Compound Finance is a lending and borrowing platform for crypto investors. On the blockchain, the Compound crypto is a form of decentralised application or dApp.
The COMP coin may also be used to vote on the Compound protocol’s governance structure. Decentralised finance has been made possible by the development of blockchain technology, and this part of it was developed by Compound Labs, an open-source software firm.
Let’s look at decentralised finance before getting into Compound Finance’s nitty-gritty. This will help you better grasp how Compound fits into the picture.
Compound Crypto and Decentralised Finance (DeFi)
‘DeFi’ is a key phrase in the cryptocurrency lexicon. It is the goal of DeFi to decentralise the whole range of financial services that are accessible to both consumers and corporations. In addition to insurance, taxation, lending, borrowing, and credit, several other financial services are offered through DeFi. When it comes to decentralised finance, there is no need for a bank to retain money, conduct transactions, or verify them. This field may also be used for the creation and governance of cryptocurrencies.
A large number of DeFi providers uses the Ethereum blockchain. Anyone may create decentralised apps (dApps) on the blockchain using their coins. Smart contracts may be used in these applications to facilitate complex transactions, lending and borrowing, and other features.
Blockchain technology has made the decentralisation of money, payments, and financial services possible. For example, anybody may mine Bitcoin, which isn’t owned or controlled by a single government or corporation. There are no restrictions on how you may transfer Bitcoin from one person to another. Miners must vote on modifications to the Bitcoin blockchain for implementation. A simple majority is required for any kind of change. Decentralisation is a unique aspect of blockchain technology. This one-of-a-kind advancement lured many people into cryptocurrency investment and trading.
Nowadays, more and more people show great interest in investing with decentralised assets such as Bitcoin, Ethereum, and various alternative coins. As biticodes-app.io has noted, “With the crypto field ballooning to over $1 trillion, many experts believe now is the right time to enter.” And Bitcoin is but one example of how crypto is gradually becoming a mainstream form of investment.
Although DeFi and Bitcoin have grown, many financial services, such as lending and borrowing, remain centralised. Owners of cryptocurrencies may lend and borrow from the compound’s pool of available liquidity.
The Mechanics
Digital assets may be crypto-staked on the compound dApp, which allows users to lend or loan certain cryptocurrencies.
You don’t have to deal with conventional financial institutions if you have assets in the form of cryptocurrency. As of this writing, the platform has more than $12.4 billion in assets under management.
cTokens, or digital assets, represent the amount of money a user deposits into the lending side of the Compound system. ERC-20 cTokens are developed on the Ethereum network. Compounds cTokens include cETH, cBAT, and cDAI, amongst other cryptocurrencies. Tokens are delivered to users in the form of the digital currency they deposited.
Tokens may be traded, transferred, or used on other dApps by their owners. During their time in the DeFi network, the tokens will continue to accrue interest on the Compound protocol. Just as with Bitcoin or any cryptocurrency, cToken owners have full control over their public and private keys. For the most part, the cToken can only be exchanged for the crypto it represents.
Because the Compound protocol takes into account the liquidity available for any cryptocurrency listed on the site, it automatically calculates and provides interest rates. The market’s supply and demand affect the prices, which vary and update on a regular basis. The interest rates are lower if a lot of money is in the Compound wallet. Adding to the pool of money accessible to borrowers means lenders make relatively little money, which is why this is the case.
However, interest rates are greater when there is a smaller pool of money for a certain cryptocurrency. As a result, users are enticed to keep their money in a smaller pool in order to receive a greater interest rate. It also encourages borrowers to borrow from big pools and refund the borrowed amount into smaller pools, resulting in reduced interest rates for all parties involved in the loan transaction.
The Transactions
With the use of the protocol, lending and borrowing operations may be completed rapidly. No intermediaries or charges are necessary; borrowers simply need to deposit money on the lending side. In comparison to using a traditional financial institution, smart contracts and decentralised execution make the procedure simpler, quicker, and less costly.
It is possible to lend any quantity of cryptocurrencies, which is also known as “locking,” “sending,” or “depositing.” This is comparable to putting fiat money into a savings account, where it instantly begins collecting interest. But unlike bank accounts, the Compound dApp is decentralised, and investors’ deposits of any given cryptocurrency are pooled together in a single account. Whichever cryptocurrency the lender chooses to deposit will be used to pay back the loan.
The Compound protocol also includes the option to borrow against money that has been deposited and locked. Anyone who contributes a portion of their cryptocurrency holdings to the Compound pool has instant access to those funds for the purpose of borrowing. There is no need to do a credit check or meet any other prerequisites for this. Depending on how much a user deposits, they may borrow a certain amount of money.
To guarantee that their funds are secured, borrowers must put down a larger sum of money than they expect to borrow. This implies that if the user does not pay back the interest and the monthly payments, there are funds available to cover the debt. When the collateralised amount falls in value, the borrower cToken smart contract immediately shuts when the value approaches the borrowed amount. This results in the borrower keeping the cTokens they borrowed but forfeiting the collateral they had put up in exchange for those cTokens.
Borrowers must pay interest on the amount of money they borrow, just as if they were borrowing from a bank or other financial organisation. The interest rates, which differ for each cryptocurrency on the site, are automatically calculated and implemented by the Compound protocol.
Final Thoughts
Users may participate in the Compound protocol’s decentralised governance system based on the number of COMP tokens they own. Every 15 seconds when an Ethereum block is mined, all lenders and borrowers get a certain quantity of COMP tokens, which are governance tokens. Each crypto asset’s interest rate and transaction volume determine how much money users get.
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