Compound Token listed on the CoinmarketCap on June 17, 2020 at around $74 then lost XX% value to land at $64 then it quickly shot upto $334 in less than 3 days. At the time of this writing Compound is coasting at around $200.
What is the craze behind this DeFi token?
What to expect in this article?
- What is Compound?
- How does Compound work?
- How to Lend and Borrow on Compound?
- How does Liquidity Mining work on Compound?
- How much interest can I receive?
- Advantages and Disadvantages of Compound
- Red Flags you need to consider
- How to earn interest on Compound using Coinbase Wallet?
- How to earn interest on Compound using Exodus Wallet?
- How to earn interest on Compound using MetaMask wallet?
- How to earn Interest on Compound using Ledger?
What is Compound?
Compound is a Decentralized Finance (DeFi) project that allows you to place your crypto assets as collateral to earn interest and even take a loan against your crypto collateral.
There are many DeFi projects out there that let you deposit your crypto to earn interest, however, what makes Compound special is the ability to earn a spread between your deposit vs. your loan while earning COMP tokens. The COMP token is currently trading at over $234 dollars.
How does Compound work?
To get started with Compound you will need to have some crypto. As of today, the cryptos that are accepted on the Compound platform are: 0x, Augur, Basic Attention Token, DAI, Ether, USD Coin, USDT, Wrapped BTC.
For every cryptocurrency you deposit on Compound platform you receive a receipt of deposit in the form of cTokens. That means, for example, if I deposit Ether on the platform, I will receive cEther. These ERC20 cTokens are proof that you have deposited money on Compound. When you are ready to take your money out, you simply exchange your cTokens for the underlying asset.
You can check how many cTokens you can receive from your crypto assets.
For example, cETH is valued at .02001216 ETH which simply means that for every 1 Ethereum(ETH) we deposit on Compound we get 50 cETH. You will always retain this 50 cETH until you are ready to redeem your ETH.
When you redeem your 50 cETH you might receive 1.1 ETH, the extra represents the interest you have accrued for the time you have supplied your crypto asset to the platform. In theory, cTokens increase in value over time based on the interest that gets accrued into the cTokens. In addition, you would have accrued COMP tokens throughout the duration of your deposit.
How to lend (supply) money on Compound?
To get started, you need to click on the App button on the Compound website.
You will then be prompted to connect with one of your wallets to transfer the funds. Right now, there are three options: Coinbase Wallet, Ledger and Metamask.
Click on the option that best suits you. Once connected, you can transfer the money into your Compound account.
How to borrow on Compound?
Once you have supplied the assets on the platform, Compound lets you borrow against your collateral. Generally, there is a collateral to borrow limit, that means, for every $100 you supply to the platform you will be able to borrow a certain % (depending on the asset), in this case, let’s say the limit is 75% then you can borrow $75.
How does Liquidity Mining work on Compound?
Liquidity Mining is a concept that has evolved in the past year with the DeFi projects.
Incentivizing users for providing liquidity to the platform is termed as Liquidity Mining. Liquidity mining replaces the rigs and PoW with the ‘usage of platform and creating value on the platform.’
Let’s use an example. For a platform like Compound to run it needs two parties: those who are willing to put their assets on the platform and those who are willing to take loans from the platform. Because most DeFi platforms require ‘collateral’ to borrow, the users act as borrowers as well as lenders.
In other words, the users create liquidity on the platform by both supplying their assets and then taking loans against their assets. For creating liquidity on the platform they are rewarded with COMP tokens. While the increasing price of the COMP tokens is definitely a factor in wanting to access more, these COMP tokens also provide them with ‘voting’ rights so that people who have provided the most to the platform can also have a voice in how the platform operates.
To avoid 51% attack, Compound keeps 50% of voting rights with the core team while assigning 50% voting rights to those who acquire most COMP tokens by providing liquidity to the platform.
Bubble in the making?
Some industry voices have raised concern that the Compound’s model of creating value by exchanging one asset to ‘game’ the system to generate more COMP tokens will not sustain in the long term. For instance, one could take a $1450 USDT loan against crypto collateral of $1500 and receive COMP for bringing their assets to the platform as collateral and for taking the loan. However, some people are now taking that 1450 in USDT back to the platform (as a supply) and taking a loan against this USDT in USDC (for example, $1400), thus getting paid for lending and borrowing again.
In this situation, the liquidity on the platform will show as if it has a supply of $2950 and lending of $2850, however, in reality the total assets on the platform are only $1500 and total lending is still $2850. In other words, total asset collateral is much less than the money lent.
And we have only run 1 iteration. People have been playing multiple iterations of this gaming model to inflate the value on the Compound platform.
This is very close to the broken fractional reserve model that Banks use in the traditional financial markets and having this model in a place that is highly unregulated is somewhat disconcerting.
Advantages of Compound
Elite team backing the project
This is what distinguishes Compound from other DeFi projects (some may even be superior to Compound) but Coinbase and the VC relationships that Compound has is quite crazy. This is why Compound got listed on Coinbase so quickly bringing exposure to a big trading base.
The US Banks pay almost no interest on your deposits. In certain cases, you are charged with ‘maintenance’ fees while the bank turns around and makes money on your money. The DeFi changes this equation and provides an opportunity for your money to work for you. DeFi platforms like Compound and Celsius Network help you earn interest on your cryptos.
The thing we like the most about the up and coming DeFis’ including Compound is that there is no lock-in period. You will earn interest for the time you held your cryptos on the platform. You will have complete control on when you get in and get out.
When you are in a fix for some immediate cash but don’t want to sell your crypto wealth – platforms like Compound can be of immense help (don’t forget to look at market volatility aspect below in the disadvantages).
No credit checks to borrow
Traditional financing options are available to people with good credit history. People who do not have good credit history are penalized with massive interest rates. DeFi takes away the need for credit checks to borrow money.
Compared to the loan sharks in the traditional market the interest rates on the DeFi platforms are quite reasonable. The only drawback is that you need to have collateral to avail the loans which is counter-intuitive for many people in need. In the future, when the non-crypto assets are brought to the DeFi platforms – they could upend the existing loan shark practices with the roots.
Disadvantages of Compound
What happens if there is a flash crash and a quick recovery? Between March 10 through 12th of 2020, Bitcoin fell from $8000 to $4900, a crash of 40%. In the next 30 days or so Bitcoin cruised through its $8000 price point. If you had taken a loan using Bitcoin as Collateral (let’s say you took $6000 against $8000 Bitcoin, when the price tumbled, your bitcoin would have been liquidated to cover the $6000 loan. You could have lost in the eventual recovery. The whole point of using Crypto as collateral is to AVOID liquidation of your favorite cryptos but that is exactly what will happen if the market faces a flash crash. You must be aware of this before putting your assets as collateral.
Same is true if the value of the asset you borrow increases. For instance, let’s say you put your $1000 in DAI as collateral and borrow Ethereum. Let’s assume that on the day $750 (maximum loan) was equal to 3 Ethereum at $250 each. If Ethereum’s price shoots up to $500 each, you would have experienced a partial liquidation since the asset you borrowed has gone over the underlying ‘collateral’.
Auto-Liquidation of crypto
This is a no no for longterm crypto hodlers who never want to liquidate their crypto wealth and if the market takes a nosedive (like it did in March 2020) you will run into the risk of auto-liquidation of your crypto wealth to cover the ‘loan’. You cannot do anything about it as these smart contracts are executed automatically when the value of your collateral goes to a certain level you agreed to when taking out the loan.
No customer support in case sh*t hits fan
If you run into problems or there is loss of funds either during transfer or after transferring the funds for whatever reason, your options to get help might be limited to none.
Collateral, instead of credit rating
If you have Bitcoin but need USD – you could simply sell your Bitcoin to avail the USDT. The real value of a loan is where people are short on money. Compound doesn’t address this market since it needs people to have collateral. Compound model works for people who have cryptos that they don’t want to dispose of because they expect the prices to go up, as such, they could use a platform like Compound to take care of short-term cash flow issues through a collateral based loan.
Limited crypto options
Compound may add more assets in the future but for now they have limited options which could deter many potential clients from using the platform.
Meager interest rates for non-Stablecoins
Compound’s model is based on demand and supply. Since most people want to avail loans in stablecoins like USDT and USDC the volume for those stablecoins is through the roof while other good cryptos lack demand on the platform, this in turn limits the interest rates on these crypto collaterals.
Every transaction on Compound costs you gas (fees in ethereum). You have to keep an eye on the fees you are paying each time you transact on the platform.
Red Flags with Compound to consider
Hacks/future vulnerabilities in smart contracts
You don’t know what you don’t know. This is particularly true about the smart contracts and system vulnerabilities in the crypto space. What happens if someone finds an exploit in the code to mine Comp or what happens if the system is hacked by brute force? What happens to the coins that are collateralized on the platform? There were some concerns about the Compound code that was brought to the company’s attention.
Connecting your wallets to withdraw might be risky
You are connecting your Coinbase/Metamask wallets to Compound. What happens if there is a glitch in the contract or someone deliberately attacks through brute force to execute unauthorized transfers?
Not fully decentralized
Don’t let the name DeFi fool you. Compound aspires to be a fully Decentralized Finance platform in future, however, it is not fully decentralized at the moment. This means, in theory, the team can override the control on the assets on the platform to walk away with your funds, again this is in theory not that the team will do such a thing.
What happens if and when Comp token value falls down?
People are getting creative and choosing to get paid in Comp tokens. When people have accumulated Comp tokens and dump it on the market, what happens? If the value of Comp falls down drastically, it could disrupt the entire model on which the current framework works.
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Compound is an interesting project. We are not fully convinced about its future sustainability and for that reason we are sticking with Celsius Network for now until this hype cycle dies down with Compound and then we will come back to test it out for ourselves.
Many Compound fans might think that we are missing out on an awesome project and they may be right, however, we have decided not to FOMO a long time back even if it means missing out on a few good opportunities.
You do what is right for you.
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