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DeFi decrypted: Compound and COMP

DeFi decrypted: Compound and COMP

Explainers DeFi

03 Aug 2020

What if you could deposit savings into an account, earn interest, and still be able to spend that money? It wouldn’t be possible in a traditional bank account, but DeFi project Compound has made it possible to do exactly that.

Compound was founded in 2017 by Robert Leshner and during the last funding series led by VC Andreesen Horowitz it raised $25 million. The DeFi project allows borrowers to take out loans and lenders to provide loans in a decentralized manner as it operates using smart contracts.

While at first it may look similar to other decentralized lending platforms, Compound does things a little differently.

Tokenizing assets to earn on top of earnings

Available markets on Compound are DAI, ETH, USDC, WBTC, ZRX, USDT, REP, BAT and SAI. The amount of interest paid and received by borrowers and lenders is determined by the supply and demand of each crypto asset, meaning the interest rates vary for each coin. Across all markets, total supply and borrow amounts to $1.8bn and $1bn respectively with DAI, ETH and USDC in the top 3 for both.

Most DeFi lending protocols use the model of locking crypto assets as collateral to borrow more crypto assets. What’s different on Compound is that locked assets are tokenized using cTokens. When you supply assets, you get cTokens in return that represent your deposit. For example, when you put BAT in the protocol, you get an equivalent amount of cBAT which automatically earn interest for you. At any time, you can redeem your cBAT for regular BAT and get the interest you earned paid out in BAT.

That model makes your locked assets tradeable and usable in other decentralized applications (dApps) across the DeFi ecosystem. For example, if you supply USDC to earn interest on Compound, you can use the cUSDC to buy into a trading set on the TokenSet protocol – a dApp for automated trading based on pre-programmed conditions that put your crypto portfolio on autopilot. So, you’re earning interest on your USDC on Compound, while at the same time reaping the benefits of trading USDC through TokenSets.

It’s one of the most innovative features of DeFi: the ability to combine different protocols as building blocks merging dApps to create entirely new financial constructs.

Compound releases COMP to increase decentralization

Earlier this year, Compound released COMP, a governance token to replace the centralized team as a way to administer and maintain the Compound protocol. COMP token-holders and their delegates debate, propose, and vote on all changes related to Compound.

At first, the token was not available to the public and was only held privately by VCs, big DeFi players and the operators of the protocol Compound Labs. But on 15 June 2020, the institutional holders of COMP unanimously agreed to make the token available to the public. The token was officially available on June 16, and in just 5 days it shot up 300% reaching $371 up from $92. Since then COMP slowly retreated to $129 today – still up 40% from 16 June.

What’s the purpose of a governance token like COMP? It allows anyone to suggest, debate and implement changes to Compound without relying on the Compound team. These changes are called governance actions, which are pieces of executable code that are integrated into Compound once it secures a majority vote. When someone initiates a proposal, it is voted on by COMP holders and if the proposal receives at least 400,000 votes and the majority supports it, the action is queued in a timelock after which it is activated.

Governance actions that could be taken include listing additional cryptocurrencies to create new markets, changing interest rate calculations, collateral factors and indeed something like Proposal 7: making COMP publicly available.

COMP further decentralizes the protocol by letting smart contracts decide the steps it takes going into the future. But there is a catch, it’s not really open to just anyone. Only addresses that represent more than 1% of COMP’s supply – either by holding it directly or through delegation – can propose governance actions. The idea is that it stops addresses with little economic stake in the protocol to propose dangerous or compromising actions.

That is the utility layer of COMP. Trading COMP on crypto exchanges is a way for traders to benefit from DeFi uptake without actively taking part in it. With its current market cap at $330 million and 24-hour volume over $36 million, it is on par with more established DeFi tokens such as MKR, DAI, SNX and LEND.

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