Table of Contents

πŸ€” What is Compound Finance?

Compound finance is a decentralized bank that connects cryptocurrency borrowers and lenders.

Users can:

  • Deposit their cryptocurrency to earn interest.
  • They can also lock their cryptocurrencies as collateral and take out loans in a different cryptocurrency.

πŸ’‘ What role does COMP token play ?

COMP token is the governance token for Compound finance. COMP holders propose and vote on future updates to Compound finance protocol.

πŸ“ Origin of Compound Finance

  • Compound finance white paper was released in Feb 2019.
  • The team launched COMP token and decentralized the governance of Compound finance in June 2020.

πŸ‘΄πŸ» Founders

Robert leshner

  • Robert is from Pipersville, Pennsylvania.
  • He attended the University of Pennsylvania and graduated with an Economics Degree.
  • Robert co-founded Safe Shepard(a service that focuses on the removal of personal information from companies that sell it by scanning both the internet and private databases) in 2011.
  • He co-founded Compound Finance in August 2017.

Geofrey Hayes

  • He earned Bachelor of Science degree in Computer science from the University of Pennsylvania in 2008.
  • He worked as a software engineer at Applied Predictive Technologies after graduating.
  • He co-founded Safe Shepherd along with Robert Leshner in 2011.
  • He also co-founded Compound Finance with Robert Leshner in August 2017.

😌 What problems does Compound Finance solve ?

  • Take out loan:
    • None of the traditional banks issue loans against crypto.
    • Compound Finance allows users to take out loan against their crypto holdings.
    • Users do not have to sell their crypto holdings and incur capital gain tax. Instead, they can use it as collateral to borrow.
  • Flexible payment solutions:
    • No fixed payment schedules
    • No min payments
    • No credit history
    • Users pay at their own pace.
  • Most banks in the world offer no interest on savings. People can choose to store their savings on Compound Finance and earn a much higher interest.
  • Traditional banks have to build relationships over many years to partner with other institutions whereas other Defi apps can build permissionless on top of Compound to access its liquidity and interest rates on savings.
  • There is no transparency in how banks operate. Most banks take excessive risks because governments insure deposits. Whereas Compound finance code is open-source.
  • Central banks set arbitrarily low-interest rates that result in capital misallocation. Whereas interest rates on Compound Finance are a pure function of supply and demand of underlying assets.
  • No complicated paperwork like KYC and long waiting period is involved to take loan from Compound Finance.

πŸ€–How does it work ?

How the process works ?

Compound Finance is built on Etherium. It works as follows:

  • Users deposit their cryptocurrencies on Compound finance.
  • Their crypto assets start earning interest.
  • The user can then decide to stake their crypto asset as collateral and take out loan in another crypto asset as per the borrowing interest rate.

c Tokens

c Tokens are token representations of crypto deposited by user to Compound Finance. For example, a user receives cETH when he deposits ETH to Compound.

1 cETH is not equal 1 ETH. The exchange rate of c Tokens increases in accordance with the interest rate of underlying asset.

Over time, each cToken becomes convertible into an increasing amount of its underlying asset, even while the number of cTokens in user’s wallet stays the same.

The user can transfer the cToken out of Compound and use it anywhere on the crypto ecosystem. However, the user has to deposit the cToken back to Compound to redeem the underlying asset.

How intrest rate is calculated ?

All the crypto assets have different lending and borrowing interest rate, which updates in real-time. The interest rate of a crypto asset is based on its current supply and demand.

Liquidation

All the loans on Compound must always be fully collateralized at all times.

Hence users can only take out loan that is less than their collateral. The user’s collateral is liquidated in case the value of their collateral falls below a certain threshold. In addition, the users also have to pay a liquidation penalty.

Collateral thresholds of cryptocurrencies are decided based on their volatility.

βš™οΈ How to use Compound Finance platform

πŸ›οΈ Governance model

The team decentralized the governance of Compound protocol in June 2020. COMP holders propose and vote on updates to the protocol.

Following steps are involved in updating the protocol:

  • Addresses delegated at least 65,000 COMP can create governance proposals; any address can lock 100 COMP to create an autonomous proposal, which becomes a governance proposal after being delegated 65,000 COMP.
  • Governance proposal enters a 2 day review period, after which voting begins.
  • Voting lasts for 3 days; if a majority and at least 400,000 votes are cast for the proposal, it is queued in the timelock and implemented 2 days later.

πŸ€‘ How much money does the project have for future development ?

  • The project has raised $33.2 million to date.
  • The project has 775,000Β  COMP tokens in reserve to fund future development.
  • The project does not have any profit model to generate revenue.

πŸ‘ Tailwinds

  • Many apps are using Compound to access liquidity and offer saving interest rates.
  • Most of the banks offer no real interest on savings. As a result, most people are searching for ways to earn a safe yield on their savings.

History of hacks

  • The Compound protocol accidentally gave out $ 90 million worth of COMP tokens to users because of a bug in an upgrade in 2021.

😨 Risks and challenges

  • Market crash:
    • The value of crypto held as collateral crashes.
    • The protocol becomes under collateralized.
    • The protocol is unable to liquidate and users cannot add more collateral/payback loan because of congestion on the Etherium network.
  • Compound protocol depends on external price feeds to maintain collateral ratio and liquidate CDPs. It is possible that a hacker manipulates the price feed and benefits from an arbitrage opportunity.
  • Compound Finance is built on Etherium. This exposes the protocol to risks and issues outside its control:
    • Scaling issues
    • Gas fees, etc.
  • Banking sector is heavily regulated by the respective governments. Many governments will try to ban/regulate Defi for operating without a banking license and threatening their banking sector.
  • There are many lending and borrowing crypto platforms like Aave, Maker DAO etc.
  • Compound protocol has sufficient funds, however, they do not have any ongoing source of revenue. Compound is a long-term project whose growth can be affected by lack of funds.

πŸ’° Tokenomics

COMP token have a fixed max supply of 10 million tokens. They have been distributed as follows:

  • 2,396,307 COMP has been distributed to shareholders of Compound Labs, Inc.
  • 2,226,037 COMP are allocated to founders & team(subject to 4-year vesting).
  • 372,707 COMP are allocated to future team members.
  • 4,229,949 COMP are reserved for users of the protocol(every day 2880 COMP tokens are being distributed to users).
  • 775,000 COMP are reserved for the community.

Compound is incentivizing new users to join the network and distributing COMP tokens to the right people(actual users) at the same time.

Vesting schedule

Token Inflation

The token inflation will fall down to zero in 2025 when the complete max COMP supply will come into circulation.

Demand pressure

Token’s price increases due to demand pressure.

Demand pressure on COMP token will come from:

  • Governance: Users will buy COMP tokens to participate in governance.
  • Speculators:Β They will buy COMP tokens to profit from future price appreciation.

Market opportunity

Compound Finance aims to replace a multi-trillion-dollar banking industry. COMP token, used to govern such a system would be worth a lot.

🧐 Indicators to watch out for

  • Their Twitter following is growing:
  • Total value locked in Compound is growing:
  • Number of users is growing:

πŸ‘‹Final remarks

Protocols like Compound Finance are going to destroy traditional banking sector:

  • Which cannot give any real interest on savings.
  • Which is tightly regulated by governments and central banks.

The team has a working product all that remains is to add new assets and onboard new users.

😊 Do further research