What is the Compound protocol?
Think of it as putting your savings into a bank. When you deposit a certain amount into your savings account, you earn an annual interest on that amount. Now imagine being able to actually use that money, while it’s earning you interest. That’s the brilliance of Compound.
How it works
Let’s say you put 0.5 UNI into Compound. The amount of supply and demand for a particular asset automatically determines its interest rate. This means that (at the time of writing), you would earn a whopping 6.50% annual percentage yield (APY) on the amount of UNI you supplied. After supplying, you also have the option to use it as collateral to borrow any other token of your choice on Compound.
This is where cTokens come in. The Compound white paper explains it best:
Assets supplied to a market are represented by an ERC-20 token balance (“cToken”), which entitles the user 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 a ERC-20 cToken.
Here’s how it would play out: your 0.5 UNI would be converted into ERC-20 form as cUNI. You would then be free to do as you wish with it: trade, move, or use it in another decentralized application (dapp). This interoperability is a crucial aspect of DeFi—the ability to combine multiple protocols and dapps to have control over your own assets.
Compound also possesses other important hallmarks of DeFi: Since there is no central party that controls its functioning (more on that below), it cannot be shut down. It also operates entirely through smart contracts built on Ethereum, which makes it non-custodial. This is extremely important for the security of your assets. The Compound protocol is also completely free and open-source.
What is the Compound token (COMP)?
The Compound platform was built using traditional equity fundraising. Venture capital firm Andreeson Horowitz—with now-legendary companies such as Facebook, Lyft, and Slack under its belt—was a major investor. This generated some amount of criticism: Compound couldn’t claim to be truly decentralised when its users didn’t have a say in how it runs. That all changed this year, with the launch of the COMP token.
COMP is the governance token of the Compound platform. The COMP token is distributed to users of the Compound protocol, in proportion to their contributions. The higher the demand of the token you’re supplying, the more COMP you earn.
The token is used to vote on proposed changes to the Compound protocol. COMP token holders receive voting power on a 1–1 basis to the amount of COMP held.
Still unconvinced? Rashi Jaiswal, our Senior Software Engineer summed it up best: “Compound provides an environment to enjoy benefits of multiple assets while truly owning just a single asset.”
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