Definition
Auto compounding is a process in decentralized finance (DeFi) where rewards generated by a position, such as interest or incentive tokens, are automatically reinvested back into that same position. Instead of leaving rewards idle or requiring manual action, the system periodically adds them to the principal, increasing the base amount that can earn future rewards. This process aims to maximize the compounding effect without requiring ongoing user intervention. It is typically implemented by smart contracts that follow predefined rules for when and how rewards are reinvested.
As a process metric, auto compounding directly affects how frequently returns are added to the principal and therefore influences the realized growth rate of a position. Protocols that offer auto compounding often express returns using metrics like APY, which assume regular reinvestment of rewards. The more efficiently and frequently the auto compounding process runs, the closer the realized performance can align with the advertised APY. In DeFi, this mechanism is central to many yield-focused products and strategies.
Context and Usage
Auto compounding is commonly associated with yield-generating activities such as liquidity provision, staking, or lending in DeFi protocols. In these contexts, rewards are continuously produced over time, and the auto compounding process determines how those rewards are folded back into the position. This can occur at fixed intervals or dynamically, depending on the design of the underlying smart contracts and the economics of the protocol.
The concept is closely tied to how APY figures are interpreted, because APY generally assumes that rewards are compounded at a given frequency. When a protocol or external service offers auto compounding, it is effectively operationalizing that assumption by automating the reinvestment step. As a result, auto compounding has become a standard feature in many DeFi ecosystems, shaping expectations around what advertised yields represent in practice.