Compound is a decentralized open-source protocol built on Ethereum that functions as a crypto money market. Compound enables companies and individuals to earn interest on their crypto holdings. Users can supply crypto to Compound and earn interest income, or can take out crypto loans.
In traditional money markets, participants can lend and borrow large sums of money for short periods of time while maintaining high liquidity. Participants earn income on their idle cash while maintaining the option to withdraw funds on demand. Money markets are a safe and liquid alternative to earn profit but are inaccessible to many members of the public. Since money market transactions are wholesale and involve large amounts, mainly financial institutions and big corporations can participate in these markets.
Compound is offering a decentralized, secure, liquid, and accessible alternative money market established in the cryptosphere. With Compound, individuals can earn interest from their crypto assets, or simply borrow crypto without having to interact with counterparties in any stage of the transaction. This eliminates intermediaries, reduces fees incurred by the participants, and increases the accessibility of the market by removing financial barriers to allow individuals and smaller companies to participate.
While money market returns can be relatively small, they can still be significant for companies and crypto funds that hold sizeable crypto balances. Therefore, Compound CEO Robert Leshner predicts that most of their users will be institutional. However, many of Compound’s functions can also apply to individuals.
Compound currently supports the following cryptocurrencies: Basic Attention Token (BAT), MakerDAO’s DAI, Augur (REP), 0x (ZRX), and ETH. Its current gross supply of all cryptos sits at $34.5 million, with $4.6 million already borrowed by users.
The company received $8.2 million in seed funding from Andreessen Horowitz, Polychain Capital, and Bain Capital Ventures in May 2018. By August 2018, they added 26 fund partners who have each committed a minimum of $100,000 each in crypto to guarantee a lending pool of at least $2.6 million when Compound launched.
How does Compound work?
Users can either lend, borrow, or short crypto assets. Users can earn interest on the cryptocurrencies they hold by supplying them to Compound’s shared liquidity pool.
A key difference between Compound and other crypto lending solutions is that Compound uses a decentralized protocol while other companies use a peer-to-peer framework. Instead of dealing with a counterparty, Compound’s users interact with a protocol that always takes the other side of the transaction. The result is a trustless and decentralized borrowing solution.
Borrowers can post crypto-assets as collateral for loans in ETH or other supported cryptocurrencies. Borrowers, however, are required to maintain a specified balance that is equal to the amount of all of their crypto loans. The collateral requirement in Compound is 150%, with a liquidation discount of 5%. This system provides a cushion for the system in the event that loan repayment becomes an issue.
Compound’s algorithm sets interest rates based on supply and demand. The interest accrued is tied to the price of the asset at the time it was supplied to the Compound platform. The interest rates may range from 5% to 45% APR, depending on the liquidity of specific tokens and accrue every fifteen seconds. When liquidity is high, interest rates are lowered. When the borrowing demand increases and the supply decreases, interest rates increase. These rates are publicly stated for suppliers and borrowers. The system is designed to encourage more crypto supply to the platform while ensuring repayment to lenders.
Users can access the Compound protocol by visiting the site and connecting it with their Web3 browsers like MetaMask or Coinbase Wallet. Through its UI, users can view interest rates for borrowing, shorting, or lending Compound’s supported tokens. Compound uses a transparency dashboard that shows users how their assets are moving through the protocol and how much Compound is earning.
Benefits and Use Cases
Additional source of returns on investment
Anyone holding a relevant cryptocurrency can use Compound to earn passive interest income. Users can supply crypto to the Compound protocol and accrue interest without having to directly managing the assets or take on speculative risks.
Alternative “sweeping” account for companies, dApps, machines, and exchanges
In traditional banking, checking accounts also function as “sweeping” accounts, especially for companies and institutions. In this type of transaction, account holders specify that a portion of their idle cash be automatically transferred to money market funds to earn interest while remaining liquid. Compound offers the same functionality. Companies, dApps, machines, and exchanges that have idle crypto assets can use Compound as an alternative interest-bearing or “sweeping” account while ensuring that these assets still liquid and safely stored.
Trading Long or Short
Traders can borrow from Compound to long or short almost any cryptocurrency as long as it is tradable with the currencies that Compound offers.
Traders who want to increase a long position in a given token can borrow from Compound to buy more of their desired token. For example, a trader wanting to increase their long position in OmiseGo (OMG) can borrow ETH from Compound and use it to purchase OMG.
To short a token, a trader can borrow a token from Compound at a fee and sell it on the open market. When the price falls, the trader can buy back the token, repay the loan to Compound including fees, and pocket the difference.
Leshner studied Economics at the University of Pennsylvania and is a Chartered Financial Analyst. He was the Co-Chair at the San Francisco Revenue Bond Oversight Committee. He previously founded two software startups including Safe Shepherd, which is a personal information opt-out service for consumers.
Hayes studied Engineering and Computer Science at the University of Pennsylvania. He leads Compound’s projects on Elixir, Solidity, and Elm. Hayes was also a founder and CTO of Safe Shepheard.
MakerDAO is a Decentralized Autonomous Organization (DAO) that manages its stablecoin, DAI. It allows people to collateralize their Ethereum to obtain DAI loans through a system called Collateralized Debt Positions (CDPs). So far, MakerDAO only supports collateralization of ETH but is planning to expand into a multi-collateral system for other crypto assets in the near future. Compound is also collaborating with MakerDAO, and users can use their DAI to supply at Compound’s liquidity reserves.
Although Maker and Compound are both in the crypto space, they are also collaborators in a sense. After all, Compound supports DAI, which is Maker’s USD-pegged stablecoin.
Click here to read our Deep Dive report on MakerDAO.
BlockFi is a decentralized lending platform that offers USD loans to crypto-asset owners. So far, these loans can be collateralized through BTC or ETH. BlockFi aims to provide liquidity for crypto assets, transaction transparency, and greater efficiency in settlement of crypto lending transactions.
Dharma is a protocol that allows the creation of tokenized debt agreements. They enable open and permissionless lending through smart contracts. Dharma also lets users short ERC-20 tokens, or loan stablecoins.
Nuo Network is a decentralized lending platform on Ethereum that links lenders to borrowers and utilizes smart contracts for its transactions. The objective is for lenders to earn interest from their crypto assets and to provide easy loans. Nuo also supports the use of Wrapped Bitcoin (WBTC) in lending or borrowing.
ETHLend is a decentralized application on the Ethereum blockchain aiming to offer secure, peer-to-peer loans for ERC20 tokens. Through the platform, borrowers can create loan requests and have lenders decide how they can meet them on their terms. Users do not have to find their own intermediary to settle transactions.
Lendroid is an open protocol based on Ethereum that handles the lifecycle of collateralized digital asset loans. Borrowers can loan ETH or ERC20 tokens by putting up other ERC20 tokens as collateral. Holders of its native token, the Lendroid Support Token (LST) are considered “market creators” that determine the parameters for Lendroid’s loan market, such as setting loan terms.