Compound is a protocol on the Ethereum blockchain that establishes money markets, which are pools of assets with algorithmically derived interest rates, based on the supply and demand for the asset. Suppliers (and borrowers) of an asset interact directly with the protocol, earning (and paying) a floating interest rate, without having to negotiate terms such as maturity, interest rate, or collateral with a peer or counterparty. Each money market is unique to an Ethereum asset (such as Ether, an ERC-20 stablecoin such as Dai, or an ERC-20 utility token such as Augur), and contains a transparent and publicly-inspectable ledger, with a record of all transactions and historical interest rates.
Unlike an exchange or peer-to-peer platform, where a user’s assets are matched and lent to another user, the Compound protocol aggregates the supply of each user. When a user supplies an asset, it becomes a fungible resource. This approach offers significantly more liquidity than direct lending; unless every asset in a market is borrowed, users can withdraw their assets at any time, without waiting for a specific loan to mature. Assets supplied to a market are represented by an ERC-20 token balance, a “cToken”, which entitles the owner to an increasing quantity of the underlying asset. As the money market accrues interest, which is a function of borrowing demand, cTokens become convertible into an increasing amount of the underlying asset. In this way, earning interest is as simple as holding an ERC-20 cToken.
With smart contracts systems, Compound has become a key player in revolutionizing the outdated finance system. It is one of the smooth, highly secure, and easily accessible DeFi protocols out there. Although highly reputed, the smart contract system is a little too volatile, so the risks must be kept in mind while investing in the platform. Compound Finance is one of the oldest and tested lending and borrowing platforms in the ecosystem of Decentralized Finance. It was designed as an experiment to overcome the shortcomings of the fiat money market, but slowly rapidly became one of the central pieces of the DeFi ecosyste.