How Does Compound Defi Work?

Before you start to learn about Compound Defi, you should be aware of how it works. It is a tool that enables users to leverage their web 3.0 wallets to supply, borrow, and sell assets. This tool also tracks interest in real time. This article explains the key components of Compound. If you’re wondering how Compound works, read on to discover how it can benefit you. After all, this tool is a perfect tool to learn about Compound.

Interest rate

The concept of Compound is quite unique within the world of Defi. In contrast to other decentralized lending systems, Compound works with crypto assets as collateral. Instead of using conventional bank deposits, Compound uses COMP tokens to tokenize assets and pay interest on them every time a block is mined. To make the concept as easy as possible, we’ve outlined the basic principles of Compound here. If you’re interested in learning more, read on!

Liquidity mining

The first step of compound liquidity mining is to lend crypto assets to a liquidity pool. The pool contains smart contracts that allow users to deposit and withdraw money. The pool’s returns are usually shared among platform users in the form of the platform’s native token. Liquidity pools are also used as collateral for loans, which makes the process of lending and exchanging easy. The underlying smart contract of a liquidity pool can be monitored by anyone, anywhere in the world.

Collateral tab

In case of default, when the Borrow Balance exceeds the collateral factor, the account becomes insolvent. During this situation, other users can repay the borrower and exchange collateral for borrowed funds. The incentive for liquidation is currently 8%, which means that liquidators receive collateral at a discount from the market price. Nevertheless, liquidation is not good for the borrower since some collateral will be lost.

Liquidity pool

A Compound Liquidity Pool (CLP) is a system of smart contracts that need liquidity at all times. This type of liquidity structure is optimal in many ways. Participants in the Compound supply digital assets to create a shared and open market. Then, the participants lend and borrow from that market, recouping interest through fees. The entire process is transparent and decentralized. And it only requires a minimal amount of digital assets to participate.

No counterparty risk

Despite the fact that the Compound protocol has more than $16 billion locked into it, the risks associated with DeFi still need to be assessed carefully. The risk of error in the distribution of Compound tokens, for example, cannot be completely eliminated. The Compound founders emphasized that the protocol did not provide administrative controls or community tools to prevent the distribution of Compound tokens. This is not a comprehensive analysis of the risks associated with DeFi, but it will help investors understand the nuances of the concept and avoid unnecessary risks.

8% liquidation incentive

The 8% liquidation incentive for compound defis is a way to encourage lenders to restructure their loans if the market values them at a lower level than their original loan amount. It is a global standard defined as the ether value of the borrow balances and collateral in an account. The liquidation incentive is calculated for each account based on the markets entered into the transaction. For example, if the liquidator receives an ETH loan, they will receive BAT as collateral. In this way, the liquidator can recover a loan amount in a single transaction with ease.

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