The decentralization of monetary systems, payment networks, and other financial services has been made possible by blockchain technology. For instance, Bitcoin may be mined by anyone, anywhere in the globe, including businesses and people, and it is not kept or governed by any centralized body.
Anyone who has Bitcoin can transfer it to another individual without making use of the services of a centralized financial institution. Miners have a say in deciding whether or not the functioning of the Bitcoin network should be altered, and to make changes, a majority vote is required.
The conventional method of handling our finances usually involves opening a bank account to store cash savings and receive interest on them. If we were to consider the possibility of earning interest on bitcoin assets, that would be quite an interesting prospect for a great number of cryptocurrency investors.
The unavailability of this service has meant that cryptocurrencies often just stay in a digital wallet or on an exchange without generating any interest for their owners. Usually, the only way crypto owners can profit from their assets is if the coin they HODL goes up in value, but this does not always happen.
The DeFi lending platform, known as Compound Finance, solves this problem. It's a protocol for the algorithmic money market, or in simpler terms, a public forum for monetary transactions.
Members are granted the ability to store cryptocurrencies in exchange for borrowing other crypto assets against them or earning interest on their deposits that they lend out to other users.
An account with Compound Finance allows you to earn interest without having to entrust your money to a third party, so you can think of it as an alternative to traditional bank accounts. It makes it possible for creditors to provide credit to borrowers who lock their crypto assets as collateral in the Compound system.
In this article, we will talk about Compound Finance technology, its native currency, and how to invest in it, including topics like:
- How does Compound Finance work?
- What is COMP?
- How to Invest in COMP
- Features of Compound Finance
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How Does Compound Finance Work?
When you borrow cryptocurrency from Compound, keep in mind that the value of your collateral must remain above a certain threshold; else, the company will sell your collateral to cover the cost of the loan. After the loan has been redeemed, you can retrieve any of your crypto assets that have been locked in the Compound system.
The supply and demand of any cryptocurrency asset are taken into account while determining interest rates. Compound allows borrowing crypto assets that do not necessarily have to be the same as the collateral deposited. For example, I can put as collateral ETH and receive a borrow in DAI.
A cToken is produced each time a lender deposits its crypto assets in the Compound protocol. As they are tokens based on the ERC20 standard, they may be bought and sold or utilized in other kinds of decentralized apps and minted using an ETH wallet.
Because everything on Compound is automated, users can withdraw any amount of money from their accounts at any moment. Lenders can borrow an amount of another cryptocurrency that is equal to or less than the value of their initial deposit.
Borrowings may be liquidated at any time if the value of the cryptocurrency that was borrowed increases to the point where it is worth more than the cryptocurrency that was deposited.
If this occurs, other users will be given the option to repay a part of what is still owed in exchange for a piece of the collateral at a discount depending on the price of the collateral on the current market.
The cryptocurrencies that can be transacted by Compound users include ETH, BAT, USDC, ZRX, REP, DAI, and WBTC. New cTokens are created and added to your account whenever you make a deposit on the network.
If you wish to borrow cryptocurrency against your ETH, you will get an identical amount of cETH in return for the ETH that you placed. For instance, if you deposit Ethereum (ETH) into Compound, it will be swapped to compound Ethereum (cETH).
When you make a deposit using the stablecoin USDC, the currency is changed to cUSDC. When you deposit several coins, each coin will receive interest depending on its interest rate, regardless of how many coins you deposit.
In other words, cUSDC will earn the interest rate that is associated with cUSDC, and cETH will earn the interest rate that is associated with cETH.
What is COMP?
The Compound Decentralized Finance (DeFi) system uses its native governance token known as COMP for its operations. Traditional monetary infrastructures are being replaced with their decentralized counterparts by the DeFi network.
Regular users can get a portion of the returns that were previously only accessible to huge financial organizations thanks to this system.
A user's ability to participate in the decentralized governance structure of the Compound protocol is proportional to the number of COMP tokens that they own. When a new Ethereum block is mined, a certain quantity of COMP tokens is distributed to all lenders and borrowers on the network.
This happens once every 15 seconds. The quantity received by users is proportional to the interest rates of the various cryptocurrencies as well as the number of transactions they do while using the protocol.
Every COMP token represents one vote in the poll, and if a user has one percent or more of the total quantity of COMP tokens, they are eligible to participate in the governance system. This allows them to propose and vote on any proposals that will alter the functionality of the Compound blockchain.
How to Invest in Compound (COMP)
The whole process of buying COMP tokens is uncomplicated and can be completed in no time. All you will require is a means of identification, a method of payment, and a smartphone or a computer with an internet connection.
Examine various cryptocurrency markets
A cryptocurrency exchange provides the most user-friendly environment for purchasing Compound. You can choose the one you prefer depending on features including cheap costs, convenience of use, and round-the-clock customer service.
Sign up on the exchange
You will be required to authenticate both your identity and your email address before you can open an account on an exchange. Prepare some kind of picture identification and have your phone ready.
You’ll need a cryptocurrency wallet
A cryptocurrency wallet is a piece of software that gives you a private address that you can use to keep your assets in an offline environment. In the case of a hack or security breach, this helps reduce the liabilities that you are exposed to.
Make a deposit
After your account has been validated, you will be able to make monetary deposits through any of the available payment methods, including wire transfers, internet banking, bank transfers, crypto, and credit card payments.
You should now be able to trade your money for COMP tokens. On more user-friendly exchanges, buying COMP is as easy as inputting the amount of cryptocurrency you want to get and pressing the buy button. You can transfer your Compound to the cryptocurrency wallet you choose.
The Features of Compound Finance
Let's take a look at the prominent features associated with Compound Finance. They are as follows:
To take part in the administration of the Compound network, all that is required of you is to possess over 1% of the total COMP supply, and anyone can participate.
Those who control more than one percent of the supply are the only ones who are allowed to make fresh propositions. It is important to note that token holders have the power to assign control of their tokens to whatever address they choose.
In the DeFi industry, decentralized governance systems are now the norm. Compound was an innovator in this particular approach. Users of the compound network have the ability to cast votes on a variety of topics, including the listing of new cToken markets, the updating of market interest rates, the updating of oracle addresses, the withdrawal of cToken reserves, and the selection of new administrators.
People who possess the cryptocurrencies hosted by the Compound platform have the ability to lend any quantity of them to other users, a process that is also known as depositing, locking, or sending. This is analogous to placing fiat funds into a savings account, which immediately begins collecting interest on the deposit.
However, unlike making a deposit into a savings account, Compound is decentralized. This means that the money is added to a huge pool along with the bitcoin deposits made by other investors.
Whichever cryptocurrency the lender uses to make their deposit will be one in which interest will be paid back.
The primary function of the Compound protocol is that it provides the capacity to take out loans against assets that have been locked and deposited on the platform.
Any user who contributes cryptocurrencies to the Compound pool is immediately eligible to borrow using their crypto assets as collateral without having to subject themselves to a credit check or meet any other further requirements.
The amount of money that a user can borrow is proportional to the amount that they first deposit, and the interest rates for the various cryptocurrencies vary.
In order to ensure that their money is properly collateralized, borrowers are required to make deposits that are more than the amount they want to borrow. This indicates that there is the potential for funds to be made available to pay off the loan in the event that the user does not pay off the installments and interest.
The value of cryptocurrencies can also go up and down, and because of this, a borrower’s smart contract will automatically liquidate the amount locked by the borrower if the asset backed goes down in value and falls near the same amount it was originally borrowed.
In this scenario, the borrower will be able to keep the tokens that they have borrowed, but they will forfeit the collateral that they have deposited.
Borrowers are required to pay interest on the total amount of cash that they have borrowed, just as they would if they had borrowed the money from a traditional financial organization.
The Compound protocol is responsible for automatically determining and putting into effect the interest rates, which are unique to each cryptocurrency on the platform and can change at any time.
The amount of liquidity that is accessible for each cryptocurrency that is provided on the Compound platform is used in the automatic calculation and issuance of interest rates by the Compound protocol. Prices shift frequently since they are determined by the market's supply and demand at any given time.
If there is a significant amount of money stored in a Compound wallet, the interest rates will be significantly reduced. This is due to the fact that there is a large amount of money accessible for borrowers, meaning that lenders do not gain a significant amount in exchange for contributing further funds to the pool.
However, if there is a very limited amount of money available for a particular cryptocurrency, the interest rates will be higher. This results in a continuous incentive for users, since they will receive a greater rate if they lock their assets away in pools that include a smaller total amount of funds.
Borrowers are also encouraged to borrow from larger pools of funds and to repay borrowed funds into smaller pools in order to reduce the amount of interest that they are required to pay.
What to take away on Compound Finance
Compound Finance is one of the many decentralized financial service possibilities that are becoming available as the DeFi ecosystem continues to grow and develop. Within the Decentralized Finance ecosystem, Compound Finance is among the most well-known and widely used loan and borrowing options.
Compound Finance is currently in a unique and significant position as a groundbreaking entity within the DeFi industry. As a direct result of this, Compound continues to acquire new members on a regular basis. However, the protocol still makes use of smart contract technology, and it is a part of the larger DeFi ecosystem.
Hence, the risks associated with lending through Compound should still be evaluated despite the fact that the protocol has an excellent reputation. To learn more about other DeFi platforms, you can read up on our piece on Uniswap and how to invest in it.