What Is Compound Finance? Understanding The DeFi Lending Protocol

By Stephen Carter


Reviewed by: Stephen Carter


Compound Finance

Compound is a decentralized finance (DeFi) platform that lends crypto coins to its users. The protocol is originally built on the Ethereum blockchain network.

Several cryptocurrencies such as Dai (DAI), Ether (ETH), USD Coin (USDC), Ox (ZRX), Tether (USDT), Wrapped BTC (WBTC), Basic Attention Token (BAT), Augur (REP), and Sai (SAI) are currently active on the Compound protocol.

Since it is a decentralized finance network, lending and borrowing on the protocol is much simpler and cheaper than similar activities on traditional financial platforms.

Investors can borrow digital assets at a nominal interest rate, which is much more feasible than buying the tokens.

Learn more about Compound Finance, its features, its method of working, and the risks associated with the platform to decide whether this will be a good investment in the coming years.

Compound Finance

Features of Compound Finance

Compound finance follows the trustless, permissionless model of transactions. The communications within the protocol are done between the smart contracts without the interference of any intermediary authorities.

The platform is enabled to read the codes of the smart contracts trade with them and ensure its veracity.

The defining features of Compound Finance are as follows.

  • The transactions on the platform are highly transparent and secure as the smart contracts are tamper-proof. This makes the platform more accountable in terms of preventing any fraud.
  • The interest rate determination of the platform is not governed by any centralized authority, but the process is algorithmic with the fluctuations in the market rates.
  • Compound Finance is a DeFi protocol that provides an easy method to enhance asset liquidity. The liquidity of the protocol is enhanced in such a way that the users can easily enter and exit from the protocol.
  • Another major feature of Compound Finance is the right of governance that the platform provides to investors and token holders. Investors can vote for innovations that benefit them rather than obeying the rules imposed by authorities.

How Does Compound Finance Work?

Compound Finance has a liquidity pool of several Ethereum-based tokens. Investors can deposit the crypto coins they have with them on Compound Finance’s liquidity pool from where borrowers can borrow these coins. The lenders get an interest rate from the interest paid by the borrowers to the platform.

The interest rates are low for lenders for tokens that are available in plenty on the platform. Lenders can earn higher rates if they lend to the liquidity pool of tokens that are rarely available on the platform as well as the tokens having high demand.

Borrowers from the platform are required to provide collateral to ensure their credibility. The collateral are higher value cryptocurrencies than the borrowed token.

A coin with a somewhat stable value is what you should use as collateral. If the value of the collateral declines and reaches the value of the borrowed token, the platform will automatically close the account and you will lose the collateral tokens. This process is done to prevent any losses incurred by the platform.

What are the Risks Associated with Trading on the Compound Finance Platform?

Even though Compound Finance gives many benefits to its users, it is not completely risk-free. Like any other crypto trading platform, the market trends and price volatility of the tokens can affect the investors.

To counter the risks posed by the market, you are advised to invest in several tokens instead of investing in a single token.

The platform provides top-notch security to its users, but such instances of security breaches can also occur due to the online connectivity of the platform and any other vulnerabilities to which the smart contracts are exposed.

Security breaches can also occur if you are not careful about the authentication methods. The platform is also prone to phishing attacks.

Should You Invest in Compound Finance?

Compound Finance is a viable decentralized finance platform from where you can safely borrow and lend to its liquidity platform.

The lending-borrowing model is suitable for investors who have excess, unused liquidity and also for those investors who do not have the means to spend huge amounts on buying crypto tokens.

Compound Finance is a growing platform with a high potential for scalability in the future.

Stephen Carter

Stephen Carter is a software technology expert. He writes about market research on various hot topics like cryptocurrencies, explaining how they started. He's good at making complicated tech ideas easy to understand for everyone.

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