Compound is a decentralized money market built on Ethereum that enables users to lend and borrow from a pool of whitelisted assets. Compound v3 introduces a new borrowing model that facilitates a single borrowable asset, while all other supported assets function as collateral.
Compound V3 launched as a streamlined version of the V2 protocol. The initial deployment of V3 on Ethereum introduces the concept of a base asset. The protocol's new functionality transitions away from a pooled-risk model, where users are able to borrow any asset. In V3, users are can only borrow one base asset, USDC, instead of any asset from a pooled set of assets. This new borrowing model facilitates a single borrowable, interest-earning asset, while all other supported assets function only as collateral and do not earn interest. Users can only earn interest by supplying the baset asset or USDC. Users with a positive balance of the base asset earn interest, paid in the base asset, based on a supply rate model; users with a negative balance pay interest based on a borrow rate model.
Liquidations on Compound V3 use a different mechanism than V2. In V3, the protocol absorbs the borrower's account when the value of collateral locked in the protocol is less than the total value borrowed. The underwater positions are repaid using the protocol's reserves and the protocol seizes the the entirety of the account's collateral assets. Compound determines a discounted price for the seized collateral and sells it publicly for the base asset. Anyone can buy this discounted collateral asset and sell it on an exchange to profit on the difference.
Protocol reserves are a balance of the base or collateral asset and stored internally on Compound. Reserves may be withdrawn or used through the governance process. Compound accumulates reserves in two ways: the difference in interest paid by borrowers, and earned by suppliers of the base asset. Second, the liquidation process uses, and can add to, protocol reserves based on the target reserve level set by governance.