What is Compound?

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robertstevens

Robert has reported for a variety of international publications including the Associated Press, The Guardian, Vice, and Decrypt. Current areas of interest include the political economy of technology, cryptocurrencies, and privacy. Robert has a Bachelor of Science from UCL, and a Master's degree from the University of Oxford's Internet Institute.

Trading crypto need not be limited to just buying and selling bitcoin. For the past few years, developers have been busy creating sophisticated financial products that let you do far more. Compound is among the finest of such products.

The protocol lets you earn interest on any cryptocurrency you’ve deposited in its smart contracts, just like earning interest from a bank. You can also borrow crypto, just like a bank. But unlike a bank, you can spend your crypto that is currently earning interest in the platform without taking that crypto out of Compound. In other words: instead of only earning interest in money held in a bank, you can put that same money to use on other trading platforms at the same time.

Compound’s innovation is part of a wider trend called “decentralized finance” (DeFi), an umbrella term for decentralized financial products that offer new ways to trade crypto. Untethered by regulation, they’re progressing at such a fast rate that they are beginning to outpace offerings from traditional financial institutions, letting you do things never seen before in financial markets.

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And Compound has its own token, too, called COMP for short. COMP, which powers Compound’s governance system (more on that later) is one way to trade Compound’s success, a little like how Tesla shares represent the success of the company.

COMP has had a rip-roaring time on the markets since its launch in June 2020. When it launched, a single COMP was worth $64. The following week, the token was worth $346; this price boom inspired hundreds of other DeFi platforms to do the same thing, sparking a run within the DeFi industry, which today is worth about $26 billion. Such inspiration generated fierce competition, and Compound shares its crown with several other top DeFi projects, such as AaveMakerSushiSwap and Uniswap.

What is the Compound protocol?

In a nutshell, Compound lets you lend and borrow cryptocurrencies. Want to take out a loan of 100 ETH? Compound will let you do that for no fuss. It’ll cost you though: The interest rate is currently 2.47%. You can also lend out crypto. ETH goes for 0.09%. However, many markets are much more profitable. Lend out the US dollar-pegged stablecoin, USDT (Tether), and Compound will give you a (variable!) interest rate of 13.19%. USDC, another US dollar-pegged stablecoin, offers variable annual returns of 4.98%.

And unlike regular loans companies, Compound requires no identification and there is no processing time. As long as you pony up Ethereum’s hefty network fees (It can cost $20 to take out a loan of $0.01; the service only really makes sense for larger loans), you can take out a loan whenever you like.

There are a few other crypto loan companies. BlockFi, for instance, is a US-registered company that sorts all of this on your behalf. So what’s unique about Compound? A few things.

First, the whole service is built on top of Ethereum, the blockchain that houses its eponymous coin. Compound, therefore, is known as a dApp, short for decentralized application (think of an app on Apple’s app store, then add a heavy dose of crypto to any fuzzy memory that threads through your skull). This means that Compound is “decentralized”, which means that it can’t be shut down by regulators (whether that’s a good thing or not is beyond the scope of this explainer). It also means that Compound is “non-custodial”, unlike a bank or a crypto loans company (such as BlockFi). This means that nobody, not even Compound’s creators, can access your crypto. What’s yours is yours.

Second, Compound lets you use your deposited crypto on other platforms. When you deposit, say, DAI, a decentralized US dollar stablecoin, into Compound, Compound will generate an equivalent amount of cDAI that represents your deposit. So, if you invest $1 worth of DAI, Compound’s protocol will issue you with $1 in cDAI tokens. These cTokens (Compound tokens that the protocol issues in exchange for deposits of a token) accrue in value over time. So, if DAI’s interest rate holds steady at 10% a year, you will have $1.1 worth of cDAI tokens, which you can redeem for $1.1 worth of DAI.

The advantage of doing things like this is that you can do whatever you like with these cTokens—they are simply Ethereum-based tokens that represent your initial investment into Compound’s lending markets. You could, for instance, transfer these tokens to a friend. That friend could use those cTokens to redeem money from that pool. Or, you could send these tokens to another decentralized application, which could use that money to do something else, like spend them in an app or use them as collateral for another trade. Whatever you do with them, the point is that it’s different from a bank, which forces you to hold your deposits with it to earn interest. On Compound, you can earn interest on assets and use that money elsewhere. It’s like lending without the opportunity cost.

What is COMP?

COMP, Compound’s main token that trades on exchanges, is something quite different. To become a decentralized project—one that is not run by a company, but a community—Compound had to come up with a system that let its users control the future of the platform. So they came up with “COMP,” a so-called “governance token.” You can use COMP to vote on how the platform is run. Such topics as “COMP Speed Recalibration“ or “Adjusting Reserve Factors” were put up to community vote, and anyone with COMP could vote. The biggest bagholders have the greatest sway; this is not a democratically elected government.

But unlike cTokens, which are back-end tokens and trickier to trade, COMP tokens are listed on all major exchanges, such as WealthsimpleBinance and Coinbase. As of January 2021, COMP is worth $241, has a market cap of $1.1 billion and traders shift $271 million of the coin each day. And there’s 4.5 million COMP in circulation, out of a total 10 million COMP. Not bad for a token that only launched in June.

One of the reasons why COMP did so well initially is not because of all the wondrous governance opportunities that its complicated design facilitated, but because you could earn COMP by taking out or lending crypto on Compound. And because COMP was so valuable and increased at such a rate, it made sense to just take out loans of…anything, just to earn COMP.

This practice, known as “yield farming,” wasn’t entirely new, but COMP popularized it and kickstarted a huge run for the DeFi industry. At some points, yield farming offered rates of over 1000% a year—although lots of these protocols have since crashed or turned out to be scams.

The issue with the short-lived yield-farming bubble is that it was unsustainable, since rising prices required more and more of these governance tokens to be minted all the time. And since lots of these platforms rewarded people with governance tokens (think of them like loyalty points) for using the platforms, all of that business went away once the bubble popped. Volumes on decentralized exchanges tanked shortly thereafter.

But even if the bubble popped, wiping some of the less sustainable protocols from the market, the post-pop DeFi world is perhaps the better for it, and the site of modern financial innovation. And Compound, one of the tokens that started it all, is stronger than ever. As of January 2021, it is the third most popular DeFi application, with $3.1 billion locked up in its smart contracts. It trails behind Aave, with $3.9 billion, and Maker, with $4.62 billion. But remember: in June 2020, there was just $88 million locked up in Compound. And the entire value locked up in DeFi was about $1 billion at the start of last year; a year later, it’s pushing $26 billion, per metrics site DeFi Pulse.

How to buy COMP

Buying COMP is just like buying Bitcoin or Ethereum. You can buy it on most major exchanges and trade it just like any other coin. However, since the market for COMP is smaller than Bitcoin (a market cap of $1.1 billion compared to Bitcoin’s market cap of $594 billion), it is generally available on fewer markets and with fewer pairings. You can find the most popular COMP markets here. The three most popular COMP pairings are for USDT (Tether), US dollars, and Bitcoin. To trade COMP for USDT or Bitcoin, you’ll first have to buy those coins and then trade them for COMP on those platforms. For USD, the most popular market is on Coinbase Pro; there, you can buy it directly for US dollars. To buy it directly with Canadian dollars, you can buy it through a prime brokerage platform such as Wealthsimple or directly from Coinbase. These platforms make the process easier, but again, they’re simply buying COMP from one of the exchanges and then reselling it to you for Canadian dollars. Convenience is king!

Last Updated April 28, 2021

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