At a time when high interest savings accounts are languishing at an anemic 2%, Craig Hammell found a way to earn more than 8% this past summer. Instead of storing his money with a bank, the software engineer lent it out to cryptocurrency owners on Compound, an automated lending platform.
Hammell is one of a growing number of investors seeking high yield who have turned to Compound, a startup that’s part of an exotic industry known as decentralized finance. The San Francisco company, which recently raised a $25 million Series A round from venture capital firm Andreessen Horowitz, relies on software and so-called smart contracts to bring together crypto borrowers and lenders.
In an interview with Fortune, founder Robert Leshner said Compound now has over $150 million worth of assets on its platform, and that it plans to use its new investment to make the service more accessible to ordinary people.
Currently geared towards those comfortable with “private keys” and other esoteric elements of cryptocurrency, Compound will be integrated with crypto exchanges, custodians, and wallets by the end of 2020, Leshner says. This means ordinary consumers could soon be able to use a service like Coinbase or Kraken to lend out their cryptocurrency.
An economist by training, Leshner spent years studying interest rates and predicting rates of the Federal Reserve. He began Compound in part because he felt the cryptocurrency world has been stuck for too long in a zero interest environment—one that made sense in the wake of the financial crisis when Bitcoin was born, but not in subsequent years when interest rates ticked modestly upwards.
The way Compound works is lenders—who can be anyone—provide capital in the form of so-called stablecoins, which are a type of cryptocurrency pegged to the value of the U.S. dollar. On the other side, borrowers take out stablecoin loans by providing collateral in the form of Ethereum (the second most popular cryptocurrency after Bitcoin) or a handful of other digital currencies.
The process involves neither paperwork nor intermediaries, since the entire lending arrangement is dictated by the terms of Compound’s software.
While the appeal of lending on Compound is obvious enough—namely, an outsized return on investment—the appeal of borrowing cryptocurrency at double-digit rates (the current rate for a stablecoin called USD Coin is 10.22%) is less evident. Just who is taking out such loans?
According to Leshner, there are two primary groups of borrowers. The first are the numerous cryptocurrency companies that have raised tens or hundreds of millions of dollars in Ethereum and are using it as collateral to borrow money for salaries and other operational costs. The second group Leshner says, are traders and crypto hedge funds that want to leverage their Ethereum holdings for short term investments.
And even as Compound pursues plans to expand, the company intends to adopt a more decentralized governance structure. Such decentralization is important to the many crypto enthusiasts who mistrust government and the traditional banking system, and is a hallmark of projects like Bitcoin. In the case of Compound, Leshner says it will entail devolving decision-making power over its software to a loose federation of other cryptocurrency users.
“As with Bitcoin, we want to ensure that no one, including the company that built it, can exert undue influence on Compound’s protocol,” says Leshner. “Corporations come and go but we want to build a protocol that lasts forever.”
Compound’s aspirations for immortality remain to be seen, of course, but its $25 million in new funding should keep it going for the foreseeable future. By far the largest portion of the investment came from Andreessen Horowitz, though Leshner says a smaller portion came from existing investors, including Bain Capital and Polychain Capital.
“Compound is a lending protocol that is open to anyone in the world, that disintermediates banks and allows anyone to earn interest on their money,” said Andreessen Horowitz general partner Chris Dixon. “We’ve worked with Robert and his team for over two years and think they are world class technologists and entrepreneurs.”
Leshner and Andreessen Horowitz did not disclose a valuation, but a source close to deal, who spoke on the condition of anonymity, said the investment valued Compound at approximately $90 million.
As for Hammell, the engineer who has been lending on Compound, he says his recent returns have been closer to 5% rather than the 8% he was earning over the summer. But Hammell says he is still pleased with his foray into decentralized finance.
“What makes it cool to me is how it sits right at the intersection of simplicity and utility. All it does really is let people deposit to a pool, and others withdraw from that pool,” he says. “The more borrowed money relative to supplied money, the higher the interest rate. Supply and demand is economics 101 and everyone can understand it.”
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