What Is Compound (COMP) Crypto Token? Beginner’s Guide

Five years ago, Compound and COMP popularized yield farming and liquidity mining, respectively. Thanks to being a trendsetter, Compound Finance became a major player in the decentralized finance field. So today, take this chance to learn everything you need to know about the Compound protocol and its native cryptocurrency.

Key Takeaways

• What is Compound crypto lending protocol? It is one of the foundational DeFi products that lets users make collateralized loans or borrow crypto assets, calibrating the rates according to supply and demand.
• What is COMP? This is the governance token of Compound Finance, representing voting power to make decisions on any changes into the protocol.
• How to use COMP? Aside from its primary purpose, COMP is a popular asset to use in DeFi applications, Compound itself included.

What is the Compound protocol?

The Compound protocol emerged to fill the niche in decentralized finance (DeFi) that was underdeveloped at the time: frictionless borrowing of crypto assets that lets its users gain the time value from assets. The time value of money is a concept that lies at the core of interest earning models.

The Compound protocol is designed to algorithmically calculate interest rates for each asset in accordance with the supply and demand, which was possible in traditional finance. Before Compound, the decentralized borrowing models were already in place but forced costs onto users because lenders were required to post, manage and in the case of collateralized loans, supervise offers and active loans.

On a basic level, markets on Compound incentivize liquidity: although the formula in the whitepaper is a bit more nuanced, its basic premise is the more an asset is loaned, the higher is the interest rate. Users can either supply tokens into the protocol or borrow/sell/use/re-lend assets if they put some of their balance as collateral.

Since 2020, CompoundFinance has grown from 9 Ethereum markets to 27 markets encompassing Layer-1 and 9 Layer-2 blockchains.

How did Compound and COMP start? History and Team

Robert Leshner and Geoff Hayes founded Compound Finance in 2017 with a group of developers: Art Peel, Torey Atcitty, Mason Fischer, and Calvin Liu. The announcement of protocol development was made by Robert Leshner on his Medium on January 31, 2018. The Compound Version 1.0 whitepaper was published in February 2019 by the founders. Among the investors that helped the protocol to be launched are Andreessen Horowitz, BainCapital Ventures, as well as the industry giants such as Coinbase and Polychain Capital.

It did not take the founding team too long to make advancements in the Compound protocol. Migration to v.2 happened in May 2019. By that time, the protocol already held about $24 million.

At the initial stages, though, it received a lot of criticism for being governed by the founding company, so it was about time to take the next step and introduce the community-based governance model. On May 27, Leshner made the announcement that the company delegates all the future decisions about the changes to be made to the protocol to its community. This is where the COMP token comes into play.

On June 11, Proposal 7, which signified the start of Compound crypto token distribution, was published for voting. It was unanimously approved two days later, and on June 15 the model was put in place.

How does Compound work?

Compound markets allow everyone to lend and borrow assets at an interest rate that is applied to everyone uniformly and adjusts algorithmically.

Lending Assets

The mechanism that encourages them to provide liquidity to the Compound markets and incidentally, the most attractive point in Compound for investors is earning interest on the supported Ethereum assets.

In return the users get cTokens that correspond to the asset they deposited (cDAI, cETH, etc.) which earn interest. If there is enough liquidity on a market, a corresponding cToken will not yield much, but contributing to a pool with low liquidity lets you earn more. cTokens can be redeemed for corresponding assets plus accumulated interest at any time.

Borrowing Assets

The assets deposited to the protocol in return for cTokens also act as a collateral to receive some borrowing capacity. The more demand there is for a certain asset, the more borrowing capacity its cToken gives.

In a scenario when debt outpaces borrowing capacity, the collateral will be exchanged for an overborrowed asset at a rate unfavorable to the debtor to repay the debt and discourage poor debt management. Other users can act as liquidators of debt, and they get a chance to receive this collateral at a rate favorable to them.

Under the Hood

The demand to supply ratio and prices of tokens are fetched by a Price Oracle from a committee which pools the data provided by top 10 exchanges.

In addition, there is a policy layer called Comptroller that validates the data from both the market and the user before allowing an action to proceed. For example, if a user wants to borrow ETH, the Comptroller will check if the ETH price provided by the Oracle is valid, and if they want to deposit ETH as a collateral, it will validate both price and a collateralFactor of cETH.

What is the COMP token?

The Compound token with the ticker COMP, not to be confused with cTokens, is a special type of asset called governance tokens. The idea itself is not entirely new but the Compound coin is used exclusively in community governance. COMP token holders can either debate, propose, and vote on any changes to the protocol themselves or delegate some of their voting power to other community members.

The Compound tokens are distributed to users who interact with the markets, regardless of whether they borrow, lend, withdraw or repay an asset, in proportion to the borrowing demand in the market. So, as an example, a user will earn COMP faster if they interact with the DAI market if it has low liquidity, rather than, say, USDC because the demand to borrow DAI is higher.

Daily distribution of the COMP tokens is split between suppliers and borrowers at a 50/50 ratio. COMP is accrued to a user’s wallet first, and then can be withdrawn from the account.

How to Use the Compound Crypto Token?

The Compound token, first and foremost, represents the voting power in the Compound protocol. It is transferable and therefore, purchasable, and can be delegated.

The most common uses for the COMP coin are, surprisingly, yield farming or, alternatively, liquidity mining. Since the interest rates in Compound depend on the supply/demand ratio, they are constantly changing, so to maximize profit, savvy market players move their assets between markets so that they catch the highest rate—this is what yield farming is.

Liquidity mining comes into play when on top of that, a user gets additional assets, like COMP, the value of which is supposed to come from the value of the protocol. This is, however, only a temporary situation, because when the free money is distributed like this, the market price of the token is going to decrease. By design, this effect on the Compound crypto price is supposed to be outbalanced by the growing value of the Compound protocol itself and the weight and value of the vote that has the power to change it.

Which wallet to choose for Compound tokens?

As a ERC-20 token, COMP can be stored either in Ethereum-specialized wallets such as MetaMask or MEW, or in most multi-currency wallets like Trust Wallet or Atomic. Cold storage of COMP is possible with Ledger or Trezor devices, and in Trezor you can exchange Compound tokens with an in-app function powered by ChangeHero.

However, not all wallets support the functions of COMP management. Among those that do are Exodus, ZenGo, imToken and Zerion. In Exodus, for one, you can use the Compound protocol to the full extent, and also swap COMP with our service’s help.

What future plans are there for Compound?

The future of the protocol in the new governance model belongs to the community and depends on which proposals they put out and vote for or against. For example, the USDT market was one of the first proposals made and approved by the public vote rather than introduced by the developers.

Since the protocol’s launch, plenty of partner products have started leveraging the protocol to provide value for their customers. For instance, such applications include custodial solutions (Coinbase Custody, Anchorage, BitGo), tax accounting (Lumina, CryptoTaxTools, Cointracker, Tokentax) and DeFi products (Dharma, Argent, Linen, Donut).

Summary

The Compound protocol has become the industry standard for decentralized lending and borrowing. Liquidity mining and yield farming became as big as they did in no small part thanks to the Compound (COMP) crypto token. Once a trendsetter, Compound today has matured into a stalwart of DeFi.

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