What is Compound (COMP)? Beginner’s Guide
Compound is a software running on Ethereum that aims to incentivize a distributed network of computers to operate a traditional money market.
One of an emerging number of decentralized finance (DeFi) protocols, Compound uses multiple crypto assets to provide this service, enabling the lending and borrowing required without a financial intermediary like a bank.
Put simply, Compound allows users to deposit cryptocurrency into lending pools for access by borrowers. Lenders then earn interest on the assets they deposit. Once a deposit is made, Compound awards a new cryptocurrency called a cToken (which represents the deposit) to the lender. Examples of cTokens include cETH, cBAT and cDAI.
Each cToken can be transferred or traded without restriction, but it is only redeemable for the cryptocurrency initially locked in the protocol. This entire process is automatic and handled by the Compound code, meaning lenders can withdraw deposits at any time. To incentivize this activity, Compound uses another cryptocurrency native to its service, called COMP. Every time a user interacts with a Compound market (by borrowing, withdrawing or repaying the asset), they are rewarded with additional COMP tokens.
While complex, the model has so far proved adept at attracting users and encouraging other DeFi cryptocurrencies to adopt its model. As of 2020, over $500 million in assets were locked in the Compound protocol, according to the data site DeFi Pulse.
How does Compound work?
Compound connects lenders and borrowers using a combination of smart contracts running on Ethereum and incentives paid in cryptocurrency.
The two main users of the platform include:
Anyone wishing to lend a cryptocurrency on Compound can send their tokens to an Ethereum address controlled by Compound to earn interest.
Anyone who posts collateral on Compound in the form of a cryptocurrency. They are allowed to borrow cryptocurrencies supported by Compound at a percentage of the posted value.
Compound rewards lenders with COMP tokens based on the amount of cTokens held in their wallet based on a varying interest rate dependent on the available supply of that asset. The more liquidity in a market, the lower the interest rate. Users who lend assets to the protocol, can take out a loan in any other cryptocurrency that Compound offers, up to the amount of collateral posted. Importantly, borrowers can get liquidated if the asset they borrow increases in value and becomes more valuable than the posted collateral.
Why use COMP?
Compound may be of interest to anyone who wants to earn additional income by lending or borrowing cryptocurrency.
Further, users have a built-in incentive to hold the token, as anyone who owns COMP can make decisions on the future platform. This includes being able to vote on Compound’s interest rates and other important choices that may impact their revenues or profitability.
Investors may further find COMP of interest should they want to gain exposure to emerging DeFi coins that offer exposure to the protocol’s cash flow.
Why does COMP have value?
To distribute its operations, Compound is programmed to reward users with COMP tokens. Anyone who owns COMP tokens can participate in decisions affecting the software, voting on proposals for the rules that govern the platform’s use.A COMP holder can also assign their voting rights to someone else to vote on their behalf. This means that someone who is not a COMP holder — like a legal expert — could be asked to vote on behalf of COMP holders when a particular issue arises.
Of note for investors is that new COMP tokens are issued by the network each day. As of 2020, some 2,880 COMP tokens are given out daily to lenders and borrowers, meaning anyone who uses Compound can earn COMP tokens, proportional to the amount lent to the protocol.
Who created COMP?
Compound was founded by serial entrepreneurs Robert Leshner and Geoffrey Hayes, whose previous firm, Britches, aggregated inventory from local shops to be sold on PostMates.
In 2018 Compound raised $8.2 million in funding from notable venture capital firms Andreessen Horowitz and Bain Capital Ventures, the venture-capital arm of the consulting firm Bain.
Compound raised an additional $25 million in 2019 from many of the same investors, along with new participants like Paradigm Capital, a fund started by a co-founder of Coinbase.
A share of the total supply of COMP cryptocurrency was initially distributed to investors in the company and to employees.