Lending stands at the forefront of the new trend of Decentralized Finance (DeFi). Lending is what powers the DeFi ecosystem and makes it possible to leverage existing liquidity to enable token swaps, yield farming, flash loans, and other decentralized financial instruments.
In this article, I will walk you through the third-largest lending protocol on Ethereum: Compound. You’ll learn about the basics of the Compound protocol, discover the COMP governance token, and explore its tokenomics. By the end of this article, you should know everything there is to know about Compound.
Compound is a permissionless and decentralized lending protocol on Ethereum that facilitates borrowings, lending, and savings. The protocol utilizes smart contracts to allow investors to exchange funds directly with other users. So rather than using a centralized entity as an intermediary (e.g. bank), you’re borrowing from or lending assets directly to another person.
This magical act is made possible with the help of smart contracts. Smart contracts are autonomous decentralized digital contracts that automatically execute tasks once certain requirements are met. So if you want to borrow 5 ETH from your friend Bob, you’ll be able to do that without having the assets interact with a centralized entity at any point.
Whenever you lend assets to Compound, the protocol gives you a special token representing your stake and interest. If you want to lend UNI, you’ll receive a token named cUNI which fluctuates based on the interest you’re earning. On some protocols, you can further utilize this token by, for example, depositing them into a liquidity pool and yield farming.
Compound calculates interest that lenders receive and borrowers pay depending on the collateralization rate of an asset. Overcollateralized assets yield lower interest rates (mainly referred to as APY/APR rates), while undercollateralized yield higher rates.
What’s the difference between the two? Whether an asset is overcollateralized or undercollateralized depends on its supply and demand ratio. If a UNI pool has a lot of tokens, it is more stable, and therefore gives worse rewards due to lower risk – an example of an overcollateralized asset.
In this section, you’ll learn more about the COMP token and its tokenomics.
Just like all other DeFi protocols, Compound is decentralized. And that decentralization is based on a governance system backed by a native governance token – in this case, COMP. COMP holders can use the token to participate in governance proposals and vote on different ideas. They can also submit the tokens to propose new governance proposals.
The idea behind governance is that the community of investors standing behind the protocol can control its direction. The token technically represents your stake in the protocol, meaning that you’re incentivized to vote on proposals that have a positive impact on the project.
COMP is an ERC-20 token that facilitates decentralized governance. The token launched on the 15th of June 2020 with a maximum token supply of 10,000,000 tokens. COMP is an inflationary token with daily emissions. Estimates show that the token will reach its maximum cap by July 2024.
The protocol raised $25 million in a Series A funding round led by A16z in 2019. Before that, Compound raised an additional $8.2 million in a seed round held in 2018.
The initial token distribution went as follows:
Compound has an inflationary emission rate of 1,234 COMP tokens per day. These tokens are distributed to the users of the protocol, mainly through markets such as ETH, USDC, DAI, etc. Emissions are managed within the governance process. Suppliers earn one half of the emissions while borrowers earn the other half. The protocol has distributed 1,954.916 COMP tokens through these emissions. It has 2,550,032 tokens left to distribute.
Compound is ranked ninth on DeFi Llama’s leaderboard, having a total value locked (TVL) of $2.37 billion. The COMP token is ranked 98th on CoinGecko and has a market cap of $409 million. COMP has a circulating supply of 6,856,085 tokens and a max supply of 10,000,000 tokens.
The Compound protocol is governed by its community. COMP holders can vote on governance proposals and propose new ones with the token. Governance proposals include updating market interest rates, listing new assets, choosing protocol administrators, etc.
Governance is COMP’s primary use case. Holders can delegate their votes, discuss key items, discuss existing proposals, and vote on them. Compound has a transparent governance system that shows how much voting power each address holds.
For example, you can see that the most powerful voters on Compound are VCs that participated in its funding rounds:
Everyone who delegates 1% of COMP tokens to their address (or another address) can issue new governance proposals. Keep in mind that these proposals must have executable code. They do not represent suggestions for developers or other team members to implement.
Governance proposals have an active voting period of 3 days. COMP holders are free to vote for or against the proposals. They can also abstain from voting.
If the proposal has more than 400,00 (for) votes, it passes to the Timelock. Timelock is a smart contract that modifies the protocol and relevant system parameters. The Timelock has a hard-coded minimum delay of 2 days before a proposal, and its code is implemented. Once two days pass, the timelock contract successfully implements the proposal.
Compound is a decentralized and permissionless lending protocol that connects borrowers with lenders, allowing them to exchange assets without the use of intermediaries. Compound is completely decentralized with the help of a governance system upheld by the COMP token.
COMP has a maximum token supply of 10,000,000 tokens. The protocol is estimated to emit all tokens by July 2024. Compound is the third largest lending protocol in all of DeFi, preceded only by MakerDAO and Aave.
If you want to learn more about Compound and lending in general, I recommend reading the following articles:
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