By Ki Chong Tran and Matt Hussey
5 min read
In a traditional savings account, you put money into the bank and earn interest on that money. The problem is that regular bank customers are not able to use their deposited, interest-earning money in any other way once it’s in the bank. What if you could spend the money your savings earned while still saving? That's an idea DeFi, or decentralized finance is hoping to solve.
One of the companies working on offering this service in the DeFi world is Compound. Below we explore how this Ethereum based project is trying to help people access their savings.
Like most Decentralized Finance (DeFi) protocols, Compound is a system of openly accessible smart contracts built on Ethereum. Compound focuses on allowing borrowers to take out loans and lenders to provide loans by locking their crypto assets into the protocol. The interest rates paid and received by borrowers and lenders are determined by the supply and demand of each crypto asset. Interest rates are generated with every block mined. Loans can be paid back and locked assets can be withdrawn at any time.
Built on top of that principle is cTokens, Compound's native token that allows users to earn interest on their money while also being able to transfer, trade, and use that money in other applications.
Robert Leshner, a former economist, is the founder and CEO of Compound.
On the surface, Compound resembles other decentralized lending protocols in that it uses crypto assets as collateral to borrow more crypto assets. Where Compound stands out is the tokenization of the assets locked in their system through the use of cTokens.
Compound tokens or cTokens are simply ERC20 tokens representing a user’s funds deposited in Compound. By putting ETH or another ERC20 like USDC in the protocol, users get an equivalent amount of cTokens. For example, locking up USDC in the protocol generates cUSD–tokens which automatically earn interest for you. At any time, you can redeem your cUSDC for normal USDC plus interest paid in USDC.
Each asset has its own market and the amount of supply or demand in that market determines the interest rates–how much money your cTokens will accumulate over time.
When user’s locked assets are converted into ERC20 form, they become freely movable, tradeable, and usable in other decentralized applications (dapps). The use of cTokens represents a fundamental feature of the DeFi movement–the ability to combine different protocols as different building blocks – called money legos.
For example, cUSDC has recently been incorporated into TokenSet–a popular DeFi dapp, which automatically trades crypto assets based on pre-programmed conditions. By combining cUSDC with automatic trading algorithms, holders of the Set tokens not only get the benefit of automatic trades, but are also able to earn interest on them–double DeFi benefits. But it hasn't been all plane sailing for Compound.
One of Compound's most public criticisms came from Spankchain founder Ameen Soleimani who wrote about the potential centralized point of failure in the protocol–a big no-no in the world of decentralized finance. According to Soleimani, users’ funds were vulnerable to both attack and manipulation because the protocol wasn’t fully decentralized.
Compound founder Robert Leshner responded to the critique with a promise that the Compound would eventually become the fully decentralized application the Web3 community had always hoped for.
New cTokens are created whenever a user deposits crypto-assets into the Compound protocol. If users want to take out a loan using ETH as collateral, they automatically receive cETH in return for their deposited ETH. If users want to use USDC to earn interest, they receive cUSDC when they deposit USDC into the system.
Anyone can mint or create cTokens using an Ethereum wallet such as MetaMask, Coinbase wallet, or Huobi wallet plus one of the crypto assets the Compound system currently accepts. As of December 2019, users of Compound could borrow or lend BAT, DAI, ETH, REP, USDC, WBTC, and ZRX.
Besides earning interest on your crypto assets, which is a fairly straightforward process of depositing crypto assets on the platform and receiving cTokens, you can also borrow crypto on Compound. Borrowing crypto assets has the added step of making sure the value of your collateral stays above a minimum amount relative to your loan. If the value of your collateral drops too far, you risk getting liquidated – having your collateral automatically sold to repay your loan.
Compound, and DeFi more broadly wants to help people have more access and control over the money they earn and save. While the project has had its criticisms, the long-term goal of Compound has always been to become fully decentralized over time. The Compound team currently manages the protocol, but they plan to eventually transfer all authority over to a Decentralized Autonomous Organization (DAO) governed by the Compound community.
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