Compound Finance is an open-source protocol designed to allow developers to create a transparent and autonomous monetary market, allowing users and applications to obtain loans or earn interest without relying on any counterparty.
The protocol is based on Ethereum and can be used through various interfaces created by the community, which include the Coinbase and Huobi wallets.
Compound thus becomes a “liquidity pool”, which allows more than just direct loans to individual users, but instead provides liquidity to an entire market where users can obtain loans from the market itself or earn interest by providing liquidity.
In each market, interest rates are algorithmically determined, based on supply and demand, and interest accrues with each new Ethereum block. Moreover, there are no predefined durations or terms: users can use the compound protocol even only for the duration of a single new block, or indefinitely, remaining free to withdraw or repay at any time.
Interest rates are calculated according to the liquidity available in each market and fluctuate in real-time according to supply and demand. When the liquidity is abundant, interest rates fall, whereas if it were to become scarce, they would increase, stimulating the new supply and the repayment of loans.
They are displayed as annual interest rates, but in reality, interest accrues with each new block of Ethereum, approximately every 15 seconds.
There are also no theoretical limits to the amounts that can be borrowed from the market, but the protocol involves collateral that prevents from requesting more than the funds held.
In fact, the protocol tokenises the balances of the wallets of users using the so-called cTokens, thanks to which it is also possible to determine the maximum amounts that can be loaned. The cTokens are used as collateral to apply for loans, thus determining the maximum amount that can be obtained.
The loans are immediate and the assets thus obtained are transferred by the protocol directly into the wallet of the debtor.
The interfaces that support the Compound protocol allow selecting which assets to use as collateral, and which to place in the market to earn interest on it.
Compound Finance is a DeFi (Decentralized Finance) project, considering that the markets it creates are decentralised and without intermediaries.
It acts itself as an intermediary, however, being a public and open source IT protocol only, it is neither controlled nor managed by anyone.
Compound Labs Inc., the company that developed the protocol, controls the Ethereum address 0x8b8592e9570e96166336603a1b4bd1e8db20fa20, which is the admin of the protocol, which allows adding resources, updating the oracle of the price feed, updating the interest rate models and updating the risk model of the protocol.
However, the company promises that in the future the admin will be replaced by a DAO, governed by the community.
The cToken smart contract is also publicly available on the Ethereum blockchain, while the markets currently available are those of BAT, DAI, REP (Augur), WETH (Wrapped Ether) and ZRX (0x).
The aim of the project is to allow people to exchange the temporal value of digital assets, i.e. to enable those who hold digital assets to lend them to other people and earn interest.
But the real innovation lies in the fact of having removed intermediaries by replacing them with an open-source protocol and having overcome the limits of one-to-one loans with the creation of real liquidity markets in which there is no direct relationship between debtor and creditor, but only between them and the protocol itself.
In this way, loans are not made from creditors to debtors, but from the owners of the assets to the protocol itself, thus also allowing to withdraw the tokens at any time, for example.
In addition, the negotiation is in fact conducted by the algorithms of the protocol itself, and there are no time limits imposed.
If it were to succeed, this decentralised model could expand and create many liquidity markets capable of operating in real-time with different digital assets, much faster and more secure than is possible with traditional instruments.