At the most basic level, Compound is a standalone protocol that calculates interest rates through algorithms. Also, it is permissionless, which means that anyone can access the provided tools at any time. There is no verification process and no user identification mechanism. Real-time interest rate calculation can be used for a variety of financial applications. For individuals, Compound is primarily used as a cryptocurrency lending protocol. Users can deposit one of the supported tokens into a shared pool at any time and earn interest. Or, after depositing their tokens, they can borrow a smaller amount of tokens and pay interest. The amount of interest is determined by the supply and demand of tokens deposited and borrowed in the pool
How the loan works with Compound
To borrow with this protocol, all you need to do is provide the cryptocurrency you want to provide liquidity for. Lenders deposit tokens into a liquid fund. Once you do this, you will immediately start earning interest, which is controlled by the supply and demand of the currency. When lenders put their cryptocurrency on the market, they receive Compound’s native token called “cToken”. The value of the cToken token is equivalent to the token that was placed on the net market. Thus, the value will increase as the interest of this cryptocurrency increases. Furthermore, the value of the cToken will also fluctuate with the value of the token on the market, of course. For example, if you lock X amount of USDT in the protocol, you will receive X amount of cUSDT tokens which will start to grow in value. These cUSDT tokens can be used in applications on Ethereum. That way, your locked up capital isn’t actually locked up as it would be if you were to lend to a borrower in a traditional environment. That is, you can still use it. When you need to use your cryptocurrency, all you have to do is return your cTokens and you will receive your original tokens in return. If you are a non-technical user, you can interact with Compound Dapp using interfaces like a Coinbase or Argent wallet.
How to borrow with Coumpound
Taking out loans is a little more complicated. First, borrowers need to post collateral to obtain something called “lending power”. After acquiring this power, they will be able to borrow tokens equivalent to the amount of borrowing power they have. Borrowers can borrow from this fund whenever they want, for as long as they want, at an interest rate determined by an algorithm that monitors the supply and demand of the borrowed tokens. Like many DeFi projects, Compound also operates on the principle of overcollateralization. This means that users who want to borrow need to have greater collateral than they want. In this way, the creditor and the system are exposed to zero risk. Borrowers should also note that the value of their collateral must remain above a certain amount to be viable. If it doesn’t go above that amount, the collateral will be liquidated to repay the loan. When a user’s collateral enters the liquidation event, other users will have the opportunity to repay the outstanding amount borrowed by a percentage of the borrower’s collateral. To encourage this purchase, users will get an 8% discount on the warranty. That is, they will receive the guarantee at 8% below market value. A note on liquidation: many who are wary of this term believe they will lose all of their funds in liquidation. However, these concerned individuals must realize that they would still have their funds borrowed. For example, if I guaranteed 100 and took 80 traded and if my 100 were liquidated, I would still have 80, for a loss of 20, not 100.
What makes Compound stand out
The great advantage of Compound is that it eliminates the need for trades. Thus, market lenders do not need to negotiate terms as they would at a regular bank or even other DeFi applications. Lenders and Borrowers only need to interact with the protocol to deposit or lend cryptocurrency. The entire operation is governed by algorithms. Individuals do not hold the funds. Instead, they are held in smart contracts. Thus, there is no threat of unfair or preferential treatment and no threat of counterparty risk. However, there are several other lending protocols that bring these same benefits. Compound is currently considered a centralized application. While that may be true today, it certainly won’t be true in the long run. The COMP token, which is the protocol’s native token, grants governance rights to holders. As more users join the protocol and start using the token, the protocol will continue to decentralize.
It’s easier to invest
Lenders are not the only ones who benefit from this arrangement. Borrowers who would like to buy a specific asset can use Compound to do so. For example, if a trader assumes that the price of ETH can increase exponentially in the long to medium term, he can use his existing ETH as collateral to borrow USDT, which can then be used to buy even more ETH. If the trader is right and the increase in his ETH is greater than the interest on the borrowed USDT, he can make a healthy profit. However, if it doesn’t work out, they will still have to repay the loan or be liquidated. It is important to note that the only asset types Compound can currently support are 9 ERC-20 tokens. There are many protocols at the moment that are trying to make it easier for users to borrow and borrow assets. However, Compound’s approach is certainly interesting. And it is often compared to Aave as one of the largest lending protocols available. Considering the protocol’s solid conceptual foundation, including algorithmic and non-negotiable interest rates, permissionless access, and non-custodial token management, there are many good reasons to consider this option. Disclaimer: The text presented in this column does not necessarily reflect the opinion of CriptoFácil. Also read: User makes flash loan attack and profits BRL 5 million with ApeCoin Also read: GameStop will launch NFTs market in the 2nd quarter