The traditional lending industry has drastically grown over the years. But it has several flaws due to which many applicants can’t get their loans approved. The users need to maintain a healthy credit rating and need to show submit something as collateral when applying for a loan. And for small businesses, the best option is the defi protocol like compound(COMP)
The major problem with the traditional lending market is that only banks and bigger financial institutions can take advantage of this facility. The small investors only get a small amount as interest and they aren’t directly involved in the process. The Defi protocol like Compound provides everyone with the opportunity to earn interest no matter how small their investment is.
What Is Defi Protocol like Compound(COMP)?
The defi protocol like compound is an Ethereum-based network that allows users to lend and borrow cryptocurrencies without having to deal with an intermediary like banks. The network consists of a set of liquidity pools where investors can deposit their cryptocurrencies to earn interest.
The borrowers can get their desired cryptocurrency by locking a number of crypto tokens as collateral. The interest rate is determined based on the liquidity available in the pool. Compound network issues cTokens like cETH, cMATIC, and cDAI when a user deposits cryptocurrency in a specific pool.
The users can trade these tokens for other cryptocurrencies. But they need to submit the cTokens they received at the time of depositing their cryptocurrencies. The network enables users to withdraw funds within a few minutes. The developers can integrate this Defi protocol into their decentralized apps if they’re introducing a lending and borrowing platform.
The non-technical users can also take advantage of this platform to borrow crypto tokens according to their needs.
Compound Brief History
Geoffrey Hayes and Robert Leshner founded the compound project in 2018. The team raised around $8.2 million from popular venture capital firms including Bain Capital Ventures, Andreessen Horowitz, and Polychain. The project went live in September 2018 when the crypto lending and borrowing industry was in its early stages.
The team introduced the second version of the platform after raising an additional $25 million in 2019. The new version introduced the synthetic assets and cTokens along with several other updates. The third version of the platform was introduced in August 2022 but it works in parallel with the second version.
Most operations of the network are still performed on the second version and the third version is reserved for future development. As of 2020, Compound network had $500 million worth of cryptocurrencies locked in the liquidity pools. But according to the recent update, it had around $2 billion worth of cryptocurrencies locked as of 15 September 2022. It’s a significant growth because the value of cryptocurrencies has drastically reduced in recent months while Compound’s value has increased 4x as compared to the past.
How Does Compound Work?
defi protocol like Compound network determines the interest rate of a crypto pool depending on the cryptocurrencies locked by investors. It uses Chainlink (LINK) oracles to regularly update the live prices of cryptocurrencies. The oracles collect live data from different cryptocurrency exchanges without the involvement of a third party.
The Compound network updates market pages for different liquidity pools where users can check the interest rates for their desired cryptocurrencies. The users can directly lend or borrow cryptocurrencies through the graphical user interface of the defi protocol like Compound network. The Compound network supports different wallets including Meta Mask, Telly Ho, WalletConnect, and Ledger.
Every user needs to deposit crypto tokens in the liquidity pools whether they need to lend or borrow cryptocurrencies. These funds are used as collateral when a user borrows from the platform. The users can’t redeem their funds if they’ve borrowed funds from the platform. The users can deposit 20 different cryptocurrencies within the network.
USDT, Dai, ETH, and USDC are the most common pools used for lending and borrowing on this platform. As it’s mentioned above, the network issues ctokens when a user deposits funds in a pool. The users can earn interest from the platform for their contribution while having the facility to borrow their desired tokens if needed.
The network sets an estimated borrowing capacity depending on the funds a user has deposited. The network checks the live price of deposited tokens to determine the borrowing capacity. The users can borrow coins depending on the collateral ratio of each coin.
For example, if a coin has a collateral ratio of 80%, the user can borrow 80% of the total collateral. The network ensures its stability through over-collateralization because most coins have a collateral ratio of 60 to 85%.
It’s worth noting that the network issues cTokens as loan rather than issuing the original tokens.
Risk and Liquidation
The network has the authority to liquidate a user’s fund if their account’s health ratio falls dangerously low. Therefore, it’s important to add more funds if you want to avoid liquidation. If an account is liquidated, the remaining amount is transferred to the user after clearing the debt.
The compound network doesn’t have any withdrawal penalties. It means users can withdraw their funds whenever they want. However, if they’ve borrowed some funds, they need to return the loan before sending a redemption request.
COMP is the native token of the Compound network used for the transfer of value. The network also creates different cTokens when a user deposits funds within the platform. With a circulating supply of 7.2 million tokens, COMP has a market cap of $451 million. It ranks among the 100 best cryptocurrencies in terms of market.
The compound is an Ethereum-based lending and borrowing platform that enables users to make more money from their crypto investments. It has reasonable interest rates and prevents the use of a third party for borrowing and lending. It enables users to withdraw their funds without any penalties. If you need more information about how Compound works, feel free to get in touch with us.