Compound is a decentralized finance (DeFi) protocol that allows users to lend and borrow cryptocurrencies. It is built on the Ethereum blockchain and uses smart contracts to automate the process of lending and borrowing.
How Compound Works
Compound works by creating a pool of cryptocurrencies that users can lend and borrow. When a user deposits cryptocurrencies into Compound, they are given a cToken, which represents their deposit. The cToken can then be used to borrow other cryptocurrencies from the pool. The amount of cryptocurrency that a user can borrow depends on the amount of cryptocurrency that they have deposited and the current interest rates.
Interest rates on Compound are determined by supply and demand. When there is a lot of demand for a particular cryptocurrency, the interest rates for that cryptocurrency will be higher. When there is less demand for a particular cryptocurrency, the interest rates for that cryptocurrency will be lower.
Benefits of Using Compound
There are several benefits to using Compound. First, Compound is a decentralized protocol, which means that it is not controlled by any one entity. This makes it more secure and transparent than traditional financial institutions.
Second, Compound offers competitive interest rates. The interest rates on Compound are typically lower than the interest rates offered by traditional banks.
Third, Compound is easy to use. Users can lend and borrow cryptocurrencies with just a few clicks.
Platforms that use Compound protocol and who are its investors?
Compound protocol is used by a number of platforms, including:
- Aave
- dYdX
- Fulcrum
- Zerion
Compound protocol has raised over $25 million in funding from investors such as Andreessen Horowitz, Coinbase Ventures, and Polychain Capital.
Risks of Using Compound
There are also some risks associated with using Compound. First, Compound is a relatively new protocol, so it is not as well-tested as some of the older DeFi protocols. This means that there is a risk that there could be bugs or security vulnerabilities in the protocol.
Second, Compound is a decentralized protocol, which means that there is no customer support. If you have a problem with your account, you will need to troubleshoot the issue yourself or find someone who can help you.
How to Use Compound
To use Compound, you will need to:
- Go to the Compound website and create an account.
- Deposit cryptocurrencies into your Compound account.
- Borrow cryptocurrencies against your deposit.
- Pay back your loan plus interest.
You can learn more about how to use Compound on the Compound website.
The Future of Compound
Compound is a rapidly growing protocol. In the future, Compound is likely to become even more popular as more people learn about the benefits of DeFi. Compound is also likely to expand its offerings to include more cryptocurrencies and more features.
Since a16z Crypto has invested in a portfolio of Crypto and non-crypto products, integrating the popular lending protocol is easier for them. Imagine a buy now, pay later platform offering for a marketplace. They have already invested in a marketplace and it only makes sense for them to offer crypto-based products within their portfolio. We recommend checking their roadmap regularly to understand their direction.
All of that said, there are a few things you’d need to be wary of while using Compound protocol. Some of the risks of using Compound include:
- Impermanent loss
When you lend cryptocurrencies on Compound, you are exposed to the risk of impermanent loss. Impermanent loss occurs when the price of the cryptocurrency that you have lent changes significantly. For example, if you lend 10 ETH and the price of ETH doubles, you will only receive 5 ETH back when you repay your loan. This is because the value of your collateral has increased, so you only need to repay a portion of it.
- Smart contract risk
Compound is a smart contract-based protocol, which means that it is vulnerable to smart contract bugs and hacks. In 2020, Compound was hacked for $80 million. This hack was caused by a vulnerability in the Compound protocol’s smart contracts.
- Liquidation risk
When you borrow cryptocurrencies on aCompound, you are exposed to the risk of liquidation. Liquidation occurs when the value of your collateral falls below the amount that you have borrowed. If this happens, your collateral will be sold to repay your loan.
Despite these risks, Compound is a powerful tool that can be used to earn interest on cryptocurrencies and access decentralized financial services. If you are considering using Compound, it is important to understand the risks involved and to take steps to mitigate them.