The stock market has been through many ups and downs in its history of existence. One of the critical issues that have been challenging is manipulation by governments. Many fear that it may crash as some governments overmanipulate it. However, the crypto space has brought a solution through decentralization in different innovations like Defi.
The crypto space has brought many innovations with it. One of the most significant ones is Decentralized Finance (Defi). Decentralized finance offers all services provided by traditional finance but has the advantage of being digital and running on smart contracts that are powered by blockchain technology.
The rise of Defi is a relief to many who like investing in the stock markets and trading with loans and such financial services. Compound Finance is one of the leading Defi platforms. It is best known for its crypto lending services without the need for third parties.
What Is Compound Finance?
Compound Finance (COMP) is a Defi protocol founded in 2017 by Geoffrey Hayes (CTO) and Robert Leshner (CEO). The duo is among the executives of the protocol from its launch to date. Compound exposes its users to the crypto market through crypto lending services and Yield farming features.
Compound allows its’ users to save, trade, and utilize crypto assets in other Defi Applications (DApps). Its loaning services require collaterals locked up in smart contracts, and the interest rates vary according to the market demand.
The protocol began as a centralized platform. However, it transformed and adopted a certain level of decentralization and launched the COMP cryptocurrency as its governance token. In June 2020, it also incorporated yield farming becoming the first Defi platform to introduce it. Since then, the platform has been a leader in the Defi sector.
What Are the Key Features of the Compound Platform?
Compound Finance is a leading Defi platform due to the great innovation it employs. It has several key features including:
- Time Locks: The platform requires that all administrative activities reside in Timelock for about two days to allow for implementation.
- Decentralization: The platform is decentralized and has protocols to enhance it. It gives its token holders a chance to vote in case of any voting process. It also allows its token holders to propose changes and allows the COMP users to delegate votes.
- Compound relies on COMP as its governance token: This token is an ERC-20 token that allows users to delegate voting rights between themselves.
- Yield Farming: Compound token allows its holders to utilize several Defi protocols resulting in very high-interest rates (Yield Farming). The yield farming in the platform can reach over 100%AYI. Though yielded farming is considered risky, Compound finance is capitalizing on it as one of its key features.
How Does Compound Finance Work?
An investor can deposit cryptocurrencies on the site as a lender or withdraw as a borrower. However, there is no direct contact between a lender and a borrower. A pool acts as an intermediary where one adds liquidity while the other withdraws from it.
The pool supports up to 12 crypto assets
- Ethereum (ETH)
- USDC
- Compound Governance Token
- Dai
- Basic Attention Token
- Wrapped Bitcoin
- Zero X
- USDT
- ChainLink
- TUSD
- UNI
- Aave
Each asset has its dedicated pool, and users can only borrow an asset of value lower than what they deposited. For every cryptocurrency invested in the pools, a user receives a corresponding amount of cTokens. cTokens allows its users to earn interests and acquire more underlying assets according to the number of tokens they hold.
In case of a price drop of an asset and the amount borrowed by a user exceeding their permit, a collateral liquidation occurs. The ones holding the assets are also allowed to liquidate and re-enter the market at a lower price. The platform also allows a user to clear a certain amount of debt to increase their borrowing capacity upon liquidation.
How Does Compound Finance Loan Work?
To understand how the Compound Finance platform works, it is good to look at it and read the guidelines on how to secure a loan with them. To start with, a user has to hold a supported cryptocurrency as collateral. The collateral is evaluated to determine the eligible amount of loan that a user can be given at a particular time. The user should then enter the market that corresponds to the coin that they use as a collateral
The platform then calculates a real median price after comparing the trading rates of several exchanges using algorithms embedded in its smart contract. cToken contract then examines and gives results on the sum of a user’s active borrowings and the accrued interest. To determine the available interest rate, a user has to add the borrowing rate to their account’s borrow balance.
Where a user borrows more than their limit, their account is deemed insolvent. The insolvency state is part of the liquidation process of the site. It is advisable to avoid such mistakes as they may lead to significant losses.
What Is Compound Finance Blockchain Lending Interest Rates?
Compound finance has different lending interest rates. These rates differ according to the asset in question. The current rates are as follows:
- BAT- 1.21%
- COMP- 0.99%
- DAI- 2.18%
- USDC- 1.63%
- USDT 1.58%
- TUSD-2.29%
- UNI- 0.38%
- WBTC-0.54%
- ETH- 0.17%
- LINK- 0.89%
- Aave- 1.46%
Pros and Cons
Pros
- Offers higher interest rates as compared to the traditional banks
- It does not require KYC, AML, or Credit scores to use
- One of the Defi pioneers thus offers trusted services.
- It rewards its users with COMP tokens.
- Compound Finance is a DAO that is community-controlled rather than a centralized platform.
Cons
- Some of its services like Yield farming can be very risky at times thus bringing losses to its users.
- Liquidation of collateral due to volatile markets can be a big loss for the users.
- It uses a highly volatile algorithm-based smart contract that suffers from technical errors severally.
- It has a limited number of assets for users to borrow from.
Is It Safe to Trade On Compound Finance?
Compound Fiance is a good platform to trade in but it is risky given that most crypto hackers target the Defi space as it is young. A possible cyber attack makes Compound risky since it stored its assets locked up in smart contracts rather than in cold storage.
The Compound Finance code is also available for one to see, and with the right set of skills, one can manipulate their systems. Moreover, it offers bug bounties for those who manage to see vulnerabilities in their systems. Such a challenge could expose the site to a cyber attack as it is calling for everyone to try finding a way to crack their systems in the name of bug bounties.
Final Word
Compound Finance is a good platform for crypto and Defi enthusiasts to gain passive income through yield farming. It also allows for other financial services akin to the traditional financial systems including lending. However, the platform is risky and should be used cautiously. It is a Defi project which increases its chances of a cyber attack. It also encourages people to try and crack their code for bug bounties. That is a risky move since hackers may choose to manipulate the systems rather than report to the management. It is also best to note that the site is best fitted for intermediate and experienced traders due to its technicalities and tricky user interface.