‍Introduction 

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Interest rates from traditional banks are lower than they’ve ever been. But if you’d like to earn more money than the banks will ever give you for depositing your crypto profits somewhere — Compound Finance could be the solution you’re looking for. 

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Let’s dive into it. 

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Compound is a DeFi protocol. Compound allows lenders to provide loans, and borrowers to take them out, by locking their respective crypto assets in the protocol

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Put simply, what Compound Finance does is match people who want to borrow money with people who want to supply money to earn interest. 

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Of course, it’s a little more complicated than that as the money we’re talking about here is Ethereum-based assets. 

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It is built on a system of smart contracts built on the Ethereum blockchain. Compound says they built their protocol with developer use in mind, so even more financial applications can be built using it. 

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Right now you can lend or borrow the following coins on the platform: USDC, DAI, ETH, WBTC, USDT, UNI, COMP, TUSD, ZRX, LINK, BAT, SAI, and REP. 

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Founders: 

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Robert Leshner founded Compound Finance in 2017. It was one of the first protocols of its kind to come along, and paved the way for what would eventually become DeFi. 

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Robert Lesher says he has always always been a “finance person”. He started his career in finance working in interest rate markets, and that’s where got a ton of experience about the math and science of traditional finance.

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Once he moved out to California and became a venture-backed software founder, he continued to observe crypto from the sidelines. He did some bitcoin mining as a hobby in 2013. 

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When Ethereum came out, the idea that you could program its smart contracts was most exciting to him. He decided he had to jump into the crypto space immediately at that point. 

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So in 2017, he started building what he thought was missing from the space -- and that’s what he already knew a lot about based on his previous experience: creating interest rate markets for crypto assets. 

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He said the idea of creating an entirely functioning financial market running on a blockchain sounded “crazy” at the time. When he started Compound Finance no one had any idea if it would even work. 

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But flash forward to today, and Compound now has over $8B worth of assets. 

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Robert Lesher holds the CEO position at Compound Labs, Inc, the software development firm behind the Compound protocol.  

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Compound Finance Overview

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Compound Finance is not the only DeFi lending platform out there. According to defipulse.com, Compound finance is the 6th biggest project in terms of USD value locked on the platform as of the time of this writing. 

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Over $8.29B worth of Ethereum-based stock is locked on Compound Finance.

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To put it another way, crypto holders have trusted Compound with over $8 billion dollars. 

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Aside from ETH and WBTC, USDC and DAI make up a large part of the lending action on Compound. The reason why is because by lending out DAI stablecoin on the platform you get double the interest rate of the next highest yielding Ethereum-based asset. 

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Interest is determined by supply and demand of the particular coin you’re lending out. Which can often be around 8% per year. 

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The simple way of looking at compound finance is that you’re depositing Ethereum-based assets like DAI, making interest like you would at a bank, and eventually withdrawing those assets. Your initial deposit plus interest. 

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COMP Tokens

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The native token COMP allows users to earn interest, transfer, and trade their money. 

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COMP tokens are created each time a user deposits their assets into Compound’s protocol. Those users automatically receive the COMP equivalent of the deposited currency as collateral when making a deposit. 

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Anyone can create COMP using an Ethereum wallet, and any of the crypto assets that Compound accepts. 

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These tokens automatically earn the user interest. And they can be redeemed for the corresponding cryptocurrency at any time. 

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The interest rates are determined by supply and demand, changing with each block that gets mined. 

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Other than earning interest on your crypto assets, Compound allows you to borrow crypto with no need for a credit check or background check: All you have to do is provide collateral. 

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Your collateral  has to stay above a minimum amount when borrowing these assets, or else Compound will liquidate your collateral to repay the loan. 

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Once loans get paid back, the locked assets are allowed to be withdrawn at any time. 

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When a user’s crypto assets get converted into an ERC20 compatible form, they are freely tradable and movable. 

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They also become available for use in other decentralized applications. This allows the ability to combine different protocols and building blocks. 

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Compound focuses on giving users more control and better access to their crypto assets while they earn and save. 

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They aim to be completely decentralized over time, and transfer authority of the protocol to the decentralized autonomous organization, which is governed by the community. 

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Understanding C-Tokens: 

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Anyone who’s using a platform like Compound Finance should understand what C-Tokens are, to understand what’s happening behind the scenes. 

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Crypto was created to be about self-responsibility, self-reliance, and freedom. A massive part of achieving this is for regular people like you and I to have a solid understanding of what’s happening behind the scenes of these platforms, and know what’s happening to our money. That’s how you avoid running into crypto blindfolded and being steered by hype, potentially getting wrecked. 

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To get a basic understanding, here’s what C Tokens are:

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Let’s say you have a certain amount of DAI Stablecoins you want to lend out using Compound Finance so you can earn interest. 

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When you lend out your DAI to compound finance, a new coin called cDAI will come back into your wallet. cDai is the “C-Token” version of DAI. 

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So why does this happen? You lend out 17 DAI on compound finance, and Compound finance sends you back 850 cDai. This might seem like a random amount of tokens. What’s the purpose? 

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First off, the cDai acts as a “redemption token” you can use to redeem your Dai once you want to access it. You can think about these like the old-school US silver certificates: 

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If you look at a dollar bill from the 1800s, it had printed on the bill: “This certifies that there is on deposit in the Treasury of the United States of America one dollar in SILVER [or gold], payable to the bearer on demand.” 

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So before our fiat monetary system, the US dollar along with almost every other currency was merely a promise to pay the bearer of the note REAL money — meaning gold or silver. 

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Holders of a 1 dollar silver certificate could literally walk into their bank and exchange the $1 bill for a dollar’s worth of gold or silver. 

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The same is true for cDAI. A cDAI token can be redeemed for actual DAI stablecoins. 

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With any Ethereum-based asset on compound finance, the same logic holds true. There is cETH, cWBTC, cUSDC, and so on. 

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And the currency exchange rates change to account for the interest you’re accruing. 

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So for example, at the time you deposited DAI, you'll get the equivalent in cDAI according to the exchange rate. But the longer you hold cDAI without turning it back in for DAI, the more DAI you’ll be able to trade back for your cDAI. 

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This is how you accrue interest on your deposits with Compound Finance. 

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You can find the currency exchange rate of these cTokens on the Compound Finance Website. The cToken is always going up in value in comparison to the token you deposited to account for the interest accrued. 

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Is this sustainable? How can they pull the cToken rates right out of thin air? 

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cTokens are designed to increase slightly after every Ethereum block generated. This is how interest is generated on the platform. 

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The number of cDAI tokens you will have will always remain the same. But you’ll be able to cash them out at a higher and higher rate as time goes on, as a reward for keeping your DAI inside the Compound protocol. 

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Those are the basic mechanics of Compound Finance and how it works. 

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It’s also super important for anyone using Compound Finance to note that cDAI tokens in your Ethereum wallet are redemption tokens and represent your claim of DAI on Compound Finance. 

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You can even trade them with someone else, and that person can redeem them for the DAI you deposited plus interest at a later date. 

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Borrowing

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Anyone can borrow crypto from the pool, too. You can actually be both a lender and a borrower so that you’re paying interest as well as receiving interest at the same time. 

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As stated above, you don’t have to have a credit check, there’s no bureaucracy, and there’s no red tape. It’s a very simple streamlined process that again, is decentralized. It’s run by the people. 

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All you have to do is post collateral in the form of a crypto coin the Compound Finance platform accepts. And your loan must be over-collateralized in order for everything to work. So you need to post up more than you are borrowing. 

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Compound does this using “posted collateral factors”. For example, if you supply 100 DAI as collateral, and the posted collateral factor for DAI is 75%, then you can borrow at the very most 75 DAI worth of other assets at any given time. 

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Your supplied collateral assets can earn interest too while in the protocol, but you cannot redeem or transfer assets while they are being used as collateral. 

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Risks

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There are risks you’re going to have to take on if you choose to participate in Compound Finance. 

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The first risk is liquidity. If there is not enough liquidity in the pool after you deposit, there is no guarantee you’re going to be able to withdraw your crypto whenever you want it. 

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So you need to make sure that if you are participating in any kind of yield finding, the liquidity of the pool is significant enough that you feel confident you’ll get your crypto back — plus interest — if you were to put some into the protocol. 

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Clearly this is not an FDIC insured account. There is no government backing your crypto. There is the potential that if something happens where there is a full loss, there’s no guarantee that when you want to get your crypto back there will always be enough crypto in the protocol for you to do so. 

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But that’s why overcollateralization is necessary. It doesn’t look like this problem will happen anytime soon with a total supply of $8.29B in assets, and $2.4B of that being borrowed as of this writing. 

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There have been numerous audits done on compound finance from some pretty reputable institutions like OpenZeppelin and Trail of Bits that have certified Compound Finance does have enough liquidity to meet their current needs. 

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Again, if a huge surge of people withdrawing their crypto were to happen, there is a risk factor there. But for now it seems like they’re in an excellent spot with liquidity. 

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COMP Coin Governance

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The COMP token is a governance token for the Compound Finance platform. What that means is that as a COMP token holder you get to share the profits of the platform, and also make decisions about the future of the platform. 

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COMP first entered the market in 2018 and lives on the Ethereum blockchain.. 

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In May 2018 they raised about 8.2M dollars in their first ICO, then in November of 2019 they had their series A funding round, where they raised another 25M dollars. 

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They also raised another million dollars from Coinbase. 

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This coin enables users to earn interest, transfer, and trade their money. 

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When you’re lending and borrowing using Compound Finance, you also earn COMP tokens. 

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Every day 2,880 COMP tokens are distributed to lenders, suppliers, and borrowers. This is done proportionally to however much interest is being paid. With the majority being paid to whoever is being paid the most interest. 

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COMP tokens can be withdrawn or exchanged on the likes of Uniswap. 

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COMP token holders can also vote on proposals for the Compound protocol. 

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COMP tokens are tradable tokens and hold their own value, so users may desire to earn as many as possible. 

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Tokenomics

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Like many digital assets, only a fixed number of COMP tokens will ever come into existence. The total supply is capped at 10 million COMP and as of this writing, less than a third are in circulation (about 3.3 million). 

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Out of the 10 million COMP tokens that will ever exist, just over 4.2 million of those will be distributed to Compound Finance users over a 4-year period. 

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The second biggest allotment (almost 2.4 million COMP) goes to the Compound Labs, Inc shareholders. And 2.2 million tokens will be distributed to the Compound founders and current team with a four year vesting schedule. 

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Lastly, 775,000 COMP are reserved for community governance incentives and the remaining 332,000 tokens will be allocated to future team members. 

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The exact rate of COMP production and distribution is subject to change over time, as voters are able to increase or reduce the emission rate by passing a proposal through community governance. 

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At the time of this writing there’s a current circulating supply of 6.728 million COMP, which is 67% of the total supply of coins. And the current market cap is $704,357,091. 

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Conclusion

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Compound Finance is offering new ways to use crypto in the DeFi space. Interest rates are only one of them. 

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The volume of lending and borrowing taking place on the platform is a testament to how much users trust it. And the straightforward interfaces might also play a role in the usability of the platform. 

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Compound Finance’s integration with the Coinbase wallet also helps with its user-friendliness. 

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Of course, traditional finance won’t be disrupted overnight. 

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Could DeFi Protocols Lead To More Crypto Adoption?

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Over the past few decades, traditional banks have massively scaled back all rewards to their customers for depositing with them. It’s almost the opposite: they punish their users with overdraft fees, ATM fees, fees to put money in, fees to take money out… and there are better incentives than that 0.01% API they give their customers. 

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That doesn’t mean the traditional bankers aren’t making money from you banking with them — they make anywhere from roughly 20% - 40% profit on the money you deposit with them. They’re just choosing not to reward you for letting them make money off of your money. They typically pass it on to their shareholders. 

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But now, you can go to Compound Finance and get four times that interest rate without committing to some of the terms traditional banks demand, like having your money locked up and inaccessible. 

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There are probably hundreds of millions of people around the world sitting on cash deposits in banks earning 0.01% interest. 

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And since traditional banks are basically saying, “Thanks for depositing with us, go buy yourself a gum ball” — pretty much every stock market in the world was near all-time highs in 2021. 

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It’s no secret people have trouble getting yield on their savings. Especially when they hold inflationary currencies made by central banks that lose value year-after-year. 

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Bloomberg estimates over 85 Trillion dollars worth of value is locked up in global stock markets. We’ve got to ask ourselves: does the typical stock investor think the risk to reward ratio is still good for stocks? 

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Or would they prefer the idea of getting an 8% return on DeFi via decentralized lending platforms better? And on top of that, with a cryptocurrency that is far less likely to become inflationary and lose purchasing power over time? 

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You can be your own judge about whether DeFi is offering a better solution than traditional finance. All we can say is, projects like Compound Finance offer much higher interest rates than any traditional bank you can find. 

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SOURCES

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https://www.youtube.com/watch?v=_5U-o7zQ5K0

https://defipulse.com/compound

https://www.youtube.com/watch?v=FUhlxX0pYQo

https://compound.finance/docs

https://www.crunchbase.com/person/robert-leshner

https://youtu.be/R7pFVzOvUiw

https://etherscan.io/address/0x3fda67f7583380e67ef93072294a7fac882fd7e7

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