What is Compound Finance?
Compound Finance allows anyone to lend or borrow cryptocurrencies without an intermediary.
Both lenders and borrowers benefit from their cryptocurrencies. The lender earns interest on the interest borrowers pay in cryptocurrencies to get at loans without banking problems.
As a lender, you do not lend money directly to the borrower but lend to Compound Finance’s decentralized liquidity pools, meaning that there will be no middlemen involved to manage your funds. Everything is automated by pre-designed rules set by computer codes called smart contracts.The smart contract automatically aligns the borrower with the assets available and the assets you lend to borrowers. Interest payments between borrowers and lenders are then automatically shifted through the smart contracts.
What are the risks of putting money in Compound.Finance?
Smart contract risk
For lenders and borrowers, the main risk at Compound Finance is that hackers can exploit or hack the smart contracts that make them work. This could allow cryptocurrencies locked in a compounding smart contract to be stolen, thereby locking themselves out of the cryptocurrencies.
For those with the technical knowledge, the code is available for compound, which means that more eyes are available to detect faulty code.
The bug bounty of compatible is also available to anyone who discovers vulnerabilities. You can also see security audits and formal verifications of the material on its security page. There are many risks associated with something as new as CF, but not as many as with other financial products.
For example, any bank can go bankrupt. Bankruptcies occur on things like deposit insurance, and many bank customers withdraw their money from banks if they believe they are going bust. Even banks, to which crypto is often compared, have risks, but not as much as other financial products.
In addition to the smart contract risk, Compound Finance also runs the risk of a similar bank run, albeit with a significantly higher return. The risk is based on how much of the lender’s assets go to the borrower and how much utilization is. If 70% or 100% of their assets go to borrowers, utilization rates will be 70-80%. This means that 80-90% (or more) of all lenders “assets are available for repayment. But if there is a problem with lenders removing all cryptocurrencies from the market at once, it would be a problem.
Compound is fighting this with its interest-rate model: when borrowers borrow big, interest rates rise to incentivize lending and discourage them from taking on more loans.
Bank robberies usually occur because of mismanagement, but people don’t know until it’s too late. Regardless, a run on the pound is less likely than a bank run, and bank robberies do more damage to the economy and people’s lives than bank robberies.
Compound is an established blockchain project, but it is not 100% secure. The smart contracts contain hundreds of millions of dollars worth of cryptocurrencies, and users cannot see anything in the blockchain, because everything is transparent. Add to that the growing DeFi market with over 1.5 million users and a market capitalization of over $1 billion.
Not to mention lenders “high interest rates, which make it virtually impossible to waive interest even if there is no maturity or penalty rate, because they are accessible to everyone and everywhere. Especially compared to old traditional banks with their high fees, high loan-to-value and high penalties.