Because you have the ctokens, the platform uses the ETH or DAI or any of the collaterals to lend it to another user and pays you the interest earned in cToken. The platform knows that you have a certain amount of tokens, it calculates its equivalent in dollars and based on that, it allows you to obtain a loan. If I’m not mistaken, it can’t be more than 75% of what you have deposited on the platform. When you pay the loan and decide to withdraw the collateral, the platform converts all the cTokens back to the original token.
as I mention cryptoseph here:
"Let’s say you supply 1,000 DAI to the Compound protocol, when the exchange rate is 0.020070; you would receive 49,825.61 cDAI (1,000 / 0.020070).
A few months later, you decide it’s time to withdraw your DAI from the protocol; the exchange rate is now 0.021591:
Your 49,825.61 cDAI is now equal to 1,075.78 DAI (49,825.61 * 0.021591)
You could withdraw 1,075.78 DAI, which would redeem all 49,825.61 cDAI
Or, you could withdraw a portion, such as your original 1,000 DAI, which would redeem 46,315.59 cDAI (keeping 3,510.01 cDAI in your wallet) "
Deposit 1ETH -> Compound
compumd returns you 49.858501 cETH ->to your wallet (at today’s exchange rate)
Compund has to loan another user 1 ETH
You earn interest on your 49.858501 cETH ($ 412.32 USD)
You have two options to keep them only earning interest or take a loan for the maximum of $ 309.24 USD in some other token.
Days later you pay it and you have the option to keep your cETH earning interest or withdraw it.
If your loan is liquidated, the cTokens go to the liquidator:
“When collateral is seized, the liquidator is transferred cTokens, which they may redeem the same as if they had supplied the asset themselves”