Introduction to Compound
Compound is a decentralized finance (DeFi) protocol built on smart contracts that enables users to lend and borrow cryptocurrencies. Similar to traditional banks, Compound allows lenders to earn interest by supplying assets to borrowers. However, unlike conventional banking systems, Compound calculates interest compounding every block (approximately every 15 seconds on Ethereum), maximizing yield for depositors.
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How Compound Works: Step-by-Step Mechanics
1. Over-Collateralized Loans
- Users deposit underlying assets (e.g., ETH, USDC) into Compound’s smart contracts.
- In return, they receive cTokens (e.g., cETH, cUSDC) as deposit certificates.
- The exchange rate between cTokens and underlying assets increases over time, generating interest.
Example:
Deposit 1 ETH when the exchange rate is 0.1 → Receive 10 cETH.
Later, redeem 10 cETH at a rate of 0.15 → Withdraw 1.5 ETH (0.5 ETH profit).
2. Borrowing Process
- Not all assets are eligible as collateral (e.g., USDT has a 0 collateral factor).
- Approved assets like ETH/DAI/USDC have a 75% collateral factor:
$100 collateral → $75 borrowing limit. - Borrowers risk liquidation if their collateral value drops below the required threshold.
3. Liquidation Mechanics
- External “liquidators” trigger清算 via smart contracts.
- Liquidators receive incentives (paid by the borrower) for maintaining protocol health.
Compound vs. Aave: Key Differences
| Feature | Compound | Aave |
|---|---|---|
| Supported Assets | 17 major tokens | Wider range + LP tokens |
| Rewards | COMP tokens via liquidity mining | Staking AAVE in safety module |
| Flash Loans | Not supported | Supported for arbitrage/refinancing |
| Governance | VC-dominated token distribution | Community-led model |
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Core Terminology Explained
Key Concepts in Compound
-
Underlying Token
Original assets like ETH/USDC (17 supported in Compound V2). -
cToken (Interest-Bearing Token)
Receipt representing deposited assets + accrued interest. -
Exchange Rate Formula
math
(totalCash + totalBorrows - totalReserves) / totalSupply -
Collateral Factor
Determines borrowing power (0-75% of asset value).
Risks and Best Practices
Managing Liquidation Risk
- Maintain borrow utilization below 60% of your limit.
- Monitor asset volatility – ETH price drops can trigger liquidation.
Security Considerations
- Smart contract audits are public but risks remain.
- Use hardware wallets for large deposits.
Frequently Asked Questions (FAQ)
Q: How often does Compound pay interest?
A: Interest compounds every Ethereum block (~15 seconds).
Q: Can I borrow without collateral?
A: No – Compound requires over-collateralization.
Q: What happens during liquidation?
A: Liquidators repay part of your debt for a bonus, seizing collateral.
Q: Is Compound better than Aave?
A: Depends on needs – Compound excels in institutional adoption, Aave offers flash loans.
Conclusion
Compound revolutionized DeFi with its algorithmic interest rates and transparent lending pools. By understanding its抵押 factors, cToken mechanics, and liquidation triggers, users can safely leverage this protocol for passive income or leveraged positions.
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