What is Compound crypto and how does it work?

Compound crypto refers to Compound, a decentralized lending protocol, and its COMP token. People supply assets to earn interest, and borrowers lock up collateral to take loans, all through smart contracts rather than a bank. Compound was one of the earliest DeFi lending apps and helped start the yield farming trend in 2020.

What does Compound crypto do?

Compound runs money markets. Suppliers deposit an asset, and borrowers pay interest to use it. Rates are set by code rather than by a lender, and borrowers must post collateral worth more than they borrow. The general model is explained in our guide to crypto lending and borrowing.

In Compound v2, each supported asset had its own cToken. The v2 docs explain that a cToken represents your deposit, and instead of paying interest separately, each cToken becomes redeemable for more of the underlying asset over time. Any of those deposits could also serve as collateral.

How does Compound III work?

Compound III, also called Comet, changed the design. In August 2022 Compound announced the version would start with a USDC market on Ethereum. According to the current docs, each market lets users borrow a single base asset. In the main market that asset is USDC. Users earn interest by supplying the base asset, while other tokens, such as wrapped ether, are supplied as collateral to borrow it.

Liquidation also works differently from many lenders. When a borrower's debt passes the limit set by the liquidation factors, anyone can call a function named absorb. The protocol takes over the debt and collateral, paying for it from its own reserves, and the borrower is left with no debt. If reserves drop below a target, the seized collateral is offered to buyers at a discount to refill them. The docs say Compound III was audited by OpenZeppelin and ChainSecurity, though audits do not rule out bugs.

What is the COMP token?

COMP is Compound's governance token. The Block reported that distribution to users began on June 15, 2020, from a total supply of 10 million, with about 2,880 COMP a day shared across the lending markets in proportion to interest paid. That reward scheme is a big part of why June 2020 is linked with the rise of yield farming.

Holders can vote directly or delegate their votes, which makes Compound a kind of DAO. Per the governance docs, a proposal needs 25,000 COMP delegated to its author, then a two day review, a three day vote and at least 400,000 votes in favor. Approved changes wait two more days in a timelock before taking effect. Compound III markets on every network are controlled through this system.

How is Compound different from Aave?

Both are pool-based lenders run by token holder votes. The main difference is structure. Aave lets users borrow many assets from shared pools, while each Compound III market isolates one borrowable asset with its own list of collateral. With either one, users bear the risk of code flaws, price feed errors and sharp market moves that trigger liquidations.