What is Compound?

Compound Finance is one of the pioneers of DeFi. Before the term "DeFi degen" even existed, the Compound Labs team had a wild idea. They wanted to make lending and borrowing as easy as clicking a button, without all the red tape and bureaucracy of traditional finance.

And so, Compound Finance was born! With its revolutionary use of smart contracts, users could finally maintain custody over their funds while accessing financial services. No more cumbersome KYC processes, no more complex protocols, and best of all, no more waiting in line at the bank. With Compound, you can lend and borrow crypto tokens with a flick of the wrist and a chuckle of the heart.

The platform quickly caught the attention of the DeFi world, and soon, it became the talk of the town. People couldn't get enough of its user-friendly interface and transparent fees. And, with its cutting-edge security measures, users could rest easy knowing their assets were safe from the clutches of evil cyber villains. Many have tried to hack Compound Finance, but failed miserably – except that one time...

On October 3, 2021, the smart contracts that were responsible for distributing the liquidity rewards had a bug. About $22M of those tokens were exploited due to the same bug that drained $80M the week prior. 

To explain how Compound Finance got hacked, we have to give some context about their security measures. Compound doesn't use a multi-sig wallet. Instead of having multiple signatories to approve upgrades immediately, changes can only be made after a 7-day period. This security architecture makes the protocol resilient to hostile changes, though the multi-sig security scheme is more popular among DeFi protocols. Now you are about to find out why.

This wasn't the type of hack where the bad guy preyed on the protocol. It was much funnier than that. The bug mistakenly distributed more tokens than it was supposed to. Users who were expected to receive 10 COMP woke up with 100 COMP in their wallets. Nobody is perfect, but don't tell me you would't withdraw the funds and run for the hills. And that's exactly what happened!

Compound Labs stood helpless, watching how the smart contract was drained out of funds. They had to wait for 7 days before making any changes. This situation didn't sit well with Robert Leshner, the founder of Compound. In a moment of panic, he threatened the thieves with doxxing if they didn't return the money. To this day it isn't clear how doxxing would have worked since Compound doesn't require KYC. Later on, he backpedaled on his statement and asked users politely to return the crypto.

If this happened in traditional finance, police would have knocked on everyone's doors asking for the money. In DeFi, there is no such thing as a central authority. So, the situation has been resolved in a friendly manner. Users who returned the crypto in good faith were promised perks. Overall, the protocol didn't suffer much, and the gap has been gradually covered.

The incident with Compound is a good reminder that once you sign up for a DeFi protocol you automatically accept the risks. On the other hand, Compound represents a marvelous DeFi product that serves thousands of users around the world.

It's not just the Compound Labs that manages the protocol. Compound is also led by a community of COMP token holders, who get to vote on the protocol parameters and rewards distribution. As you can imagine, whales already have a big bag of COMP tokens to influence the voting mechanism. However, they have to think in the long-term interest of the protocol. If users feel left out the governance process, they can move on to other DeFi protocols, which drives down the value of COMP. There is a delicate balance between the small guy and the whales, and Compound Labs sits as the mediator between them. 

How does Compound work?

Compound is a collection of smart contracts on Ethereum that users interact with every time they want to borrow or loan assets. If we abstract the user-friendly interface, you are actually interacting directly with their smart contracts. You can think of smart contracts as your personal clerks – except they don't take vacations and never complain.

Smart contracts on the Compound platform automate the process of lending and borrowing, providing a transparent and secure way to handle the exchange of assets. Borrowers can take out loans and pay interest, while lenders can earn interest on their deposits. The interest rates on the platform are determined by supply and demand, and can change dynamically as more assets are deposited or borrowed.

Compound Finance charges fees on both borrowing and lending activities, which are used to cover the costs of operating the platform and to compensate the Ethereum network for processing the transactions. These fees are a small percentage of the total loan amount and are automatically deducted from the relevant user's account.

The price of assets on the Compound platform is determined by the supply and demand for that asset. As more assets are deposited into the platform, the supply increases and interest rates may go down. Conversely, if more assets are borrowed, the demand for that asset increases and interest rates may go up. This creates a dynamic market that allows users to take advantage of changes in interest rates to maximize their returns.

Compound cTokens

cTokens are the primary way of interacting with the Compound protocol. Each asset on Compound is integrated through the cToken contract, which represents the balances supplies to the protocol. As a user, you are minting the cTokens yourself.

So, what exactly are cTokens? Think of them as magical coins that represent your deposit or loan on the Compound platform. For example, if you deposit USDC into the Compound platform, you'll receive a corresponding number of cUSDC tokens. These cTokens can then be traded or used as collateral for other loans, making it easy for you to move your assets around the platform and earn interest in the process.

But wait, there's more! cTokens also have their own unique interest rates, which change dynamically based on supply and demand. This means that as more people deposit or borrow assets, the interest rate for that asset may go up or down. It's like a never-ending game of financial musical chairs, and you're about to get the last laugh! cTokens accumulate interest the longer you hold them. This means you will be able to redeem the underlying tokens plus the interest anytime you want. 

How to make money on Compound?

Compound does a couple things, and they do a damn good job at it. Lending & Borrowing are by far the most popular features. Looking at where DeFi is at right now, it seems a trivial feature. Yet, most of the DeFi protocols we see today inspired themselves from Compound's architecture, and that says a lot!

You can easily lend your crypto assets and make a nice buck out of the interest rates. Or, you can borrow from Compound and increase your purchasing power. We will explore how each method works and give you out the blueprint for a practical DeFi strategy.

Compound Lending & Borrowing

Whether you have $100 or $10,000 sitting idle in your wallet, Compound helps you multiply the amount with little to no effort. As a lender, your funds are moved into a liquidity pool where borrowers have access. Each of these pools have a different amount of liquidity, which helps you assess the degree of profitability.

For example, a pool with less liquidity implies there is more demand for that asset. Therefore, your assets are more valuable for the borrowers, and they are willing to pay you a much higher interest rate. Pools with a lot of liquidity still pay, but at a lower interest rate. This is the case with less volatile assets such as stablecoin pools.

For stablecoin pools like USDC, the APY is around 3.4%. This is almost half compared to the 6.8% US Treasury bond yield, but it has a couple advantages. USDC is already part of the crypto market. In other words, you can do much more with USDC inside of the DeFi space than traditional finance. Secondly, you are able to withdraw your USDC at any time compared to the lock-up period for bond yields.

To lend on Compound, follow these steps:

1. Open the Compound app

2. Click on the asset you would like to supply

3. Before you can Supply an asset, you must Enable it first. This allows the Compound protocol to interact with the asset in your wallet. Click "Enable", and submit the transaction.

4. Type the quantity you’d like to supply

5. Click "Supply"

6. Profit!

Here's a sweet deal, as a lender on Compound you are entitled to receive COMP rewards. This means you can receive a portion of the protocol fees in the form of COMP. You don't have to take any extra action and you can monitor your rewards in the Dashboard. Ain't that cool?

If you feel like the inflation rate is going to make your dollars worthless, you can switch to crypto-native assets like ETH or WBTC. You can even borrow crypto to lend it on other DeFi platforms that pay better interest rates, or leverage (at your own risk).

As a borrower, you have to put capital upfront in accordance to the borrow collateral factor. For example, a borrow collateral of 75% for WBTC means you can borrow up to 75% of the USD value of its supplied WBTC in the base asset. So, for 1 WBTC deposited as collateral you can borrow up to 0.75 WBTC.

As much as capital inefficient it is, overcollateralization protects lenders from the risk of default and keeps the protocol running. In the event that your collateral drops in value, the liquidation process will occur. This means a portion or all of your collateral will be sold to cover the debt. To prevent your funds from getting liquidated, you can increase your collateral. Fear not, Compound will notify you if you are in danger of having you position liquidated.

To borrow on Compound, follow these steps:

1. Open the Compound app

2. Click on the asset you would like to borrow

3. Type the quantity you’d like to borrow

4. Click "Borrow" and submit the transaction.

With extra crypto capital on hand you can now play with DeFi strategies. For example, you can have a long exposure to LINK. In this case, you can supply 1000 LINK to Compound, and use it as collateral to borrow 3.5 ETH. You then send the ETH to your preferred exchange to purchase 700 more LINK. You now have 1700 long exposure to LINK, and you owe Compound 3.5 ETH. If LINK/ETH increases in value, you will be able to repurchase the 3.5 ETH you owe Compound for less than 700 LINK. You can then repay your debt, and keep the excess LINK as profit.

Holding a short position on LINK works similarly. You supply 3 ETH to Compound, and uses it as collateral to borrow 400 LINK. You send the LINK to an exchange, and sell it for 2 ETH. You now have long exposure to 5 ETH, and owe Compound 400 LINK. If LINK/ETH decreases in value, you will be able to repurchase the 400 LINK you owe Compound for less than 3 ETH. You can then repay your debt, and keep the excess ETH as profit.

Price Prediction for Compound — Can it hit $1000?

Buying and hodling COMP — the native token of Compound— is one way of potentially making money on Compound Finance.

The only utility for COMP is to serve as the governance token for the protocol. Compound, however, is not your average DeFi project. The protocol has a long standing history in the Ethereum community and it's partnering with traditional financial firms as well. That being said, COMP holders have a lot to gain from influencing the development of the Compound protocol. 

By looking at its current price, it’s natural to think about the chance of COMP hitting $1000 per token. This can happen sooner, or way in the future, and is determined by a couple of ever changing factors.

Let’s examine the potential growth of the COMP token by analyzing its tokenomics. COMP’s current market cap sits comfortably at ${MARKET_CAP}. With {CIRCULATING_SUPPLY} COMP tokens being in circulation today, that means a price of {PRICE} per COMP.

How did we come to that calculation? It’s quite easy, the price of a COMP token is equal to its current market cap divided by the number of tokens in circulation. Dividing ${MARKET_CAP} by {CIRCULATING_SUPPLY} gives us a result of {PRICE} for each COMP coin. 

By changing the order in the simple formula above we can use it to calculate other things as well. This helps us a lot because we can deduce the market cap of COMP at different token prices. Then, we can use the result to compare it to the current state of the network and see what would be required for COMP to hit that price.

At a price of $1000 per token, that means the current market cap of COMP would equal ${{CIRCULATING_SUPPLY} * 1000}. Remember that we arrived at this number by multiplying the amount of circulating tokens by $1000.

Now let’s shift our attention to the fully diluted market cap.

Some blockchains may have their tokenomics built in a way that only a small percentage of tokens are circulating at the beginning. This can be misleading because we don’t have the full picture and only take into account the current number of coins released in the market.

The fully diluted market cap represents the total value of a coin if all tokens were in circulation. COMP’s whole supply of tokens is {MAX_SUPPLY - TOTAL_SUPPLY + CIRCULATING_SUPPLY} COMP which means that no more coins above that number will ever be created.

These tokens are not created at the discretion of a specific entity. They are created automatically by the network to reward different actors that keep it secure.

How does this impact the price of COMP? Taking into account the current price of a COMP token, that would result in a fully diluted market cap of ${MAX_SUPPLY - TOTAL_SUPPLY + CIRCULATING_SUPPLY * PRICE}. COMP coins that have been burned are not taken into consideration because they have been permanently removed from circulation.

Whether it seems gigantic or not, the number we came to above only takes into account the current price of a COMP token. Doing the same calculation but with a price of $1000 gives us a result of ${{MAX_SUPPLY - TOTAL_SUPPLY + CIRCULATING_SUPPLY} * 1000} for the COMP protocol fully diluted market cap.

These are all crucial details to know when calculating if COMP can reach the price of $1000 per token. If the diluted market capitalization is way too high, the token has little room left to grow. Blockchains in general have no cap on the value they can reach, whether that number seems possible it’s totally up to you.

The future of COMP depends solely on its growth as a network used by tens and hundreds of millions of users. Beacuse Compound is an OG DeFi protocol, it is expected for it to flourish and even pump the price of COMP to $1000 by 2030.

If you’re looking to add some COMP to your portfolio, the most trusted places to get some are Binance and Coinbase.