What Is Compound Finance?
Compound Finance is a marketplace used by crypto investors to lend and borrow their digital assets. Compound crypto is a decentralized protocol, or dApp, built on a blockchain.
Users can also vote on the governance structure of the Compound protocol using the COMP token.
Compound is part of a new system of decentralized finance enabled with the invention of blockchain technology. It’s built by the open-source software development company Compound Labs.
Before diving into the details of Compound Finance, let’s explore the topic of decentralized finance. This will help with understanding how Compound fits into the picture.
» Looking for more guides? Check out our crypto glossary.
Compound Crypto and Decentralized Finance (DeFi)
DeFi is an important term in the crypto ecosystem. The philosophy behind DeFi is to decentralize the full suite of financial services available to individuals and businesses. These include insurance, taxes, lending, borrowing, credit, and more. In decentralized finance, there is no need for a centralized body or intermediary such as a bank to hold money, facilitate, or validate transactions. Decentralization can also apply to the way cryptocurrencies are created and governed.
Many DeFi services are built on the Ethereum blockchain. The blockchain allows anyone to build decentralized applications (dApps) with their own unique cryptocurrencies. These applications can utilize smart contracts which allow for complicated transactions, lending, borrowing, and other functionality.
Blockchain technology has enabled the decentralization of money, payments, and financial services. For example individuals and companies all over the world can mine Bitcoin, and it isn’t held or controlled by any central authority. Anyone who holds Bitcoin can send it to someone else without using the services of a bank or even an exchange. In order for changes to be made to the functionality of the Bitcoin blockchain, miners vote. Changes require a majority.
Despite the growth in DeFi and cryptocurrency there are still many financial services left to be decentralized, such as lending and borrowing. Compound is a liquidity pool that allows cryptocurrency owners to lend and borrow their digital assets.
Recommended: A Guide to Decentralized Finance (DeFi)
How Does Compound Finance Work?
Compound is a dApp that gives users the ability to crypto stake their digital assets and lend or borrow certain cryptocurrencies. Supported assets on Compound include:
• Dai (DAI)
• Ox (ZRX)
• USD Coin (USDC)
• Sai (SAI)
• Augur (REP)
Anyone who owns those assets can engage in crypto lending or borrowing using Compound without dealing with traditional financial institutions. Compound has gained significant popularity in recent years, there are more than $12.4 billion in assets on the platform.
When a user locks in funds on the lending side of the Compound protocol, they receive cTokens, or digital assets representing the amount that they have deposited. cTokens are an ERC-20 token built using the Ethereum blockchain protocol. There are different cTokens for each crypto on the Compound platform, including cETH, cBAT, and cDAI. Users receive the token associated with the crypto they deposited.
Owners of the tokens can transfer, trade, or use them on other dApps. The tokens will continue to earn interest on the Compound protocol while they are being used throughout the DeFi ecosystem. cToken holders control their public and private keys just as they would with Bitcoin or another cryptocurrency. Ultimately the cToken can only be redeemed for the particular crypto that it represents.
The Compound protocol automatically calculates and issues interest rates based on the liquidity available for each cryptocurrency offered on the platform. The rates fluctuate based on supply and demand in the market and change constantly. If there is a lot of money held in the Compound wallet, the interest rates are low. This is because there is a lot of money available for borrowers, so lenders don’t earn very much in exchange for adding more to the pool.
However, if the pool of money for a particular cryptocurrency is small, the interest rates are higher. This creates an ongoing incentive for users to lock funds into pools that contain less funds, so that they will earn a higher rate. It also incentivizes borrowers to borrow from large pools and to repay borrowed funds into smaller pools so that they will pay lower interest rates.
The Compound dashboard shows an annual interest rate which is what users get quoted. Every 15 seconds, any cTokens held by a user increase by 1/2102400 of the quoted annual interest rate for that particular moment. That fraction is the number of 15 second blocks there are in a year.
Up to $100 in bitcoin2 – just for you.
With 30 coins available, our app offers a secure way to trade crypto 24/7.
Compound Finance Transactions
Lending and borrowing transactions occur instantly using the protocol. There are no intermediary requirements or costs involved, it’s only required that borrowers have deposited funds on the lending side. The decentralization and automatically executionable smart contracts make the process easier, faster, and less expensive than going through a traditional financial institution.
Those who own these cryptocurrencies can lend any amount of them, also referred to as locking, sending, or depositing. This is similar to depositing fiat currency into a savings account that starts earning interest immediately. However, unlike depositing into a bank account, the Compound dApp is decentralized, and the money goes into a large pool along with other investor’s deposits of any particular cryptocurrency. Whichever crypto the lender deposits is the currency in which they’ll receive payments.
The other main feature of the Compound protocol is the ability to borrow against deposited and locked funds. Any user who puts part of the cryptocurrency portfolio into the Compound pool can immediately borrow against those funds without any credit check or additional requirements. The amount a user can borrow depends on how much they deposit, and each cryptocurrency has different rates.
Borrowers must deposit more than they intend to borrow to ensure that their funds are collateralized. This means there are funds available to pay off the loan if the user doesn’t pay back the installments and interest. Cryptos also fluctuate in value, so if the collateralized amount decreases in value, the borrower cToken smart contract automatically closes when the value gets close to the borrowed amount. If this occurs, the borrower keeps the cTokens they borrowed but they lose the collateral they deposited.
Just like if they borrowed from a bank or other financial institution, borrowers must pay interest on the amount of funds they borrow. The Compound protocol automatically determines and implements the interest rates, which varies with each cryptocurrency on the platform.
How Does Compound’s Governance Work?
The Compound protocol also has a decentralized governance system in which users can participate, depending on the amount of COMP tokens they hold. COMP tokens are governance tokens, and all lenders and borrowers receive a particular amount of them every 15 seconds when an Ethereum block is mined. The amount users receive is related to the interest rates of each crypto asset and the number of transactions that they partake in using the protocol.
When a user owns 1% or more of the total supply of COMP tokens, they can participate in the governance system by submitting and voting on any proposals to make changes to the Compound blockchain system. Every COMP token counts for one vote.
The DeFi ecosystem is constantly expanding to include more options for decentralized financial services, including Compound Finance. DeFi is a complicated system of decentralized exchanges that provide an opportunity for some crypto investors to lend or borrow their digital assets.
If you’re interested in starting to invest in cryptocurrencies, one simple way to get started is using the SoFi Invest® crypto trading platform. The investing platform lets you research, track, buy, and sell popular cryptocurrencies right from your phone. You can see your portfolio information in one simple dashboard. In addition to crypto, SoFi allows you to also invest in stocks and other assets all in one place. If you need help getting started, SoFi has a team of professional financial advisors available to answer your questions and help you create a personalized investing plan.
Photo credit: iStock/ijeab
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
The information provided is not meant to provide investment or financial advice. Also, past performance is no guarantee of future results.
Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC registered investment advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
2 Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2022. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.
|First Trade Amount||Bonus Payout|