What is Compound Coin?
What is a Compound Coin?
You may have heard of compound associated with cryptocurrency, but what exactly is it? Compound is software that is found on Ethereum in which the goal is to incentivize a computer network to run a traditional money market. Using multiple cryptocurrency assets, Compound allows for services such as lending and borrowing without the need for a bank or other middleman.
Compound Coin Cryptocurrency
Of course, it all begins with cryptocurrencies which can be thought of as digital money. The most famous of all cryptocurrencies is bitcoin. To fully understand how cryptocurrencies work, it starts with a decentralized network that is part of a blockchain. A blockchain can be thought of as a digital path that has independent nodes which verify and validate transactions independent of a central source.
In the cryptocurrency network, you can make a direct payment to a person, business, or entity without having to go through a bank or centralized financial service. But this goes beyond direct payments as the financial services that are served through a blockchain include checking, savings, lending, borrowing, insurance, taxes, and accounting.
Today, Etherium is the decentralized blockchain network that houses the Compound protocols. This network is in contact with other decentralized blockchain apps where native cryptocurrencies are created. This is where the Compound Coin comes into play. With Compound Coin, you can deposit your cryptocurrency into pools that allow access by borrowers. The result is that you earn interest by allowing your money to be invested in this manner.
Origins of Compound Coin
Created by Robert Leshner and Geoffrey Hayes, Compound represents one of their entrepreneurial adventures which includes Britches, in which PostMates hosts local shops that sell their inventory. Compound has proven to be a remarkable success, raising $8.2 million in capital for firms such as Bain Capital Ventures and Andreessen Horowitz in 2018 alone.
By 2019, over $25 million was raised by many of the same investors while adding new ones to the group. As it stands, Compound is continuing to grow in popularity as more people are discovering its benefits.
How Compound Coin Works
When you make a deposit in Compound, a cToken is created for the lender. This can be a cBat, cDai, or cEth, but these are all cTokens. You can trade a cToken with no restrictions, but you can only redeem them for the cryptocurrency that is secure in the protocol. Because the process is automatic, you can withdraw deposits at any time. A specific set of cryptocurrencies are supported by Compound which includes the following.
- DAI, ETH, and USDC
- ZRX, USDT, and WBTC
- REP, BAT, and SAI
Anyone with these cryptocurrencies can now borrow or lend through Compound without having to go through an intermediary such as a bank or financial institution. This means faster results using this direct method that also protects the borrower and lender.
For example, if you own one or more of the cryptocurrencies that have been mentioned, then you can use the Compound protocol to deposit, lend, lock, or send as they all use the same function. This mean that you can deposit money into your crypto wallet. You can lock your money just as if you put your money into a savings account into a bank. If you have someone that you need to send money to, you can do that through the Compound protocol. And finally, you can lend your money to another person on the protocol and earn interest with that cryptocurrency.
Lending Compound Coin
The interest you earn will be on the type of cryptocurrency that you have lent. So, if you are lending BAT, then you are earning interest on the BAT. This works because you are providing your cryptocurrency to those who need loans for a wide variety of reasons. Your currency is being pooled with others who are doing the same thing. This helps reduce the individual risk while providing real interests for the money that is being lent.
Borrowing Compound Coin
Once the cryptocurrency is locked into the Compound, you can borrow against it if you desire. The amount you can borrow will be based on the quality of the asset itself. This means that different currencies have different borrowing limits. In general practice, you cannot borrow more than you have locked into the compound. And, you must pay interest on what you have borrowed.
The advantage is that no credit check is required since the locked funds are used as collateral. But the heart of the lending and borrowing system is the interest rates. Locking the currency into the Compound is a necessary step. This creates Compound tokens or cTokens as they are commonly known which is representative of the balance that you have locked into the Compound. It is the creation of the cTokens that makes Compound such an innovative system.
The tokens are created from ERC-20 tokens on the Ethereum network. You can trade, transfer, or program the tokens into other systems such as Dapps. The result is that you are either paying or earning interest off the cTokens depending on whether you are borrowing or lending them.
Compound Coin Interest Rates
How the interest rates work is based on the same principle of interest rates that affect currency which has been invested. The availability of the cryptocurrency combined with supply and demand represents the current conditions of the market which in turn affect the interest rates.
As Ethereum blocks are mined, the value of your cTokens will increase every 15 seconds by 1/2102400 as part of the annual quoted interest rate. That may seem like a tiny amount, but there are 2,102400 fifteen second blocks in a calendar year.
So, the larger the pool of cryptocurrency locked in the Compound, the lower the interest rates will be. However, the lower rate will help encourage borrowing which in turn reduces the amount of cryptocurrency in the pool that is available. When you borrow against the cryptocurrency that is locked away, its position may be closed if you get too close to its value. This is margin call in which you keep the money that is borrowed but lose the collateral.
And that is how the Compound coin or cTokens work when borrowing or lending cryptocurrency.
Zanthe Alexander Bentley is a finance veteran with over 25 years’ wealth management experience advising both family offices and institutions on their corporate finance requirements including capital raises (debt & equity), restructurings and M&A activities. He has significant experience in investment management and investment banking and spent nine years at UBS focused on convertible bond arbitrage and equity derivatives.
Prior to getting involved in Asset Management he expanded a small Spanish brokerage from a handful of staff in Barcelona to a diversified brokerage company with over 150 personnel spread across 9 countries, transacting deals from High Grade to High Yield Fixed Income and Loans; Structured Products through to exchanged traded equities.
After taking time to focus on family office activities in Asia, Zanthe-Alexander now leads an ambitious zero-leveraged fund providing exceptional growth and income to Sophisticated Investors.
Zanthe Alexander Bentley Twitter: https://twitter.com/BentleyZanthe