One of the most widely used DeFi apps today is peer-to-peer lending apps, with Compound being one of the most popular. With Compound, you can deposit crypto assets to earn interest, and also borrow crypto assets for investment or other needs.
While the traditional financial ecosystem requires the role of financial institutions to lend and borrow assets, with Compound, this process is automated with a collection of smart contracts on the Ethereum blockchain.
Through smart contracts, Compound bridges the need between lenders who want to earn interest on unused assets and borrowers who need assets as investment capital.
Compound has a governance token called COMP which gives its holders the right to vote on changes to the Compound protocol. In DeFi or decentralized finance projects, the presence of a governance token is needed to distribute authority to users so that the platform remains decentralized.
As explained earlier, Compound’s two main features are as a platform for depositing crypto assets as well as borrowing assets.
As of August 2021, there are 11 tokens available in Compound, namely 0x (ZRX), Basic Attention Token (BAT), Compound (COMP), Dai (DAI), Ether (ETH), USD Coin (USDC), Tether (USDT), Uniswap (UNI), Wrapped BTC (WBTC), True USD and Chainlink (LINK). It should be noted that USDT is the only token that cannot be used as collateral for borrowing because its fee structure has the potential to affect the Compound’s liquidity mechanism.
The following is a further explanation of each of these main features.
Earn interest in Compound
To start earning interest on this app, the first thing you have to do is depositing a crypto asset. Upon depositing assets, you will receive cTokens, tokens that represent the amount of the user’s balance in the Compound protocol, and you will earn interest over time. If you deposit USDC, you will receive cUSDC. If you deposit DAI, you will receive cDAI and other tokens as well.
Interest will quickly accrue overtime on the user’s cToken. Users can redeem cTokens to receive back their deposited capital plus interest earned.
Borrow funds with Compound
Compound also allows users to leverage or invest strategies using borrowed money as capital. Before starting to borrow on Compound, users must deposit assets as collateral, and the amount deposited must be higher than the amount borrowed. This means that if you want to borrow $100 worth of crypto assets, you must first deposit assets that are more than $100 worth. This is to minimize the risk of the lender in the event of a decline in the price of the crypto asset being lent. Here is the example of a use case:
Example: You have 30 ETH (worth $7,800as of August 2021) and you predict that the price of ETH will increase in the next 30 days. You want to buy more ETH, but don’t have enough funds. With Compound, you can deposit your 30 ETH and borrow 50% of the ETH value in Compound.
Let’s say that in Compound you borrow an asset USD Coin (USDC), a stablecoin that has the same value as USD, with a loan interest of 1%. Thus you get USDC worth $3,900 or 50% of the value of the ETH you deposited.
With the 3,900 USDC you borrow, you can buy 15 ETH on the exchange of your choice. If after 30 days the price of ETH has increased by 30%, then the value of the 15 ETH you just bought will be at $5.070. You can sell the 15 ETH, return to Compound to repay the loan, and withdraw the ETH you previously deposited.
With a loan of 3,900 USDC plus 1% interest, it means that you have to pay 3,939 USDC to Compound and get back the 30 ETH that was deposited. Thus, you make a profit of $5.070 – $3,939 = $1,131.
However, if the value of the crypto assets you borrowed drops, Compound can liquidate up to 50% of the fund you deposited as a guarantee. So you have to be careful when you want to try leverage.
In Compound, the interest rate is called Annual Percentage Yield (APY), and the interest rate varies depending on the asset. Compound determines interest rates with an algorithm that takes into account the supply and demand for assets. Generally, the higher the demand for loans, the higher the interest rate (APY) and vice versa. APY on Compound is updated every 3-5 minutes.
To use Compound, you need an Ethereum wallet that can interact with dApp/Web3 (like Metamask) and some ether (ETH). Once you have a wallet, you can directly link your wallet with Compound. One thing you need to remember, every transaction on the Ethereum blockchain requires a fee called a gas fee for the miners to finalize a transaction. Therefore make sure you have enough ETH to run the transaction.
Compound was founded in 2017 by Robert Leshner & Geoffrey Hayes in San Francisco, California. Before founding Compound, Robert was a financial analyst, economist, and founder of two software startups. Meanwhile, Geoffrey Hayes was previously an engineering manager at Postmates, founder of Safe Shepherd, and an engineer at Applied Predictive Technologies.
As of this writing (August 2021), COMP is a DeFi token with a market cap of $2.2 billion. Currently, COMP tokens that have been circulating in the market have reached 5.3 million tokens with a maximum supply of 10 million tokens. The price of one COMP token as of July 2021 is $415. To check the current COMP token price, you can click the following link.
After reading the explanation above, if you are interested in buying various crypto assets such as COMP tokens, you can download Pintu, a crypto exchange app that has been registered with BAPPEBTI. With Pintu, you can start to invest in crypto from as little as IDR 11,000 and invest equal sums of assets at regular intervals with Dollar Cost Averaging (DCA) feature. Simply download Pintu and click the “DCA” feature that you can find on the app’s home page.
“How to DeFi?”, CoinGecko (2020)