Compound: Algorithm & Arbitrage Backed Money Markets

Dune Analytics analyzed the state of dApp adoption at the end of 2018. One of the apps they looked at is Compound. They shared that Compound had $8M USD worth of Dai supplied. As of today, there is a $16M worth of supply. Compound launched in September 2018. This kind of market, for crypto, is brand new in 2018. Below is our executive summary of the service; stay tuned for a review of the investor experience and trade life-cycle.

Executive Summary of Compound

Compound creates anonymous, secured, variable rate, open-term, lending agreements using a pool-based micro-structure, along with a ratio-based excess-supply, equity and incentive system to reduce risk and friction observed in existing lending markets. It enables exchange of exposure and time-value of individual digital tokens via the formation of an algorithm maintained and arbitrageur monitored pool of programmable capital. There are currently 6 supported digital tokens spanning four utility-tokens, a USD-proxy, and ETH-proxy.

Rates

There are two distinct interest rates, one seen by all borrowers, the other by all lenders. The rates float over the life of any deposit or loan. This is by design; supplied capital must always be higher than borrowed capital. Both rates are managed by an algorithm with inputs from supply and demand, with a global index for each rate on a per market basis. Interest is earned every 15 seconds, and tracked by the protocol, but doesn’t settle to the chain until the loan does.

Collateral

Borrowers need to maintain collateral deposits worth at least 1.5x the value of any loan. If the collateral is impaired below this ratio, the first arbitrageur to notice, can exploit the incentive system in order to return the loan to good standing. Any market participant can do this, by simply buying the impaired portion of the loan at a 5% discount at the expense of the borrower. A layer of equity helps to prime the market and secure loans against system failure.

Agency

The governance is currently centralized with the intent to transfer to a DAO. A 2.5 basis point origination fee is charged to the borrower by Compound for registering a new agreements. Andreessen Horowitz, Polychain and Bain Capital Ventures invested $8.2M in early 2018. The team has 7 executives and 4 open positions advertised in San Francisco, California, USA. The Compound Labs FAQ is helpful to learn more.

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