How Compound Protocol Works
🔹 How Compound Protocol Works
Compound is a decentralized finance (DeFi) lending protocol built on Ethereum. It allows people to lend and borrow cryptocurrencies without intermediaries like banks.
1. Supplying (Lending) Assets
Users deposit crypto (e.g., ETH, USDC, DAI) into the Compound protocol.
In return, they receive cTokens (e.g., deposit DAI → get cDAI).
cTokens represent the lender’s share in the pool and earn interest over time.
💡 Example: If you supply 100 DAI, you receive cDAI tokens. Over time, your cDAI balance grows in value as interest accrues.
2. Borrowing Assets
Users can also borrow crypto by locking in collateral.
Example: If you supply ETH, you can borrow stablecoins like DAI or USDC.
The borrowing limit depends on the collateral factor (usually 50–75%).
💡 Example: Deposit $1,000 worth of ETH → borrow up to $750 worth of DAI.
3. Interest Rates (Algorithmic Model)
Interest rates for lending and borrowing are dynamic.
They change automatically based on supply and demand in each asset pool.
More borrowing → higher interest rates. More supply → lower rates.
4. Collateral & Liquidation
Borrowers must maintain a minimum collateral ratio.
If the collateral value drops (e.g., ETH price falls), and the loan becomes under-collateralized:
Liquidators can repay part of the debt.
In return, they get the borrower’s collateral at a small discount (liquidation incentive).
5. Governance (COMP Token)
Compound is governed by holders of the COMP token.
COMP holders can propose and vote on protocol changes (e.g., new assets, interest rate models).
This makes Compound a decentralized autonomous organization (DAO).
✅ In summary:
Users supply crypto → earn interest & get cTokens.
Users can borrow crypto by providing collateral.
Interest rates adjust automatically.
If collateral drops too much → liquidation happens.
Governance is handled by COMP token holders.
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