The price of Compounds governance token COMP has skyrocketed from $16 to over $300 in a week and now has the highest market cap amongst all the DeFi (Decentralized Finance) tokens. To better understand what has caused this interest and if it is sustainable, we will have to take a look at what is Compound Finance and what’s the incentive for buying the COMP token?
The concept behind Compound is not brand new, it is a DeFi – Decentralized Finance lending portal. However, one can argue that Compound is the one showing the most promise and growing faster than others.
Due to the dynamic nature of the interest being based on supply and demand and the additional COMP rewards, it is one of the most rewarding in terms of total profitability (interest + rewards).
It’s quite simple in theory, you can deposit ERC-20 token and borrow another token with leverage up to around 3x if you desire. If you are confused about what an ERC-20 token is, take a look at this list over popular tokens. Examples are: Tether (USDT), BNB, Chainlink (Link), USDC, VeChain etc.
You will probably recognize a lot of those cryptocurrencies even if you didn’t know they were called “ERC-20” tokens.
COMP Governing Token
The COMP token allows users to hold power in the sense of allowing them to debate, propose and vote on changes to the Compound protocol. Simple right? Just as owning shares (stocks) in a company will allow you to vote and if you own enough shares, you can call in extraordinary meetings and cast votes on important matters. Explaining why the token is referred to as the “governing token.”
The incentive to purchase the governing COMP token for users interested in the Compound protocol should be clear and easy to understand.
The COMP token also works as a reward token. In the sense, it is granted to users borrowing or lending, which increases the overall profitability by lending or borrowing than what the interest rates suggest.
You can visit the compound vote page if you want to see what is possible to vote on.
Every day 2 800 COMP tokens (worth over $300 each at this time) is distributed to users of the Compound protocol. Which means anyone borrowing or lending in any way. The distribution is proportional to the interest, in other words the higher the interest the more COMP you will get. There is a 50% distribution between lenders and borrowers.
This means that the lending cost will be dampened by the received COMP, which is good news for borrowers, and the lenders will get a higher return than what their interest rate suggests.
The thing however that makes Compound Finance stand out is the interest rate calculation, which is quite sophisticated despite the theoretical simplicity behind the idea. It views the supply and demand for each different token and coin and then an algorithm decides an appropriate interest rate.
In other words, the interest or lack thereof dictates how much interest you pay or earn. This makes fundamental sense, if you were to borrow some highly sought-after after coins, you would expect higher interest rates, and more than likely the value of these coins would probably also go up in value in different markets.
Instead of paying you the interest rates directly to you like most things in crypto, Compound tokenizes it.
To illustrate what happens:
Say you deposit 100 USDC (one of many USD stable coins), which can for example be purchased on CoinBase. It holds its value near the dollar so it is hardly that volatile in comparison to other tokens. You decide to lend it out for 1% interest a year. Compound takes the interest you have earned during this year and gives you cUSDC (the c standing for Compound).
cUSDC will have a dynamic value that should, in theory, only grow. If cUSDC is worth $1, you will receive in 100 cUSDC for your 100 USDC. If cUSDC is worth 0.5$, you will receive 200 cUSDC. You will always receive the equivalent value of what you deposited despite the tokens varying in numbers.
It is entirely replaceable (fungible), if you were to send it to someone else, they would be able to sell it or redeem it back for the initial 100 USDC.
Getting Paid Interest
The cUSDC works as an IOU (I owe you) Compound gives you in exchange for being willing to loan out your USDC. When the interest is paid, you don’t get sent USDC instead they increase the number of USDC you get for each cUSDC. This is pretty cool as it simplifies the transaction and your reward will be immediate.
You might be wondering how this is possible, and the answer is since all the USDC lenders are owed the exact same % interest, it allows Compound to increase the value of the cUSDC that they all have.
Let us say you earned 10% interest, and when you redeem your 100 cUSDC you receive 110 USDC instead of the original 100 USDC.
This means that effectively cUSDC is an ever-growing number of USDC which grows at the interest rate. In theory, it can only go up, but of course there are certain risks such as liquidation failure (borrower side), hack or other exchange issues.
The significant part here is that you can lend your USDT on Compound without actually getting on their platform if that’s what you want, all you need to is buy cUSDT with your USDST and you will be able to benefit from the Compound interest rate.
cUSDT has newly been listed on FTX, which is a quite good crypto exchange that allows you to deposit USD/BTC or any stable coins to start trading multiple trading pairs. For people without any interest in setting up a wallet to the Compound app, this is the easiest method.
Note: The reason cUSDT is being listed above cUSDC is due to far greater interest. Compound has the highest interest on USDT compared to anybody else right now. In other words, it’s what makes the lender the most money.
If you would like to connect your wallet and use the Compound app it’s straightforward as well. And you can connect with Coinbase Wallet, Ledger or Metamask. One of the first two should be very familiar to most people involved in crypto, making it quite hassle-free.
There is no need for ID verification. In the spirit of Decentralized Finance, anyone can start borrowing and lending tokens without having to verify their identity or give up sensitive information. However, if you register at FTX to buy cUSDT and/or COMP you will have to verify ID if you plan on withdrawing more than 2 000 USD daily.
One of the significant concerns with any crypto protocol, perhaps even more so decentralized ones, is the aspect of security. Compound has been around since 2018 and since that time raised over $25 million for their project, in other words, this is not a small hobby project.
They have undergone several audits focused on security, which was conducted by several well-known agencies. As of this date, there have not been any security breaches with regards to Compound.
Start earning interest
If you want to start earning interest on your passive crypto, you can do so either through FTX or by connecting your wallet directly to the Compound app. Take a look at the interest rates to make sure you maximize the possible return on lending. As of right now USDT is the clear winner.