Morpho, which recently raised $50 million, is an innovative DeFi lending protocol.

According to DeFiLlama, Morpho’s total value locked (TVL) has reached $1.4 billion, with over $880 million in loans and a total of $68 million in funding.

So, what is Morpho, and why has it made such an impact in the DeFi space? Let’s explore with ChainTeaHouse.

To understand Morpho, you first need to grasp the entire DeFi lending sector.

Morpho’s substantial funding demonstrates that the decentralized lending market is now a crucial component of the DeFi ecosystem. The share of decentralized lending in the overall DeFi market has consistently ranked among the top, and its TVL has now surpassed that of decentralized exchanges (DEXs), making it the largest sector by capital allocation in DeFi.

From a business model perspective, decentralized lending has achieved product-market fit (PMF), meaning it has found a sustainable business model in a decentralized environment. Although the early market relied heavily on token incentives, it is now moving towards a healthier model driven by organic demand rather than subsidies.

However, the lending market is highly concentrated, with leading protocols like Aave and Compound dominating a large portion of the market share. These major players have established a strong competitive edge due to their robust brands and long-standing security records.

Lending protocols must strike a balance between liquidity and security. While pool-to-pool models offer high liquidity, they are less capital efficient. Conversely, peer-to-peer models are capital-efficient but struggle with liquidity.

Morpho offers a novel solution by combining both models:

Morpho acts as a peer-to-peer (P2P) layer built on top of lending pools like Compound and Aave. It introduces a unique interest rate mechanism that combines P2P and pool-to-pool (P2Pool) matching, allowing users to borrow and lend at more favorable rates. This approach addresses the issues of high borrowing rates and low supply rates caused by low utilization in lending pools, thereby enhancing capital efficiency. At the same time, Morpho maintains the liquidity and liquidation protections of the underlying protocols, enabling users to earn the annual percentage yield (APY) of the underlying pool or even better P2P APY.

In simple terms, traditional lending pool protocols (like Compound and Aave) often face high borrowing rates and low deposit rates due to underutilized funds. Morpho improves capital efficiency by directly matching borrowers and lenders, offering higher deposit returns and lower borrowing costs.

For instance, if Xiaoming wants to borrow 1 ETH provided by Xiaohong through Morpho, they are matched peer-to-peer and benefit from an improved interest rate. The entire process is automated by Morpho, so users don’t need to take any extra steps.

Morpho’s matching engine maximizes economic efficiency and minimizes gas costs by prioritizing and matching borrowers with lenders to ensure 100% utilization.

Specifically, when suppliers and borrowers are matched peer-to-peer, Morpho’s optimizer can freely set the P2P rate, but it must stay within the spread of the underlying protocol’s lending and borrowing rates to ensure a win-win situation.

For example, when Xiaohong becomes Morpho’s first supplier, her funds are deposited into the underlying liquidity pool. When Xiaoming joins as a borrower, the Morpho optimizer automatically withdraws Xiaohong’s funds from the pool and directly matches them to Xiaoming, providing both parties with better rates.

Whether users interact directly with Morpho or deposit cTokens obtained after contributing to Compound into Morpho, they can still earn the lender APY. Similarly, once matched with a borrower, both will benefit from an improved P2P APY, which is higher than the lender APY but lower than the borrower APY, offering better incentives for both parties.

Morpho’s optimizer uses a priority queue to match users based on the amount they want to borrow or lend. New suppliers’ liquidity is first matched with the largest borrower, and so on, until all liquidity is matched or there are no more borrowers. Likewise, new borrowers are matched with the largest supplier until all borrowing needs are met or there are no more suppliers.

If matching fails, Morpho leverages the underlying protocol’s liquidity pool as a fallback, ensuring that both suppliers’ and borrowers’ needs are met. Morpho DAO selects the P2P rate between the lending and borrowing rates of the underlying protocol using the p2pIndexCursor parameter.

Morpho’s optimizer automatically accumulates rewards distributed by the underlying protocol on behalf of users, so they can claim rewards just as if they were using the base protocol directly. Additionally, Morpho offers its own Morpho rewards to further incentivize users.

Moreover, Morpho integrates seamlessly with existing DeFi lending protocols like Compound and Aave, maintaining the same liquidity and security features. Essentially, Morpho’s business leverages Aave and Compound as capital buffer pools, providing interest rate optimization services for lenders and borrowers through matching. Users don’t have to worry about liquidity and can perform lending operations at any time.

The Evolution of Morpho: Introducing Morpho Blue

Previously, Morpho’s initial version, the Morpho Optimizer, operated on Compound and Aave, aiming to enhance the efficiency of their interest rate models. However, the growth of Morpho Optimizer was limited by the design of the underlying lending pools, as it heavily relied on its DAO and trusted contractors to monitor and update hundreds of risk parameters daily or upgrade large smart contracts.

After undergoing a transformation, Morpho introduced Morpho Blue.

Morpho Blue is a non-custodial lending protocol designed for the Ethereum Virtual Machine (EVM). It offers a new trustless primitive that is more efficient and flexible than existing lending platforms. It achieves this by specifying a loan asset, a collateral asset, a liquidation loan-to-value ratio (LLTV), and an oracle, enabling the deployment of minimal and isolated loan markets. The protocol is fully trustless, designed to outperform any other decentralized lending platform in terms of efficiency and flexibility.

Morpho Blue’s lending markets are independent. Unlike multi-asset pools, the liquidation parameters for each market can be set without considering the riskiest asset in the basket. This allows lenders to lend at a higher LLTV while assuming the same market risk as supplying to a multi-asset pool with a lower LLTV.

Additionally, collateral assets are not loaned out to borrowers, reducing the liquidity requirements necessary for normal operations on current lending platforms and allowing Morpho Blue to offer higher capital utilization. Moreover, Morpho Blue is entirely autonomous, eliminating the need for fees to cover platform maintenance, risk management, or code security.

One standout feature of Morpho Blue is its permissionless asset listing. Anyone can create markets with any collateral and loan assets, along with any risk parameters. The protocol also supports permissioned markets, expanding its use cases to include real-world assets (RWAs) and institutional markets.

Morpho Blue’s trustless risk management framework also makes it a simple foundational building block, allowing additional logic layers to be built on top. These layers can enhance core functionalities by managing risk and compliance or simplifying the user experience for passive lenders. For example, risk experts can create non-custodial curated vaults that allow lenders to earn passive income. These vaults replicate the current multi-collateral loan pools but are built on a trustless and efficient protocol.

MetaMorpho is an open-source (GPL) protocol that allows anyone to build a lending experience with optimized interest rates and transparent risk management on top of Morpho Blue. MetaMorpho vaults accept passive capital and deposit it into Morpho Blue markets. Liquidity is rebalanced across markets to manage risk and optimize returns.

MetaMorpho simplifies the lending process by allowing users to delegate risk management to experts managing the vaults, similar to Aave or Compound. Each MetaMorpho vault can cater to users with different risk profiles by investing in markets with varying collateral assets and parameters. In essence, MetaMorpho enables the creation of any lending experience, such as Aave, Compound, Spark, Flux, and their forks, on a trustless and efficient primitive like Morpho Blue.

MORPHO Token

The Morpho token (MORPHO) is the governance token of the Morpho protocol. Morpho DAO consists of MORPHO token holders and their delegates, who are responsible for governing the protocol. Governance is carried out through a weighted voting system, where voting power is determined by the number of MORPHO tokens held.

Token holders can vote on protocol changes, including the deployment and ownership of smart contracts, enabling or disabling fee switches for the Morpho Optimizer and Morpho Blue, decentralizing front-end hosting, and managing the governance DAO treasury.

As of June 2024, MORPHO token distribution is as follows:

• Users：4.2%
• Early Contributors：5.4%
• Reserve for Morpho Labs：6.0%
• Morpho Association Reserve：12.5%
• Founders：15.2%
• Investors：20.8%
• Morpho DAO Reserve：35.8%

While the Morpho token has been issued and is used for voting and project incentives, it is currently non-transferable, meaning it has no secondary market price. Users and investors who receive the token can participate in governance voting but cannot sell it.

Unlike most DeFi projects that achieve token liquidity within weeks, Morph DAO believes it could take years to build a long-term and sustainable ecosystem. Therefore, user allocations will occur not only during the Morpho Optimizer phase but also in future protocols.

Morpho’s token incentives are distributed in batches, determined quarterly or monthly, allowing the governance team to adjust incentive strategies and intensity flexibly based on market conditions.

Although the token has no market price initially, users holding the token can still participate in protocol governance. This sense of involvement and governance power has intrinsic value, encouraging users to hold and use the token.

Moreover, token holders can enjoy unique features and privileges within the protocol, such as higher lending rates, lower fees, or priority access to new features. These benefits enhance the token’s utility, providing tangible value to users even without a market price.

Looking Ahead

Questions have been raised about whether Morpho could be a potential competitor to Aave and become one of the top three giants in DeFi lending. The fact that such questions are being asked is a testament to Morpho’s potential.

The launch of Morpho Blue could pose a threat to Aave. Although Aave has a strong market share and user base, Morpho’s flexible and efficient solutions may attract more users to its platform. On the other hand, Aave has the capability to develop similar interest rate optimization features to meet user needs and maintain its market position. Furthermore, Morpho has already shown strong growth momentum in the lending market, particularly after launching Morpho Blue.

Morpho Blue’s open lending markets allow anyone to create lending markets based on the protocol, selecting collateral, loan assets, oracles, loan-to-value ratios (LTV), and liquidation loan-to-value ratios (LLTV). This flexibility and efficiency provide users with more market options, aligning with the free market principles of decentralized finance (DeFi).

Additionally, Morpho has accumulated $1.4 billion in assets under management. Although this is still far from Aave’s $7 billion, these funds are currently focused on its rate optimizer function, with numerous opportunities to channel them into new features.

Morpho’s token budget is ample and flexible, allowing it to attract users with subsidies in the early stages. With a solid operational history and significant funds under management, Morpho has built a reputation for security and reliability, increasing user trust.

In conclusion, as an innovative DeFi lending protocol, Morpho has considerable market potential and technical advantages. However, to stand out in the competitive DeFi market, Morpho must continue innovating, prioritize user experience and market education, ensure security and stability, and establish an effective governance mechanism. Will Morpho secure a place in the future DeFi ecosystem? Time will tell.

Reference Links:

https://mint-ventures.medium.com/will-rapidly-growing-morpho-become-a-formidable-challenger-to-aave-6ea3cbffad1d

https://docs.morpho.org/morpho-blue/tutorials/track-rates/

https://en.thebigwhale.io/article-en/morpho-the-killer-app-for-decentralised-finance

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