Forwarded the Original Title: How Did Morpho Solidify Its Position in the Lending Market Through Two Leaps?

Lending protocols hold the largest market share in DeFi in terms of capital capacity, making them the biggest sector in terms of liquidity absorption. The lending market has proven demand, a healthy business model, and a relatively concentrated market share.

(Source: defillama)

The moat for decentralized lending platforms is clearly visible: Aave’s market share has continued to rise, from a stable 50-60% in 2023 to the current range of 65-70%.

Source: https://tokenterminal.com/explorer/markets/lending

After years of development, by examining Aave’s growth trajectory, several key advantages have contributed to its current dominant market share:

1. Long-term Stable Security Performance:

• While many projects have forked Aave, they have been shut down quickly due to issues like attack or bad debts. In contrast, Aave has maintained a relatively acceptable security track record. Emerging lending protocols, though potentially offering innovative concepts or higher short-term yields, often struggle to gain the trust of large capital users, especially without enduring years of market testing.

1. Increased Investment in Security:

• Leading lending protocols, backed by higher revenue and a well-funded treasury, are able to allocate strong resources toward security audits and risk management. This budget advantage not only ensures the security of new feature development but also lays a solid foundation for the introduction of new assets, which is critical for the long-term sustainability of the protocol.

Morpho’s Growth and Market Position

Since securing funding from a16z in the second half of 2022, Morpho has made significant strides in the lending space over the past two years. As shown below, Morpho’s current lending volume has reached $1.432 billion, ranking just behind Aave and Spark.

Source: https://tokenterminal.com/explorer/markets/lending

Morpho’s success can be divided into two phases, and it is through the accumulation during these periods that Morpho’s market share has steadily increased.

First Leap: Optimizing Aave and Compound for Rapid Growth

Morpho’s initial business model focused on improving the capital utilization efficiency of lending protocols, particularly addressing the mismatch between deposits and borrowings in pool-based models like Aave and Compound. By introducing a peer-to-peer (P2P) matching mechanism, Morpho provided users with better interest rate options, offering higher deposit rates and lower borrowing rates.

The core limitation of the pool-based model lies in the imbalance between total deposits and total borrowings, with deposits often exceeding borrowings. This inefficiency leads to issues:

• Deposit users’ interest is diluted by idle funds.
• Borrowing users must bear the interest cost of the entire pool, rather than just the portion of funds they actually use.

Morpho’s solution introduces a new workflow: users’ deposits and collateral are allocated to Aave and Compound, ensuring they receive the base interest rate. Meanwhile, Morpho uses a P2P matching mechanism to prioritize large orders and directly match deposits with borrowers, reducing idle funds. This way, all deposits are utilized, and borrowers only pay interest on the funds they actually need, achieving interest rate optimization.

The key advantage of this matching mechanism is that it eliminates the efficiency bottlenecks of traditional models:

• Deposit users enjoy higher returns, and borrowers pay lower interest, leading to rate alignment and significantly enhancing the user experience.
• Morpho operates on top of Aave and Compound, using their infrastructure as capital buffers, thereby maintaining risk levels comparable to these established protocols.

For users, this model is highly attractive:

1. Regardless of whether a match is made, users receive interest rates comparable to those of Aave and Compound, and in the case of a match, their returns/costs are further optimized.
2. Morpho’s system is based on well-established protocols, with its risk management model and capital allocation fully inheriting Aave and Compound’s methodologies, thus lowering trust costs for users on emerging platforms.

Through this innovative design, Morpho cleverly utilized DeFi’s composability to attract more user capital while providing efficient interest rate optimization services with low-risk exposure.

Second Leap: From Application to Permissionless Infrastructure, Separating Risk and Building an Independent Ecosystem

As discussed earlier, Morpho Optimizer achieved Morpho’s first leap, allowing it to stand out among numerous lending protocols and become an important platform in the market. However, both from the product and protocol positioning perspectives, as well as ecosystem development openness, the Optimizer couldn’t provide broader possibilities. This is because the growth of the Optimizer was limited by the current underlying lending pool design, which heavily relies on its DAO and trusted contractors to monitor and update hundreds of risk parameters or upgrade large smart contracts daily. Without further innovation, Morpho would struggle to attract a wider range of developers and native protocols and would only be positioned as an ecosystem protocol for Aave and Compound. This is the reason why Morpho Optimizers is now being deprecated.

Therefore, Morpho adopted a Uni V4-style product strategy, where it only focuses on a foundational layer for large financial services, opening up modules above this base layer. This means: minimal product, referred to as “primitives,” with all lending parameters open to individuals and ecosystem protocols without permission. By transferring risk from the platform to third parties, Morpho’s own ecosystem value continues to rise.

Why does Morpho adopt minimal components and open risk parameters to third parties?

• Risk Isolation: Independent lending markets. Unlike multi-asset pools, each market’s liquidation parameters can be set without considering the highest-risk assets in a basket. Morpho’s smart contract contains only 650 lines of Solidity code, is non-upgradable, simple, and secure.
• Customizable Vaults: For instance, a provider can lend at a higher LLTV while bearing the same market risk as when supplying to a multi-asset pool with a lower LLTV. It is also possible to create markets with any collateral type and loan asset, alongside customizable risk parameters.
• Cost Reduction: Morpho operates fully autonomously, so there’s no need to incur costs for platform maintenance, risk managers, or code security experts. The singleton smart contract design, based on simple code, reduces gas costs by 70%.
• Lego-like Infrastructure: Third-party protocols or individuals can add more logical layers to Morpho. These layers can enhance core functions by managing risk and compliance, or simplify the passive lending experience. For example, risk experts can build non-custodial curated vaults where lenders passively earn returns. These vaults reimagine current multi-collateral lending pools.
• Bad Debt Management: Morpho uses a distinct approach to bad debt. Specifically, if an account still has unpaid debt after liquidation and no collateral to cover the shortfall, the loss is shared by all lenders according to a predetermined ratio. This ensures that Morpho does not go bankrupt due to bad debt. Even with bad debt, it only affects specific independent markets, and unless large-scale market failures occur, the ecosystem value of Morpho remains intact.
• Developer-Friendly: Account management allows gas-free interactions and account abstraction, while free flash loans let anyone access all market assets in one call, provided they repay in the same transaction.

Morpho provides complete autonomy for users to create and implement their own lending risk management systems. Professional financial institutions can also leverage the platform to collaborate with other market participants and earn fees by offering management services. The trustless nature of the platform allows users to flexibly set various parameters and independently create and deploy lending markets without relying on external governance to add assets or adjust market rules. This flexibility gives market creators great freedom, enabling them to independently manage lending pool risks and rewards based on their own risk assessments, meeting the diverse needs of users in terms of risk tolerance and use cases.

However, the trustless design is primarily aimed at accumulating reputation and TVL at low cost. Currently, Morpho hosts hundreds of vaults, but most of the vaults listed on the Morpho interface are created by risk management experts. Morpho allows anyone to create vaults, which adds TVL risk-free. Even if most vaults fail, it won’t cause any significant impact. However, well-performing vaults will stand out, and their positioning will be elevated to the level of risk management experts, benefiting from the user base brought by the Morpho platform. Before this, vaults created by individuals must undergo a lengthy operational period.

How does Morpho Vaults work?

Morpho Vault is a lending vault system built on the Morpho protocol, specifically designed for managing lending assets. Whether it’s DAOs, protocols, individual investors, or hedge funds, anyone can freely create and manage vaults on Morpho Vault, with each vault focusing on a specific loan asset and supporting customizable risk exposure, allowing funds to be allocated to one or more Morpho markets.

Source: Morpho

This design greatly optimizes the lending process, enhancing the overall user experience while effectively aggregating market liquidity. Users can not only access independent markets and lending pools to participate in transactions, but also easily provide liquidity, earning passive interest.

Another key feature is the highly flexible risk management and fee structures that Morpho Vault offers. Each vault can adjust risk exposure and performance fee settings according to specific needs. For example, a vault focused on LST assets will only involve relevant risk exposure, while a vault dedicated to RWA assets will concentrate on that asset class. This customization allows users to select the vault that best fits their risk tolerance and investment objectives.

Since late November, the community has passed the token transferability proposal. For the current model that relies on subsidizing Morpho tokens to attract users, the ability to trade Morpho tokens can significantly increase user participation. Furthermore, since its launch on Base in June, Morpho has seen continuous growth across all metrics and has become a popular DeFi protocol in the Base ecosystem. With the potential staking options surrounding ETH ETFs, discussions around RWA have been rising, and Morpho has launched the first Coinbase-certified RWA vault on the Base chain. The two vaults curated by SteakhouseFi and Re7Capital will support a variety of RWA collateral options, positioning Morpho in a very unique place within the Base ecosystem.

Looking back at Morpho’s development history, other lending protocols can learn from Morpho’s efforts in building its reputation. Starting with the Morpho Optimizer, the platform leveraged Aave and Compound as capital buffer pools and relied on their historical security assumptions to quickly establish its brand. When the timing was right to develop its own ecosystem and become an independent protocol, Morpho opened up the lending dimension to third parties, significantly reducing the risks it might face. This approach allowed the protocol to develop its ecosystem at a low cost while creating native applications within its ecosystem. Morpho clearly understands that, for lending protocols, maintaining a stable operational history is crucial for building a security brand, which is the foundation of its identity.

Disclaimer:

1. This article is reprinted from [BlockBooster)]. Forwarded the Original Title: “How Did Morpho Solidify Its Position in the Lending Market Through Two Leaps?” All copyrights belong to the original author [Kevin]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
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