Compound Finance is an Ethereum-based algorithmic financial market protocol that has made borrowing and lending in decentralized finance easier than ever. Anyone may contribute securities to Compound’s liquidity reserve and start earning interest right away.
Read on to learn everything you need to know about Compound Finance and how to trade, borrow crypto assets against collateral, and earn interest using it.
Compound Finance is an Ethereum based, decentralized lending protocol that allows users to borrow, deposit cryptocurrencies and earn interest by locking up their assets in smart contracts. Compound has been a vital actor in modernizing the old finance system through smart contract technology, one of the most user-friendly, secure, and open DeFi technologies available.
Compound Finance is a permissionless protocol; anyone with an internet connection and a crypto wallet like the CoinStats Wallet or a Web 3.0 wallet, such as Metamask, can freely connect and earn interest on Compound.
Compound lets anyone obtain an instant cryptocurrency loan with nothing but the borrower’s cryptocurrency assets as collateral. Getting a traditional financial loan is a complicated process, which involves KYC and employment, credit checks. Jumping through these hoops is cumbersome and expensive, with interest rates generally high. DeFi loans are straightforward and don’t involve any intermediary.
The Compound protocol acts as a lending platform/lending pool that connects lenders with borrowers using a combination of powerful smart contracts on the Ethereum blockchain.
These are users who borrow funds from the supply market. Borrowers can also deposit their supported cryptocurrency assets, then borrow more cryptocurrency, BTC and stablecoins, against their value. By depositing cryptocurrency and borrowing against it, a user maintains his existing position while squeezing more value out of them. Users can use their crypto loans to buy other cryptocurrencies or farm yield in other DeFi platforms. When a user deposits cryptocurrency as loan collateral into the Compound protocol, he becomes a lender; i.e., he earns annual percentage yield earnings that work to offset his loan’s interest rates.
These users lend their funds to the Compound protocol to earn interest. Depositing your cryptocurrency into the Compound protocol is better than holding it in a crypto wallet that doesn’t generate interest, even if you don’t intend to take out a crypto loan. When cryptocurrencies are deposited into the Compound platform, they automatically begin accruing annual percentage yield interest, paid in COMP tokens and the deposited asset. In so doing, rather than sitting idle in your wallet, your crypto assets earn you passive income.
Among Compound Finance’s advantages is that borrowers and lenders don’t have to negotiate the terms; instead, both parties interact directly with the protocol, which handles the interest rates and collateral. Smart contracts replace intermediaries in holding the assets. The interest rates for borrowing and lending on Compound Finance are adjusted algorithmically based on demand and supply. Additionally, COMP token holders have power over interest rates adjustments.
Compound Finance Token COMP
Compound Finance is powered by COMP, an ERC-20 token. Compound rewards lenders with its COMP tokens based on the amount of cTokens held in their wallets and a pre-determined rate. The more liquidity a particular token has, the lower the interest rate generated. Lenders can also take out a loan in any other cryptocurrency supported by the Compound protocol. The lending, borrowings, or repayments of debts on the platform are incentivized by rewarding users with the Compound tokens.
COMP is also a governance token, and each holder of the Compound (COMP) tokens has voting rights in proportion to their holdings. This empowers the users to participate in the decision-making processes of the platform.
COMP has a total supply of 10 million, of which 42.3% will be distributed to users letting them earn interest when they use Compound by borrowing or lending cryptocurrencies. For every Ethereum block, 0.5 $COMP is distributed across Compound’s nine markets in proportion to the accrued interest in the market. Within each of these markets, the amount of distributed COMP is divided equally between the lenders and borrowers of that particular cryptocurrency, which is why the interest rate constantly changes. Users can check Compound’s user distribution page to see the daily amount of interest paid and the COMP amount distributed to lenders and borrowers. They can also earn COMP by voting on various governance proposals.
Supported Cryptocurrencies and Their Blockchain Lending Interest Rate
Here are some of the cryptocurrencies Compound currently supports and their interest rates:
- Ether (ETH) – 0.17%
- Basic Attention Token (BAT) – 1.21%
- Dai (DAI) – 2.18%
- Ox Token (ZRX) – 0.84%
- Tether (USDT) – 1.58%
- Compound (COMP) – 0.99%
- Uniswap (UNI) – 0.38%
- Wrapped Bitcoin (WBTC) – 0.54%
- USD coin (USDC) – 1.63%
Additional tokens are likely to be added in the future.
Compound Finance Pros and Cons
- Higher interest rates compared to traditional banking
- No KYC or credit score is required to use the platform
- No constraints on multiple asset pool usage
- Increase in total value locked
- Access to DeFi Bitcoin
- Improved trading volume
- Secure and trusted
- Highly interoperable
- Competition with other DApps for market share
- Collateral liquidation due to cryptocurrency unpredictability
- Few cryptocurrencies to borrow or lend
- Yield farming can be extremely risky
- Technical errors due to the highly volatile algorithm-based smart contract system
- Questions raised about its decentralized status
Compound Crypto Loan
Getting a crypto loan on Compound Finance is a beginner-friendly process. Users only need to supply the Compound platform with crypto, enable it as collateral, then borrow against it. With Compound crypto loans, you essentially borrow from yourself; therefore, if you choose not to repay the loan or the value of your deposited asset drops to the point that your loan to value ratio is exceeded, the same outcome is met. Knowing this lets lenders have peace of mind.
Compound’s smart contracts are immutable, secure, and automatically respond to changes in crypto prices and market conditions.
To get a loan on Compound, you only need a few requirements:
- Supported crypto-assets, i.e., ETH, BTC, DAI
- Supported crypto wallet, i.e., Ledger, Metamask
- ETH to cover gas fees (transaction costs)
Follow our step-by-step guide to secure a crypto loan on Compound:
- Access the Compound app
- Connect your wallet
- Select the crypto you want to deposit, enter the amount, and click supply
- Sign two transactions – one to enable Compound to spend your crypto, the other to deposit it
- Choose the crypto you want to borrow, enter the amount, and click borrow
- Sign two transactions – one to interact with compound SC, the other confirms tx
After the second transaction is confirmed, the borrowed amount will show in your crypto wallet; that’s it!
How to Borrow on Compound
You are also required to pay fees when borrowing cryptocurrencies on Compound.
Users have first to deposit funds or collateral to cover their loan. In return, they earn “borrowing power”; this is required to borrow on Compound.
Users borrow according to how much borrowing power they have, and every asset available for supply adds a different amount of borrowing power.
The Compound platform works with the concept of over-collateralization, similar to several other DeFi projects; this means that to avoid liquidation, borrowers have to supply more value than they wish.
How to Use Compound Finance
Follow the steps below to start using the Compound Finance platform:
Step #1: Connect Wallet
The platform currently supports three wallets: Metamask, Ledger, and Coinbase wallet. When you first visit your dashboard, you’ll be asked to connect your Ethereum wallet, which must contain at least 0.05 ETH required to make Ethereum transactions. The dashboard is roughly divided into three parts:
- Supply Market – Left-hand side
- Borrow Market – Right-hand side
- Lending/Borrowing summary information – Top part
Also check our “How to Buy Compound” article.
Step #2: Enable Collateral
You need to click on the desired collateral to enable it.
Step #3: Supply Collateral
First, click on the asset you want to supply. A pop-up will appear displaying the supply APY (amount of token per year) and the distribution APY (amount of COMP per year) you’ll earn by supplying it. Type the quantity you want to supply on top of the pop-up, click supply, and submit the transaction.
Step #4: Borrow
You can borrow assets directly from the protocol and check the annual borrow rate associated with the token. Select the token you’re interested in borrowing, enter the amount you want to take out as a loan on the right side of the pane, and approve the transaction. The borrow, as well as the supply balance, can be seen on the dashboard. The same amount of tokens will appear in your wallet. You can either lend or borrow and lend simultaneously, but you can’t borrow alone because borrowing requires lending some collateral.
Step #5: Enable Repay
You first have to enable repaying to repay the borrowed token. To repay your borrowed token, click “repay” and approve the transaction; your borrowed balance will become zero on the dashboard.
Step #6: Withdraw
You can withdraw the collateral if you have repaid all your borrowed tokens. Your supply balance becomes zero on the dashboard after withdrawal, and the collateral amount will then be moved to your connected crypto wallet.
Step #7: Vote
To vote for proposals on the platform, you must click “get started” and set up the voting process. Two kinds of voting are supported on Compound:
- Manual voting: allows users to vote on proposals directly
- Delegate Voting: when users delegate their voting power to other users
Step #8: Market
You can also check the market overview of supported tokens.
Liquidation is triggered when the loan value becomes more than the collateral value. Your borrow limit is the maximum value of assets you can owe the protocol. It’s displayed on top of the dashboard as a meter, which tracks what portion of your borrow limit has been used. The protocol will partially liquidate your account if the meter reaches ≥100%; this occurs when the collateral value declines or the value of the borrowed asset increases. If your account is in liquidation, a fellow community member can repay up to 50% of your borrowed assets and, in return, receive a reward proportionate to the amount of your collateral at an 8.0% discount.
Remember to continuously monitor your borrow limit and the portion you’re using.
Compound Finance is a key player in revolutionizing the outdated finance system.
While it currently deals only with cryptocurrencies on the Ethereum Blockchain, it could strengthen its place in DeFi as one of the core money market protocols once its governance is fully decentralized.
When investing in the platform, remember that the crypto market is highly volatile, and there are serious risks associated with it.