Compound Finance or simply Compound is now the leading DeFi platform in terms of Total Value Locked (TVL), as well as in its governance token’s market cap relative to other DeFi tokens.
Simply put, Compound allows anyone to be able to earn money on the crypto assets they save (lock up).
DeFi has been on the rise, posting double digital gains and outperforming even Bitcoin in terms of growth. The decentralized lending market, in particular, has seen the most tremendous surge both in price and locked-up assets.
Even mainstream media has heavily reported and praised decentralized lending platforms due to their new and innovative approach to borrowing and lending. DeFi platforms like Compound enable users to easily lend or borrow money by locking up assets in smart contracts, allowing them to save or earn more since intermediaries are eliminated.
In this guide, we shall review the inner workings of the Compound protocol, as well as explore the steps in creating passive income while using this DeFi platform.
Table of Contents
Background
Compound is a San Francisco based company founded by chartered financial analyst and former economist Robert Leshner. Leshner is currently the CEO of Compound.
The company was able to successfully raise funds from private investors twice: an $8.2 million seed funding round in May 2018 and a $25 million Series A round in November 2019.
Compound was financed by the leading VC firms in the crypto space such as Andressen Horowitz, Coinbase Ventures, Polychain Capital, and Bane Capital Ventures.
How the Compound Protocol Works
Compound is a protocol composed of smart contracts built and designed to run on the Ethereum blockchain. Like most lending protocols, it enables lenders to provide loans and borrowers to take out loans by locking up crypto assets into the system.
These assets can be withdrawn anytime. Similarly the loans can be repaid anytime as well.
Compound can be accessed via software or web wallets including Metamask, Coinbase Wallet, TrustWallet, etc. If you want lend or borrow, all you need to do is connect to the compound network via any of these wallets.
Once that’s done, you simply need to enable an asset, then start lending or borrowing.
Different crypto assets have different Supply and Borrow Annual Percentage Rate (APR). These APRs change frequently according to the supply and demand of the asset.
Interest Rates
The interest rates received by the lenders and paid by the borrowers are calculated algorithmically depending on the supply and demand of the underlying asset. These interest rates are updated every time a block is mined. In Ethereum’s case, a block is mined roughly every 10-19 seconds, hence, the interest rates change accordingly.
Native Assets
Compound Finance has two native assets in the system: cTokens, the main unit of account of the platform, and COMP, the governance token.
cToken
Compound tokens, denoted as cTokens are cryptocurrencies built on the ERC-20 protocol standard. Each cToken represents your balance in the compound platform. Therefore, it entitles you to an underlying asset locked up in the system.
Furthermore, each market has its own cToken. E.g. cUSDC, cETH, etc., which will be generated and sent to a user wallet once an asset has been locked up in the protocol.
For instance, if you want to take out a loan by collateralizing your ETH, you will automatically receive cETH in your wallet. The same goes for other assets.
COMP
Like any promising DeFi platform, Compound is governed by a decentralized system and community. This governance system is powered by COMP, the native governance token for the Compound Finance platform.
COMP is used to by by the token-holders and their delegates to submit proposals and vote on protocol upgrades. Proposed changes to the system parameters may include protocol fees, interest rates, supported collateral, and others.
Upgrade proposals require a minimum of 100,000 COMP delegated to its address. Once the proposal is created, the community can vote on a three-day period.
In order for the new upgrade to become implemented, it needs to have at least 400,000 votes and be chosen by the majority. If successful, it will be queued in a Timelock contract and become effective in two days.
Supported Currencies
Here are the available assets that you can lend or borrow on Compound:
- DAI
- BAT
- ETH
- USDC
- ZRX
- WBTC
- REP
The prices of these assets are generated by taking the median prices of the cryptocurrencies in top exchanges like Binance, Coinbase Pro, Bittrex, and Poloniex.
Compound is currently building an advanced Open Oracle System, which aims to decentralized the price feed mechanism similar to how Chainlink does it.
How to Earn Passive Income with Compound
Compound is probably one of the best if not the best way to earn money through lending. This is evidenced by the sudden spike of users participating in supplying assets.
Let us take you through the steps required in making passive income with Compound.
Choose which asset to lend
Compound allows many different crypto assets to be supplied in its system. Choose which one you’d like to lend. To make it easier, go over to Defipulse where you could input the asset and quantity you’d like to lock up and generate the estimated income you’ll get. You could even compare interest rates with other lending platforms.
In this example, let’s say we choose Basic Attention Token (BAT). From here onwards, you can replace ‘BAT’ with whichever token you have chosen, and follow the guide as is.
As you can see from above, Defipulse says that if I lend 5000 BAT (worth roughly $1350 as of post date) I’ll be able to generate a 24.95% passive income monthly, which is roughly $28.27/month. Not bad for earning money while you sleep eh?
The larger the amount you lend, the more money you make. But be careful with locking up large amounts of assets. And be aware of the risks involved such as losing your seed phrase or having bugs and other unknown vulnerabilities that will cause the system to fail.
Once you get past all that, the first thing you need is to buy BAT from one of the exchanges that offer the cryptocurrency, which we trust that you’ve already learned to do at this point. You can buy BAT on Binance, Coinbase Pro, OKEx, Huobi Global, etc.
Install and set up MetaMask
MetaMask is a web extension wallet that connects you to the Ethereum blockchain and manages your private keys. Head over to Metamask.io and click download, then install. Remember that this extension only supports Chrome, Firefox, and Brave.
Once successfully installed, you should see the orange fox icon on the top-right of your browser near the address bar. Click it and then click the “Continue’ button as well to begin your account setup.
You’ll then be asked to input a password for your MetaMask account. Make sure to remember this as it will be required each time you want to access the browser wallet. Once the password has been typed, click ‘create’.
Once that’s done, click the shaded area to uncover your seed phrase. Write it down and store it somewhere safe as it is extremely important.
It will allow you to recover your wallet in case you forget your password or your MetaMask account becomes inaccessible for other reasons. Remember that if you lose your seed phrase there’s no way to recover it anymore.
Transfer your BAT from the Exchange to MetaMask
Now that you’ve bought BAT and set up a MetaMask account, it’s time to transfer.
First you need to copy the address of your Metamask wallet. Open the extension and click on the hamburger button ≡ on the top-left side and click ‘Add Token’ and then type in ‘BAT’ or whichever token you choose. Now you can receive BAT tokens.
Hover over the account name at the top of the window, which will show ‘Copy to clipboard’. Click on that to copy your address. Then paste the address to the ‘recipient’ field in whichever exchange you bought your BAT.
Once all that’s done, press send. Your BAT will soon reflect on your MetaMask wallet.
Enable BAT on Compound
Go to the Compound web app and be prompted to use one of three wallets. Choose MetaMask. You will be shown a list of available assets to lend. Choose BAT in the ‘Supply’ category and then click enable.
An Approve transaction will then pop up, which you’ll confirm using the same steps as before. Open the MetaMask menu, click the pending transaction, as well as the diagonal arrow on the right-side.
Supply BAT to Compound
After your transaction is confirmed, you should be able to see a green ‘Supply’ button and a purple ‘Borrow’ button under the BAT section. Click supply and then input the amount of BAT you’d like to lend to the platform.
After you input the amount, click the ‘Supply’ button at the lower part of the pop-up menu which would open up a Metamask transaction. Confirm the transaction like earlier by clicking ‘Confirm’, and then wait for it.
Make Money Grow As You Sleep
And now you have cBAT in your MetaMask wallet. This means that you’ll be earning a passive interest every 10-19 seconds as Ethereum blocks are mined. Congratulations! You are now making money while you sleep.
How Safe is Compound?
The primary risk for DeFi platforms like Compound is the likelihood that cybercriminals might be able to exploit or hack its smart contracts, which would allow them to steal locked-up assets in the platform. After all, this has happened more than once in similar lending platforms such as bZx and dForce.
Fortunately, the Compound team considers security their highest priority and have invested heavily ensuring the safety of user funds.
All of Compound’s code is made public, which enables anyone to spot and report faulty code or other vulnerabilities. Furthermore, a bug bounty is available to incentive security researchers to be on the lookout for any of attack vectors in the protocol.
With that being said, we can never be certain of the security of any financial system, especially with DeFi platforms that are very new. That’s why it’s important to not put all your eggs in one basket.
Latest Compound News
As of June 25, Compound has locked up over $547 million worth of assets, dethroning MakerDAO, and becoming the new largest DeFi platform based on TVL. This is mostly thanks to Compound’s COMP reward scheme which has triggered a gold rush among users. As a result, the price of COMP has spiked in the last few days just after its issuance.
On the flip side, there are some pundits who see the sudden surge in locked-up assets and price as a threat to the long-term sustainability of the Compound ecosystem.
Then there is the scalability issue as the Ethereum network has hit a new all-time high recently. Furthermore, gas usage analysis proves that gas consumption came from higher utilization of smart contracts instead of normal payment transactions.
This means that DeFi is the one of the major reasons for the surge in gas usage.
On June 25, Binance had decided to list COMP and opened its trading against BTC, BNB, BUSD, and USDT pairs. Users can also deposit COMP in the exchange.
Conclusion
Compound is one of the most promising DeFi platforms to date and it has been moving very fast lately.
Compound appears to be one of crypto’s biggest players and is pushing the entire industry forward. We are finally seeing blockchain and smart contract platforms being applied in the real world solving real problems and innovating old business models.
The revolution is unfolding before our very eyes. But like most DeFi platforms, Compound will eventually face scalability issues as it grows further. For that reason, its long-term success partly relies on the rollout of Ethereum 2.0, which the Ethereum devs have been planning and working on for the past several years.
