Aave V3 and Compound V3, at their core is a "managed" interest rate model. For example, Aave has a famous "kinked rate curve" (Kinked Rate Curve). Governance sets an "optimal utilization rate" (for example, 80%), when the utilization rate is below 80%, the interest rate rises slowly; once it exceeds 80%, the interest rate rises "steeply" to "force" borrowers to repay, or "attract" depositors to deposit money.
This model is intricate, but it has two "original sins":
There is always a "spread". The borrowing interest rate is always higher than the deposit interest rate. This spread is the protocol's income and also represents the user's "efficiency loss."
It is set by 'governance'. Is this 80% 'inflection point' reasonable? Is the underlying interest rate curve 'optimal'? This is a parameter set by humans, not a market-discovered result.
Morpho Blue has discarded all of this.
In any market of Morpho Blue (like WETH/USDC), there is no interest rate curve, no optimal utilization, and no spread.
Its interest rate model is simple enough to have only one line of mathematical formula:
Interest rate = f (capital utilization)
This function is a smooth, continuous curve. If the utilization is 50%, the interest rate is 2%. If the utilization is 50.1%, the interest rate is 2.01%. If the utilization is 100% (all money has been borrowed), the interest rate will spike to a very high value to incentivize repayment.
The crucial point is that in this market, supply interest rate = borrowing interest rate.
If the instant interest rate of the WETH/USDC market is 5%, then depositors earn 5% (APY) and borrowers pay 5% (APR). (Here we will ignore the small protocol fees that the DAO may initiate in the future).
This is 'zero spread'. This means 100% capital efficiency. Every penny of interest flows precisely from the borrower to the depositor.
What profound implications does this design have?
It transforms lending protocols from a 'price-setting bank' into a 'price-discovery market'.
In Aave, interest rates are 'managed'.
In Morpho Blue, interest rates are 'discovered'.
This 'primitive', 'frictionless' interest rate discovery mechanism is highly attractive to me as a researcher. It eliminates all governance noise and human intervention, allowing capital to find its 'true' price on its own. This may be the 'ultimate form' of DeFi lending.
@Morpho Labs 🦋 Labs 🦋