What is Compound Finance in Decentralized Finance (DeFi)?

Binance Academy · 2022-11-05T01:43:17.000Z
Summary You can lend and borrow cryptocurrencies at Compound Finance. Simply hold an Ethereum wallet and some funds to instantly borrow funds or earn interest. Injecting assets into Compound is easy, and the funds are never held by third parties. Interested in understanding how Compound works? Please read this article to find out. Table of contents Introduction What is Compound Finance? How does Compound Finance work? What assets does Compound Finance support? How is Compound governed? Advantages and Disadvantages of Compound Finance Summarize Introduction
Summary
You can borrow and lend crypto on Compound Finance. All you need is an Ethereum wallet and some funds to borrow money instantly or earn interest.
It’s easy to inject assets into Compound, and those funds are never held by a third party. Interested in learning how Compound works? Read this article to find out.

Table of contents
Introduction
What is Compound Finance?
How does Compound Finance work?
What assets does Compound Finance support?
How is Compound governed?
Pros and Cons of Compound Finance
Summarize

IntroductionFund lending has always been a difficult problem in the field of decentralized finance (DeFi). Compound Finance is a first-class cryptocurrency lending protocol in the DeFi field. In a sense, Compound is a savings account that can earn interest without going through a trusted third party.
The user experience is very smooth and the protocol is currently in full swing of testing. In addition, many liquidity miners use Compound to borrow assets and invest in other DeFi protocols.
But how does Compound Finance work? Let’s find out.

What is Compound Finance?Compound Finance is a DeFi lending protocol. In more technical terms, it is an algorithmic money market protocol. You can think of it as an open money market. It allows users to deposit cryptocurrencies and earn interest, or use these currencies as collateral to borrow other crypto assets. It uses smart contracts to automatically save and manage the funds deposited to the platform.
All users can use Web 3.0 wallets (such as Metamask) to connect to Compound and earn interest. Therefore, Compound is a permissionless protocol. This means that anyone can interact with it freely as long as they have a cryptocurrency wallet and are connected to the network.
Why is Compound useful? Unlike traditional markets, suppliers and borrowers on Compound do not need to negotiate terms. Both parties interact directly with a protocol that handles collateral and interest rates. Assets are deposited into smart contracts called "liquidity pools" and there is no counterparty holding the funds.
Compound's supply and borrowing rates are adjusted algorithmically. Therefore, the Compound protocol automatically adjusts according to supply and demand. In addition, COMP token holders also have the right to adjust the interest rate.

How does Compound Finance work?The positions (supply assets) in Compound are anchored to Compound’s native token “cToken”. cToken is an ERC-20 token that represents the share of various tokens in the Compound pool.
For example, when ETH is deposited into Compound, it is converted into cETH. When stablecoin DAI is deposited, it is converted into cDAI. If multiple tokens are deposited, they will earn interest at their respective rates. In other words, cDAI can earn cDAI interest rates, while cETH can earn cETH interest rates.
cTokens can be redeemed for their share of the pool, causing the supply assets to be deposited into the associated wallet. As the money market earns interest (more borrowed funds), cTokens also begin to earn interest and can be redeemed for more underlying assets. This basically means that as long as you hold ERC-20 tokens, you can earn interest on Compound.
First, the user connects to a wallet that supports Web 3.0 (such as Metamask). Next, unlock the asset you want to interact with. Once the asset is unlocked, the user can borrow or lend the asset.
The principle of lending is very simple. Unlock the asset you want to provide liquidity for, sign the transaction through your wallet, and start supplying funds. The asset will immediately enter the fund pool and start earning interest. At this point, the asset is converted into cToken.
Borrowing is a little more complicated. First, users deposit funds to repay the loan (collateral). In return, they receive the "borrowing rights" needed to borrow on Compound. Each supply asset will increase the number of borrowing rights. Users can borrow funds based on their borrowing rights.
Similar to many other DeFi projects, Compound uses the concept of over-collateralization, which means that borrowers must supply collateral worth more than the amount they borrow to avoid forced liquidation.
It is important to note that each asset has its own borrow and supply annual percentage rate (APR). The borrow and supply rates are adjusted based on supply and demand, so the borrow and lend rates are different for each asset. As mentioned above, each asset earns a different interest rate.

What assets does Compound Finance support?As of September 1, 2020, the lending assets supported by Compound include:
ETH
WBTC (Wrapped Bitcoin)
USDC
COME ON
USDT
ZRX
ONE
REP
Other tokens may be added in the future.

How is Compound governed?Compound was originally founded by Robert Leshner and funded by venture capitalists. However, thanks to the COMP token, Compound Finance's governance is becoming decentralized. COMP tokens give holders the right to receive fees and governance protocols.
Therefore, token holders can change the protocol through improvement proposals and on-chain voting. Each token represents a vote, and holders use tokens to vote for proposals. In the future, the protocol may be fully managed by COMP token holders.
What are the most common issues COMP holders encounter when voting?
What are the cToken markets?
The interest rate and required collateral for each asset.
Which blockchain oracle to use.

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Pros and Cons of Compound FinanceWhat do users use Compound for? Earning interest is just a simple use case, and Compound's user experience is very friendly to beginners. For experienced traders, Compound is a great way to increase position leverage.
For example, let's say a trader is long ETH and supplies ETH to the Compound protocol. They then use the supplied ETH as collateral to choose to borrow USDT and buy more ETH. If the price of ETH rises, the profit earned exceeds the interest rate paid for the borrowed funds, and they make a profit.
However, the risk also increases. If the price of Ethereum falls, their Ethereum collateral may face forced liquidation in order to repay the principal and interest.
What are the other risks? Compound has been audited by companies such as Trail of Bits and OpenZeppelin. Although these auditing companies are generally reputable, defects and vulnerabilities can breed unexpected problems, and no software is immune.
Before investing money in smart contracts, you should fully consider all risks. No matter what kind of financial product you invest in, never risk more money than you can afford.

SummarizeCompound is the most popular lending solution in the DeFi space. As many other products incorporate their smart contracts into applications, Compound will become an important part of the DeFi ecosystem.
As a core money market protocol, Compound can solidify its position in the DeFi space once governance is fully decentralized.
Do you have any other questions about Compound Finance and DeFi? Visit Ask Academy, our Q&A platform, where members of the Binance community will patiently answer your questions.