Ultimate Compound Finance Cheatsheet: Complete Guide to DeFi Lending and Borrowing

Introduction to Compound Finance

Compound Finance is a decentralized, blockchain-based protocol that allows users to lend and borrow crypto assets without traditional intermediaries like banks. Built on Ethereum, it creates money markets with algorithmically set interest rates based on supply and demand. As one of the pioneering protocols in decentralized finance (DeFi), Compound enables anyone with a crypto wallet to earn interest on deposits or take out loans against collateral, all with full transparency and without credit checks.

Core Concepts of Compound Finance

Key Terminology

Interest Rate Model

Compound uses algorithmic interest rates that adjust based on market conditions:

• Supply APY: Interest earned on deposited assets
• Borrow APY: Interest paid on borrowed assets
• Interest rates increase when utilization is high (more borrowing)
• Interest rates decrease when utilization is low (less borrowing)

Risk Parameters

• Collateralization Ratio: Required value of collateral relative to borrowed amount
• Liquidation Threshold: Point at which collateral can be liquidated (when health factor < 1)
• Close Factor: Maximum portion of a loan that can be repaid in a liquidation event
• Liquidation Incentive: Premium paid to liquidators (typically 8%)

Step-by-Step Processes

How to Supply Assets to Compound

1. Connect Wallet

   • Visit Compound app (app.compound.finance)
   • Connect an Ethereum wallet (MetaMask, WalletConnect, etc.)

2. Approve Asset

   • Select the asset you want to supply
   • Approve the Compound smart contract to access your tokens

3. Supply Assets

   • Enter the amount you wish to supply
   • Confirm the transaction in your wallet
   • Pay Ethereum network gas fees

4. Receive cTokens

   • Upon successful deposit, you receive cTokens representing your share
   • These cTokens automatically increase in value over time as interest accrues

How to Borrow on Compound

1. Supply Collateral First

   • Supply assets to be used as collateral
   • Enable the asset as collateral in the dashboard

2. Check Borrowing Power

   • Review your borrowing capacity based on collateral value and collateral factors

3. Select Asset to Borrow

   • Choose the asset you want to borrow
   • Ensure you maintain a safe collateralization ratio (recommended: >200%)

4. Borrow Assets

   • Enter the amount to borrow (stay well below maximum to avoid liquidation)
   • Confirm the transaction and pay gas fees
   • Monitor your health factor regularly

How to Repay Loans

1. Access Borrow Tab

   • Navigate to the borrow section in the app

2. Select Asset to Repay

   • Choose which borrowed position to repay

3. Enter Repayment Amount

   • Input full or partial repayment amount
   • Approve the asset for repayment if needed

4. Confirm Repayment

   • Execute the repayment transaction
   • Verify successful repayment and updated borrowing capacity

Key Features and Tools

Compound Dashboard Features

• Supply Markets: View all available assets for lending
• Borrow Markets: View all available assets for borrowing
• Position Management: Monitor all supplied and borrowed positions
• Health Meter: Visual indicator of account health and liquidation risk
• Transaction History: Record of all interactions with the protocol
• Governance Portal: Interface for COMP token voting and proposals

Compound Tools and Integrations

Comparison with Other DeFi Lending Platforms

Common Challenges and Solutions

Challenge: Risk of Liquidation

Solutions:

• Maintain a conservative collateralization ratio (>200%)
• Regularly monitor market conditions
• Set up liquidation alerts through services like DeFi Saver
• Consider diversifying collateral across multiple assets
• Borrow less than 50% of your maximum borrowing capacity

Challenge: High Gas Fees

Solutions:

• Execute transactions during periods of low network congestion
• Use gas price trackers to find optimal transaction timing
• Batch multiple operations when possible
• Consider Layer 2 solutions when available
• Optimize transactions for gas efficiency

Challenge: Understanding Variable Interest Rates

Solutions:

• Use Compound’s interest rate history charts to identify trends
• Consider the asset’s volatility when assessing rate risks
• Compare current rates to historical averages
• Utilize interest rate prediction tools
• Stay informed about market liquidity trends

Challenge: Smart Contract Risks

Solutions:

• Verify Compound’s audit history and security measures
• Start with small amounts to test the system
• Use hardware wallets for additional security
• Diversify across multiple protocols
• Consider DeFi insurance options like Nexus Mutual

Best Practices and Tips

For Lenders

• Diversify Lending: Spread funds across different assets to minimize risks
• Choose Liquid Markets: Supply assets with high liquidity for better rates and lower risks
• Compound Over Time: Reinvest earned interest to maximize compounding returns
• Consider Impermanent Loss: Be aware that price changes affect the value of your supplied assets
• Tax Tracking: Keep detailed records of all lending activities for tax purposes

For Borrowers

• Strategic Borrowing: Borrow assets with lower interest rates or those you expect to decrease in value
• Health Factor Management: Maintain a health factor above 1.5 to provide a safety buffer
• Collateral Strategy: Use stablecoins as collateral to reduce volatility risks
• Liquidation Avoidance: Set up automated monitoring and alerts for your positions
• Capital Efficiency: Use borrowed funds productively (yield farming, trading, etc.)

For Advanced Users

• Leverage Trading: Carefully use recursive borrowing for amplified exposure (high risk)
• Governance Participation: Stake COMP tokens to participate in protocol governance
• Yield Optimization: Move assets between lending protocols to capture higher rates
• Tax-Loss Harvesting: Strategically realize losses for tax purposes when appropriate
• Contract Interaction: Learn to interact directly with Compound smart contracts for advanced operations

Resources for Further Learning

Official Resources

• Compound Finance Website
• Compound Documentation
• Compound Governance Forum
• Compound GitHub Repository

Community Resources

• Compound Community Discord
• DeFi Pulse – Compound Stats
• DeFi Prime – Compound Guide

Educational Material

• Finematics – Compound Finance Explained
• Bankless – Compound Strategy Guide
• The Defiant – DeFi Lending Guides
• CoinGecko – How to Use Compound Finance

Analytics Tools

• Compound Markets Overview
• DeFi Llama – Compound TVL
• Dune Analytics – Compound Dashboard
• LoanScan – Compound Rate Trends