed in relation to the amount of assets deposited.
The collateral factor for each asset determines the management mechanism of Compound Finance.
How is the liquidation of assets carried out?
If the amount of debt exceeds the maximum borrowing right of the user, Compound exchanges the re-borrowed asset for the collateral provided by the borrower at a rate slightly below the market rate. Thus, the user is motivated to effectively manage debts.
Compound allows community members to act as liquidators using tools such as Compounder Liquidator. Participants can repay other users’ credits in exchange for ETH at the best market rate.
For example, a loan of 10 ETH, the collateral coverage of which is no longer lacking, can be repaid (re-mortgaged) by another user. This user receives the basic collateral of this loan at a discount of 5% or more (paid in ETH).
To prevent liquidation, Compound also provides an Account Service API for monitoring addresses at risk.
How does compound finance management work?
- The voting period for any proposal shall last three days.
- Any address with the right to vote can vote “for” or “against” a proposal.
- If the proposal receives at least 400,000 votes, it is queued and implemented two days later.
- If the required number of votes is not obtained, the proposal is rejected.
Examples of issues on which holders of COMP tokens vote:
- Support for the new cToken market.
- Change the interest rate model.
- Update the oracle address.
- Output of the cToken reserve.
- Select new administrators.
Compound uses the Timelock mechanism to update compound finance system risk parameters, such as the annual interest rate or collateral factor. It changes the parameters with a delay in time, guaranteeing protection: any attempts by intruders to interfere with the operation of the system can be tracked and prevented.
The website сompound.finance specifies:
“Any proposal to manage the system is published with a delay of at least two days. For suggestions for important updates, such as changing risk settings, the delay may be 14 days. Currently, Timelock manages an address whose administrators are members of the Compound team.”
Thus, now the risk parameters of the platform are controlled by the company, although with a delay in time. However, Compound, using smart contracts for control, can eventually open access to the Timelock distributed committee of community members. This will give Compound Finance the opportunity to become a Decentralized Autonomous Organization (DAO), similar to MakerDAO.
Why use Compound Finance?
- Interest income on the funds placed on the platform.
- Decentralized applications and exchanges can use Compound as a source of monetization in the Ethereum ecosystem
- Traders can borrow ETH from the liquidity pool and place these assets in their portfolios as collateral to participate in crowdsales.
- Traders interested in shorting a certain token can borrow it from the liquid pool and sell it.
How is Compound evolving?
In August 2020, Compound joined the Global DeFi Alliance, an international consortium of centralized and decentralized financial service providers and platforms formed by cryptocurrency exchange Huobi.
In August 2020, the project launched its own cryptocurrency price oracle as part of the transition to a price flow channel with free Access to the Open Price Feed.
The developers also created an aggregator of information about the declared prices. Data is available directly from each publisher through their API.
In September 2020, the MakerDAO community voted to add COMP tokens as a new option to enable the release of the DAI stablecoin.
Currently, Compound only works with ethereum ecosystem coins. In the future, it is planned to support tokenized versions of real-world assets: the US dollar, the Japanese yen and Google shares.
On December 17, 2020, Compound presented a white paper detailing Compound Chain, a new protocol designed to enable the interaction of assets from different blockchains.
Compound Chain was subsequently renamed Gateway. The Protocol TestNet was launched on March 1, 2021. The main network will be launched in the summer or near the end of 2021.
Gateway functions similarly to the Compound protocol on Ethereum. However, there are differences:
- Gateway allows you to borrow and lend assets on any blockchain.
- Interest is paid in dollars (stablecoins) through CASH, the gateway’s native unit of account.
- Gateway has a more effective risk assessment mechanism. It is based on the volatility of security and borrowed assets. This increases the capital efficiency of the use of less volatile coins.
Gateway is focused on cross-chain interaction, and its functionality resembles THORChain.
Gateway users can download supported assets from a variety of independent blockchains using a system of connected peer-to-peer chains. A Starport contract is associated with each chain. It allows you to block and unblock assets on the Gateway.
Once uploaded to the Gateway, users can deposit and borrow assets from various blockchains. For example, you can borrow Ethereum tokens using Solana as collateral, or borrow Celo assets using Polkadot assets, etc.
Gateway is designed to give blockchains the ability to interact directly, without wrapping (wrapping) tokens.
For example, to wrap bitcoins (WBTC), DeFi users are forced to turn to intermediaries in the face of BitGo or Ren. Because of this, they loosen control over their private keys. Gateway offers a solution that allows bitcoin holders to interact with other blockchains without resorting to the services of third parties.
Switching to Gateway will allow Compound users to avoid Ethereum’s high fees.
CASH is the gateway’s native unit of account. It is used to pay transaction fees. Similar to MakerDAO’s Dai stablecoin, this token is created through a loan. The amount of CASH in circulation is equal to the number of coins borrowed.
It is assumed that initially CASH will correspond to one US dollar. Subsequently, this setting can change the community by collective decision. Potentially, CASH can become a competitor to DAI and USDC.
All users and validators who own CASH tokens receive income, which increases based on the interest rate index. This happens whenever the user/validator generates, redeems, borrows, returns or liquidates CASH.
Gateway uses the Proof-of-Authority (PoA) algorithm. The network is managed by trusted validators. Consensus is achievable even if one-third of the nod breaks the rules. Block finalization occurs when at least two-thirds of the nods agree to add a block to the chain. Borrowers pay validators a percentage for each block they confirm. Also, validators receive a commission for sending assets.
The Proof-of-Authority model allows banks and centralized crypto exchanges to become Gateway validators.
Holders of COMP tokens will manage the Gateway within the Framework governance system on Ethereum.
At first, Gateway will be predominantly an interest income market based on interconnected blockchains. Over time, other dapps can be integrated with this system – for example, decentralized exchanges.
On June 28, 2021, Compound Treasury, a new company under the umbrella of Compound Labs, began operations. Compound Treasury allows neobanks and other fintech companies to convert US dollars into the USDC stablecoin. USDC tokens will be used in Compound at a guaranteed interest rate of 4%. This is much more than what companies can receive within traditional bank savings accounts(0.55% -0.7% per annum).
Links:
Official website: compound.finance
