Compound is an algorithmic, autonomous interest rate protocol— allowing users & applications to frictionlessly earn interest or borrow Ethereum assets.
How does the Compound protocol work?
Compound is the first “liquidity pool” — instead of lending assets directly to another user, you supply liquidity to a market, and users borrow from that market.
In each market, interest rates are determined algorithmically (based on supply and demand), and interest accrues every Ethereum block.
There are no pre-defined durations or terms (such as “90 days”) — you can use the Compound protocol for as short as one block, or as long as you’d like; you’re free to withdraw or repay at any time.
How are interest rates set?
Interest rates are a function of the liquidity available in each market and fluctuate in real-time based on supply and demand. When liquidity is plentiful, interest rates are low. As liquidity becomes scarce, interest rates increase, incentivizing new supply and the repayment of borrowing.
You aren’t locked into an interest rate — expect it to change frequently.
Why is the supply rate lower than the borrowing rate?
In each market, there is excess liquidity (assets supplied > assets borrowed), which allows you to quickly withdraw or borrow funds from the protocol.
The interest paid by borrowers is earned by the suppliers of the asset. Because there are more suppliers, the interest rate they earn is proportionately lower; this is the liquidity effect.
Second, a portion (
1/20th by market) of the interest paid by borrowers is set aside as reserves, which provides a liquidity cushion, and is a safety mechanism in the liquidation process.
How is interest calculated?
The interest rates you see in the Interface are quoted as annual interest rates. Interest accrues each Ethereum block; every ~15 seconds, your balance will increase by
(1/2102400) of the quoted interest rate. Really!
Is the Compound protocol safe? Has it been audited?
All Compound smart contract code and balances are publicly verifiable, and security researchers are eligible for a bug bounty for reporting undiscovered vulnerabilities.
List of all security audits https://compound.finance/developers/security