A Compound protocol is gaining a lot of attention these days. This article briefly explains the Ethereum-based compound protocol, focusing on the concept of lending and borrowing assets.
Learning of the Blog
- What is COMPOUND?
- What’s Special About It?
- How are Interest rates managed in Compound?
- Understanding the Concept of Lending & Borrowing Assets
- Conclusion- Is Compound Safe?
What is COMPOUND?
Few crypto experts define cryptocurrencies as the money of the future. But there is no denying that they lack a mature and diverse ecosystem of financial services compared to traditional fiat currencies.
COMPOUND is a decentralized protocol for the frictionless borrowing of Ethereum tokens that enables suitable money markets to function and offers a positive approach to store digital assets, without the demerits of traditional approaches. It lets users earn interest or borrow assets against collateral. With Compound, anyone can supply assets to Compound’s liquidity pool and begin earning interest rates where the rates are based on supply and demand. Soon after the launch, the protocol support Ether and ETH-based tokens, along with TrueUSD, Basic Attention Token, 0X, and. November 2019, Compound managed to raise $25 million to expand the crypto lending.
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What’s Special About It?
As we have learned a bit about this protocol, let’s quickly understand what’s so special about this protocol.
Before we delve deep, it is important to note that Compound is an entirely open protocol, which indicates that the lending process neither involves lengthy paperwork nor any intermediaries.
The compound protocol offers users a positive yield while storing assets. When dealing with Compound, a user can simply specify the asset he desires, and unlike traditional exchange, the transaction takes place instantly. Borrowers and lenders don’t have to negotiate interest rates or maturity dates. Moreover, there are no pre-defined terms; one can use the protocol as short or as long as they want and can withdraw or repay at any point in time. In this, users don’t have to wait for days or months for their loan to get matured as transactional processing is instantaneous.
How are Interest Rates Managed in Compound?
The compound protocol enables borrowers and lenders to interact directly with the protocol, rather than exchanging digital assets with one another. Now comes the question, how interest rates are set in this protocol?
Interest rates are a function of the liquidity available in each money market. Such rates fluctuate in real-time on the basis of supply and demand for the underlying asset. Here it is important to note that interest rates and liquidity are closely related, i.e., when liquidity is abundant, then interest rates are dropped while when liquidity becomes scarce, interest rates increase up. It is as simple as that.
Understanding the Concept of Lending & Borrowing Assets
Now, without any further delay, let’s understand how fair and transparent the lending and borrowing process of the Compound is.
Lending Process in Compound
The lending process in Compound seems similar to that of the banking system where customers are paid for depositing their money at the bank. Similarly, in Compound, the customer has to deposit his assets in order to earn decent interest rates. With this protocol, one could earn an interest rate on their fiat money market accounts. But unlike traditional finance systems, users at any time can withdraw their assets and start earning interest. This is because there is no duration lock neither for deposits nor credits and no penalties involved when dealing with the Compound protocol.
What user has to do is connect their wallet, select the preferred assets, specify the quantity, and then enable assets. The wallet will then ask for confirmation, and the user just needs to pay a small gas fee for the same. Finally, the assets are supplied from their wallet directly to Compound, and one can instantly begin earning interest.
Just like lending, the borrowing process is easy and instantaneous in the compound protocol. To have zero counterparty risk, in the compound protocol, borrowers have to deposit collaterals, and in fact, they are not allowed to exceed their capacity of borrowing. Thus, it does not allow borrowers to borrow or redeem that would raise the value of their borrowed assets above their capacity. Compound maintains excess collateral to ensure that there are nearly zero risks of a borrower defaulting.
Conclusion- Is Compound Safe?
Many blockchain professionals believe that the Compound is a reliable and trusted protocol for lending and borrowing as so far it has have not been breached by hackers. But the risks associated with it shouldn’t be overlooked in any sense. Many products are coming up that relies on Compound’s smart contracts, which ensure that protocol is efficient in offering the desired viable solutions. The Compound’s main design goals, such as avoiding credit risk, providing liquidity, and frequent adjustment of interest rates, is what makes this protocol unique.
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