Compound

What is Compound?

Compound is an algorithmic interest rate protocol run by Compound Labs, an open-source software development firm focused on tools, products and services for the decentralized finance space.

Compound was founded in 2017 by Robert Leshner and Jeff Hayes. They worked together with investors who had an interest in the project and helped launch it. Among them were Bain Capital Ventures and Andreessen Horowitz, as well as Coinbase and Polychain Capital. At the initial stages, Compound faced substantial criticism, mainly caused by its centralized authority. This eventually led to the founding company’s decision to transfer more control over the protocol to the community.

On May 27, 2019, co-founder of the company Leshner announced that decisions on protocol changes were transferred to the community. Soon, Compound’s in-house token, COMP, was launched, and by June 15, 2019, a token distribution model was approved by the community and put into effect.

Compound basics

Compound was developed as a decentralized, blockchain-based protocol based on the Ethereum network’s smart contracts and enabling users to lend and borrow a large number of virtual coins.

When a client deposits a coin to the platform, it is automatically swapped into the protocol’s ERC-20-standard tokens - Compound coins or cTokens. cTokens show the user’s balance in the deposited crypto. For instance, if a user deposits ETH, they receive cETH in exchange, etc.

It supports the borrowing and lending of a large number of cryptos, including Ether (ETH), Tether (USDT), USD Coin (USDC), Dai (DAI), Wrapped BTC (WBTC) and Basic Attention Token (BAT).

To some extent, depositing any of these tokens to the Compound protocol is similar to putting money in a savings account at a regular bank. However, the difference is that when a user sends cryptocurrencies to a Compound wallet, the coins are locked in a decentralized, blockchain-based protocol.

And, similarly to depositing cash to a bank, a user immediately begins earning interest on their coins, denominated in the same token that was deposited. For example, if a user deposits BAT, their interest is denominated in BAT, if they deposit DAI, the interest is in DAI, etc.

All coins lent by users are subsequently added to a pool of that same token, and other users can borrow from it - which is similar to a bank loan. And, just like with borrowing money from a traditional financial organization, users pay interest on the crypto they borrow.

Once a user has locked crypto in Compound, they can also borrow against their coins. Unlike regular banks, the Compound protocol doesn’t require any credit checks. As a result, any user based anywhere in the world can borrow from Compound’s crypto pools, using their own crypto as collateral.

Compound determines how much a user can borrow based on the amount and quality of their assets. For instance, if a user has deposited 1,000 BAT worth $500 and Compound’s borrowing limit for BAT is 50%, the user will be able to borrow $250 worth of any other coin supported by the platform.

COMP token

The COMP token is the native token of the Compound protocol. It was designed to facilitate protocol governance by users. COMP is used and distributed by Compound’s participants, with its holders automatically receiving the right to vote on changes to the protocol’s parameters.

COMP holders can, for instance, propose changes to interest for coins supported by the protocol. They can also discuss and vote on the implementation of interest changes proposed by other users. COMP holders are also in charge of making decisions on adding new markets, setting conditions for them and making changes to COMP issuance and distribution. Under this model, the protocol’s participants are expected to influence Compound’s development.

In early October 2021, COMP’s price was around $295, and its market capitalization was $1.6 bln, according to CoinMarketCap.

Compound security

In early October 2021, it was unveiled that, due to a buggy system upgrade, the Compound protocol made roughly $150 mln worth of its native COMP tokens vulnerable to a third-party hack.

Although the error was discovered relatively early and a proposal to fix the bug was subsequently passed and executed, questions still remain about the security of Compound, going forward.