Redefining Crypto Lending and Borrowing: What Is Compound Finance?

Crypto programmers are constantly developing innovative use cases in decentralized finance (DeFi), but intermediary-free lending remains one of the most popular activities. Today, traders have many crypto loan protocols to choose from, but Compound holds a special place in the DeFi landscape. Thanks to its long history in DeFi, the Compound protocol has influenced how developers think of designing their decentralized applications (dApps).

Since Compound’s 2018 launch on Ethereum (ETH), it has become a fixture of DeFi and a popular model for web3 programmers. Learn more about Compound’s past and how it continues to bring crypto borrowers and lenders together. 

Compound’s history

Entrepreneurs Robert Leshner and Geoffrey Hayes introduced the concept of a decentralized money market protocol called “Compound” in 2017. One year later, the Compound team released its first version of a money market dApp on the Ethereum mainnet, allowing crypto traders to access peer-to-peer (P2P) loans or earn interest by lending their virtual assets. 

Between 2019 and 2022, Compound introduced version 2 and version 3 upgrades to its protocol, each offering different collateral terms and available cryptocurrencies. Between these two updates, the Compound protocol also released its native crypto token COMP in 2020, often considered the first cryptocurrency designed specifically for a DeFi protocol (aka DeFi tokens). COMP serves as both an incentive mechanism for lenders and borrowers plus a governance token for voting on proposed changes to Compound Finance. 

How does Compound work? 

Compound runs as a dApp on top of the Ethereum blockchain, and it uses pre-programmed commands called “smart contracts” to enforce actions in its application. All cryptocurrency available to borrow on Compound comes from crypto traders who lock funds in smart contract-controlled “liquidity pools.” Lenders receive cryptocurrency copies of their initial deposit called “cTokens” as a receipt and a percentage of interest paid to the protocol from borrowers. 

If crypto traders want to borrow from Compound, they link their self-custodial crypto wallet to the dApp, select their preferred token, and deposit approved crypto collateral. After a borrower receives their digital funds, they must pay off their loan plus interest before Compound sends the collateral back to their wallet. 

Compound uses overcollateralization on loans to mitigate price volatility in the cryptocurrency market. If the market value of a borrower’s collateral dips below Compound’s requirements, the borrower receives a “margin call” and must either send more collateral or pay more interest to prevent losing their crypto (aka liquidation). Because all transfers on Compound happen thanks to smart contract technology, traders never interact with a third-party intermediary whether they borrow or lend virtual assets. 

Compound FAQs

What is the COMP token? 

COMP is an Ethereum-based token using the ERC-20 token standard developed for the Compound ecosystem. Released in 2020, this token was the earliest in the category of DeFi tokens—or cryptocurrencies associated with a DeFi protocol—and helped inspire more DeFi dApps to release platform-specific cryptocurrencies. In addition to rewarding borrowers and lenders for using its protocol, the COMP token carries governance rights, letting token holders vote on proposed upgrades. 

As a fungible crypto asset, Compound’s coin price has a transparent 1:1 ratio on the crypto market, making it easy to quickly find Compound’s price and establish an exchange rate with a real-time Compound price chart.

How do crypto traders use Compound? 

To borrow or lend on Compound, traders need a compatible self-custodial wallet like MetaMask to connect with the official Compound dApp. Once users link their crypto wallet, they can deposit crypto to take out digital assets or contribute to a liquidity pool for interest. 

What are the average interest rates on Compound? 

Typically, Compound quotes the expected interest rates for each liquidity pool in terms of the annual percentage rate (APR) or annual percentage yield (APY). Interest rates for borrowers and lenders on Compound fluctuate depending on market dynamics and governance changes. Since these rates are variable, traders must carefully monitor news in the Compound community, especially when they take out a loan.  

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