



Compound is playing an increasingly large role in the decentralized finance (DeFi) landscape. It is one of the most popular DeFi applications at the moment, but it’s not always easy to understand. Here’s how Compound works.





Understanding Compound’s hype







“ Today, Compound is launching its money market protocol on the Ethereum blockchain — allowing individuals, institutions, and applications to frictionlessly earn interest on or borrow cryptographic assets without having to negotiate with a counterparty or peer. Each market has a dynamic borrowing interest rate, which floats in real-time as market conditions adjust.”





This quote is from a post published on September 27, 2018, by Compound’s CEO and founder, Robert Leshner. As he explained, the platform is one of a growing subsection of lending platforms in the cryptocurrency space.





Compound is notable for a few key reasons. The platform was the recipient of the first-ever investment from Coinbase’s venture fund, Coinbase Ventures, at the time the funding round closed.





In addition, Compound is now the second-highest ranked platform according to a tracking tool known as Defi Pulse. This tool lists ten decentralized finance projects alongside the USD value that is locked into each of them.





As of press time on March 8, 2019 (8 am UTC), DeFiPulse.com values the total digital assets locked into Compound at around $23.4 million USD. According to the tool’s rankings, the only platform surpassing Compound is MakerDAO, which accounts for $298 million USD.





How lending platforms like Compound function





The way a platform like Compound works is that a user locks up a portion of their digital assets as collateral in order to take out a loan in the form of a different cryptocurrency. While this practice has some similarities to MakerDAO, one key difference is that CDP creation on MakerDAO creates new tokens, whereas Compound users borrow existing tokens instead.





Today, Compound functions on the Ethereum blockchain, which its developers called a starting point. The company’s CEO acknowledged issues such as “scalability and platform risks” in a Q&A on Reddit, where he expressed his belief that leveraging the Ethereum platform is a safer, and less centralized, alternative to launching a blockchain agnostic product.





The market need that Compound is trying to address is best explained in the following quote from Leshner:





“Blockchain assets are novel and exciting, but they lack the most fundamental financial infrastructure — efficient interest rates,” he said. “Over time, hundreds of trillions of dollars of assets will be tokenized, but the institutions that deploy them will require the usefulness of traditional financial markets.”





Effectively, Compound’s users can borrow digital assets for a fee, or lend assets in order to earn interest. In December 2018, Compound added support for its first stablecoin, Dai, as the result of a community vote. This lets users lock up their own Dai tokens as collateral in order to take out a loan in the form of Ether (ETH), Basic Attention Token (BAT), 0x (ZRX), or Augur (REP).





Alternatively, there is also the option to use either ETH, BAT, ZRX, or REP as collateral in order to borrow Dai. Compound’s developers previously said they intend to grow the amount of tokens it supports in the future.





Compound uses dynamic interest rates, which react to market liquidity. In theory at least, this means that interest rates are low at times of low demand and high supply, and high when liquidity is scarce.





As a recent addition to the already turbulent cryptocurrency space, lending platforms like Compound are not without risk, especially with the market often proving volatile.





Additionally, according to the platform’s FAQ, Compound Labs currently owns an admin address with the authority to support additional assets, suspend assets, upgrade the price feed oracle, upgrade the interest rate models, and withdraw sponsor equity. However, the team said that there are plans for the protocol to become “fully decentralized,” with the admin eventually being replaced by a decentralized autonomous organization.



