Compound is a decentralised borrowing protocol, enabling crypto holders to earn yield on their assets. The initial whitepaper was published in 2019, and Compound protocol currently has over USD 9 billion in assets earning interest across 18 markets.
Compound is structured as a DAO has issued COMP tokens, and token holders can vote on proposals to govern the protocol’s activity. It was established in 2017, and is backed by A16z, Bain capital venutres and Polygon Capital.
The protocol creates pools of assets with algorithmically derived interest rates, based on the supply and demand of a particular asset, thus establishing money markets. This makes it very easy to interact with the protocol, and borrow and lend your assets as the terms are automatically and transparently available. Each money market is unique to each asset, and contains a transparent and publicly inspectable ledger, with past transactions and interest rates.
Compound is not a strict peer to peer lending platform, where each lender is matched to a borrower. The lender’s assets are all pooled in a fund, which are typically not 100% utilised thus allowing a user to withdraw their assets at any time (Important: This is not guaranteed, although the protocol incentivises liquidity by increasing interest rate as utilisation rate increases, thereby incentivizing supply and disincentivizing borrowing).
Users get an ERC-20 cToken in exchange for depositing assets into the pool, the value of the token increases as the assets accrue interest.
To borrow from the protocol, Compound requires cTokens as collateral. Borrowers can deposit cTokens and borrow an amount which they are free to use as required. The borrowing terms including interest rate and collateral levels are also algorithmically set and transparent for each asset pool, so borrowing is instant and predictable.
If the collateral levels are breached, the collateral token is liquidated by providing a liquidation incentive (currently set at 8% to the market value). This also acts as an incentive for borrowers to avoid collateral breach, to avoid collateral liquidation at below market valuation.
The below charts show the total supply across assets (as at 14 April 2022), along with the total borrowing and the lending and borrowing rates.
Compound for Treasury Managers:
We believe Compound makes a lot of sense for treasury managers who have spare liquidity that they want to earn yield on. Of course it depends on which assets you hold, but if you have spare USDC or DAI you can earn a yield of 2.42% and 2.69% respectively.
Compound protocol is also well tested, managing over USD 9 billion in assets, which can provide additional confidence to treasury managers. The ability to withdraw funds, with the liquidity incentives built in the protocol, means that funds are always available should they be needed. We do advise that it should be monitored, and used in conjunction with other protocols to maximise yield. As there can be cases where a liquidity pool for an asset builds up quickly, bringing the yield down. This has happened with Ethereum where total supply is USD 3.1 billion with total borrowing at USD 72.1 million, giving investors a yield of 0.05%.
Note: These are just thoughts and opinions of Coracana’s writers and should not be taken as investment advice. We advise readers to do their own research before making any investments.