Resources

People often ask me "How did you learn how to hack?" The answer: by reading. This page is a collection of the blog posts and other articles that I have accumulated over the years of my journey. Enjoy!

Compound is a borrowing and lending protocol built on Ethereum. Naturally, Compound needs funds to lend out. This is done via liquidity providers (LP). When an LP deposits funds, they are put into a huge pool and receive the ERC-20 token cToken. This cToken represents a portion of the total pool. As the pool earns interest, the amount of funds a user can claim grows.

cTokens represent ownership of a loan to be taken out. The value of the cTokens increases over time as borrowers make payments. The cTokens allow a user to take loans by using them as collateral. This means that the funds a user deposits as an LP to get cToken can directly be used to get another asset.

cTokens are generic. For instance, cDAI is the DAI token cToken. How does it know how much a token is worth or what the exchange rate is? They use a Chainlink pricefeed in order to do this. This oracle is used to determine collateral requirements and all of the other fund work.

The Controller manages risk within the protocol. This is done by setting collateral requirements and liquidation thresholds based on risk weights, user balances and prices from the oracle. Naturally, loans need to be overcollaterized in DeFi in order to work. This logic ensures that the protocol never loses funds on a loan when the market goes down.

How does the protocol remain solvent - or have enough funds? Either too many people are borrowing or there are not enough funds being lent. To solve this problem, Compound has a formula known as the utilization rate for a pool. The higher the current utilization rate, the higher the interest on the loan is. Naturally, if the utilization rate is high, less loans will be taken out. Additionally, it will have high interest rates, leading to more LPs to provide value.

The interest rate is calculated using the utilization rate, the profits to the protocol and the general borrowing interesting rate. This final value is calculated using an interest rate model to determine the cost of it. In particular, it has a flat fee and a yearly multiplier. This makes the interest linear. The graphs in the article use the purple line as what the borrower pays and the green line as what the LP receives.

Most borrowed assets use the Jump Rate model. It's exactly like the previous model with two additional parameters: kink and jump multiplier. The kink is the point on the graph that the jump multiplier is used. The jump multiplier is the rate of increase once the kink has been hit. This makes a very steep climb once a particular threshold of utilization has been hit.

The goal is that a high APY will incentivize users to deposit more to ensure there is always liquidity for withdrawal. With these values in mind, it is possible to calculate the amount of interest that would be paid for a loan over a given time period.

Overall, good explanation on Compound! I had a lot of misconceptions cleared up.