If you think it's good, please share, follow, and comment. Thank you.
Introduction
Morpho is a trustless, efficient, over-collateralized lending native protocol that allows permissionless market creation. It can deploy minimized and isolated lending markets by specifying the following:
A type of collateral asset (cryptocurrency supported by the protocol)
A type of loan asset
Liquidation Loan-To-Value (LLTV)
Interest Rate Model (IRM)
An oracle
Borrowers can repay their loans at any time by returning the borrowed assets and accrued interest. Once the repayment is confirmed on the blockchain, borrowers can retrieve their collateral from the smart contract.
LLTV
What is LLTV?
LLTV, or Liquidation Loan-To-Value, is a very important concept in decentralized lending protocols. It is essentially a safety coefficient used to measure the sufficiency of the borrower's collateral assets.
The Role of LLTV
Risk Control: The presence of LLTV is to protect the stability of the lending platform. When the value of the assets borrowed by the borrower exceeds the LLTV ratio of the collateral assets, it indicates that the borrower may not be able to repay the debt. At this point, the protocol will enforce the liquidation of the borrower's collateral assets to ensure that the debt is repaid.
Collateral Sufficiency: LLTV specifies the minimum collateral ratio that the borrower must maintain. If the price fluctuations of assets cause the collateral ratio to fall below LLTV, the borrower needs to add more collateral, or they will face the risk of liquidation.
The Calculation Method of LLTV
LLTV is typically expressed as a percentage. For example, if a lending protocol has an LLTV of 150%, it means the value of assets borrowed by the borrower cannot exceed 150% of the value of the collateral assets.
Calculation Formula:
LLTV = (Loan Value / Collateral Value) * 100%
The relationship between LLTV and liquidation
Triggering Liquidation: Liquidation is triggered when a borrower's LLTV falls below the LLTV threshold set by the protocol.
Liquidation Process: The protocol will automatically auction the borrower's collateral assets to repay the debt. If the auction proceeds are insufficient to cover the full debt, the borrower will bear the difference.
Factors Influencing LLTV
Asset Price Volatility: The fluctuations in asset prices directly affect LLTV. If the price of collateral assets drops while the price of borrowed assets rises, the borrower's LLTV will decrease, increasing the risk of liquidation.
Interest Rate Model: The interest rate model affects borrowing costs, thereby influencing the borrower's ability to repay debts.
Market Demand: The market demand for borrowing assets will also affect LLTV. When the demand for a certain asset increases, the price of that asset may rise, thus lowering the borrower's LLTV.
Arbitrage Strategies
[Cross-Protocol Arbitrage]
One can consider arbitraging the differences in LLTV across different protocols. For example, if the LLTV for ETH/USDC on Morpho is 150%, while others are 180%, one can first borrow USDC on Morpho, collateralize ETH, then borrow more USDC on another platform to increase leverage. Transaction costs and slippage must be considered.
[Inter-Asset Arbitrage]
Different assets have different price volatility, and arbitrageurs can exploit these differences for arbitrage. For example, if the price of ETH is relatively stable while a certain altcoin is highly volatile, an arbitrageur can borrow ETH, collateralize it, borrow the altcoin, and then sell it when the price of the altcoin rises to realize the arbitrage.
[Interest Rate Arbitrage]
Using differences in borrowing rates: AAVE's rates are dynamically adjusted, and different assets have different borrowing rates. Arbitrageurs can borrow assets with lower rates, then collateralize and borrow assets with higher rates to earn the rate difference. Generally, the borrowing rates for altcoins are relatively high.
Liquidation Mechanism
Morpho has a liquidation mechanism to mitigate default risk and protect lenders' capital.
What is Liquidation?
Liquidation is a mechanism to protect lender funds. When the borrower’s Loan-To-Value (LTV) exceeds the market-set Liquidation Loan-To-Value (LLTV), that account is considered unhealthy, thus facing liquidation risk.
How to Trigger Liquidation?
When the borrower's LTV exceeds LLTV, anyone can initiate liquidation. The liquidator repays the borrower's debt and receives the corresponding amount of collateral assets along with an incentive reward.
How to Avoid Liquidation?
Borrowers can avoid liquidation by:
Repaying Debt: Partially or fully repaying the loan.
Adding Collateral: Increasing the amount of collateral assets.
How to Calculate LTV?
The calculation formula for LTV is as follows:
LTV = (Borrow Amount Collateral Asset Price) / (Collateral Asset Quantity ORACLE_PRICE_SCALE)
Where:
Borrow Amount: The quantity of assets borrowed by the borrower.
Collateral Asset Quantity: The quantity of collateral assets provided by the borrower.
Collateral Asset Price: The oracle price of the collateral asset.
ORACLE_PRICE_SCALE: Scaling factor, adjusting asset precision
How Liquidation Works
Liquidators can liquidate the entire debt of an account and receive corresponding collateral assets and incentive rewards. The Morpho protocol itself charges no fees; all incentives belong to the liquidators.
The calculation of incentive rewards is as follows:
Incentive Reward = Debt Amount * LIF
Where, LIF (Liquidation Incentive Factor) is calculated based on the market's LLTV, usually around 1.06.
LIF = min(M, β * LLTV + (1 - β))
Where:
* LIF: Liquidation Incentive Factor
* M: Maximum incentive factor, usually a constant, e.g., 1.15
* β: A weight coefficient, usually a constant between 0 and 1, e.g., 0.3
* LLTV: Liquidation Loan-To-Value
Liquidation Example
Assuming a borrower provides $100 in collateral, with market A's LLTV at 80%. When the borrower's debt reaches $80.00001, the LTV exceeds 80%, and the account can be liquidated.
Borrower: A person who borrows on the platform. They provide collateral to obtain loans.
Liquidator: A person who identifies that a borrower's account is at risk of liquidation and is willing to repay the debt to obtain the collateral.
The liquidator can repay $80 of debt and receive:
Available Collateral = Debt Amount LIF = 80 1.06 = $84.8
Therefore, the liquidator will receive up to $84.8 in collateral assets, while the borrower will retain the remaining $15.2 in collateral assets, resulting in a significant loss.
Interest Rate Model
The interest rate model determines the interest borrowers need to pay. In traditional finance, interest rates are usually set by central banks or financial institutions. In DeFi (Decentralized Finance), the interest rate model is determined by the protocol itself.
Morpho is a protocol independent of interest rate models (IRM), which means it can support any interest rate model in its market. In Morpho, the interest paid by borrowers in a specific market is defined by an IRM selected from a governance-approved set at the time the market is created.
Traditional Lending Pool Model
The horizontal axis represents utilization, which is the proportion of borrowed funds to total funds.
The vertical axis represents the interest rate.
The curve shows the relationship between interest rates and changes in utilization.
We can see that when the utilization is low, the interest rates are also low; as the utilization increases, the interest rates gradually rise. Especially when utilization approaches 90% (the target utilization), the growth rate of interest increases.
If r90% is 4%, then when the utilization reaches 100%, the interest rate will instantly rise to 4 r90% = 16%. Conversely, if the utilization drops to 0%, the interest rate will drop to 1/4 r90% = 1%.
Adaptive Model
The adaptive mechanism acts like an automatic regulator, continuously adjusting the interest rate curve according to the actual market situation to maintain system stability and efficiency.
r90%: This value represents the target interest rate when utilization reaches 90%.
Curve: The relationship between interest rates and utilization can be represented by a curve. This curve changes over time.
How It Works:
When utilization exceeds the target:
The system will continuously raise the interest rate curve.
As interest rates rise, borrowers tend to repay to reduce interest expenses.
With the increase in repayments, utilization will gradually decrease until it returns to the target level.
When utilization is below the target:
The system will continuously lower the interest rate curve.
As interest rates decrease, borrowers will be more willing to borrow, thereby increasing utilization.
With the increase in borrowing, utilization will gradually rise until it returns to the target level.
Adjustment Speed
The speed of curve adjustments depends on the gap between the current utilization rate and the target utilization rate. The greater the gap, the faster the adjustment speed.
For example
Assuming the initial value of r90% is 4%.
Scenario 1: Utilization remains low at 45%
Due to the utilization being far below the target, the system will continuously lower interest rates.
After 10 days, r90% may drop to 2%. This means that when the utilization reaches 90%, the corresponding interest rate will also be halved.
Scenario 2: Utilization remains high at 95%
Due to the utilization being above the target, the system will continuously raise interest rates.
After 10 days, r90% may rise to 8%. This means that when the utilization reaches 90%, the corresponding interest rate will also double.
Scenario 3: Utilization remains at 100%
Due to the utilization being far above the target, the system will raise interest rates at the fastest speed.
After 5 days, r90% may rise to 8%.
Interest Rate Calculation
Annualized Borrowing Percentage
Borrow APY = (e^(borrowRate × secondsPerYear) - 1)
*e*: The base of natural logarithms, approximately equal to 2.71828. This is the basis for continuous compounding.
borrowRate: Borrowing interest rate, usually expressed in decimal form (e.g., 5% expressed as 0.05).
secondsPerYear: The number of seconds in a year, typically 31,536,000 seconds (non-leap year) or 31,622,400 seconds (leap year). Here, a simplified time model is used, assuming a year has 365 days, 24 hours per day, and 3600 seconds per hour.
Assumption:
borrowRate = 0.05 (5%)
secondsPerYear = 31,536,000
borrowAPY = (e^(0.05 × 31,536,000) - 1)
≈ Annualized Return Rate of 5%
Deposit Annual Percentage
Supply APY = Borrow APY × Utilization Rate × (1 - Fee Rate)
Borrow APY: Annualized Borrowing Yield
Utilization Rate = Total Borrowed Assets / Total Supplied Assets
Fee Rate: Percentage fee set by the market
Assumption:
Borrow APY = 5%
Utilization Rate = 0.7 (70%)
Fee Rate = 0.1 (10%)
Supply APY = 5% × 0.7 × (1 - 0.1)
= 5% × 0.7 × 0.9
= 3.15%
Morpho Vaults
Morpho Vaults is an open-source, permissionless risk management protocol built on the Morpho lending market.
How Morpho Vaults Work:
User deposits assets: Users deposit assets (e.g., WETH) into a Morpho Vault.
Vault Allocated Assets: The curator of the Vault allocates these assets to multiple Morpho markets and weights them according to each market's risk characteristics.
Earning Returns: Users can participate in multiple markets through the Vault to earn diversified returns.
Key Features
Technical Characteristics
Following the ERC4626 Standard
Each Vault only has one loan asset
Funds can be allocated to multiple Morpho markets
Non-custodial and immutable
Users have complete control over their assets
Why Do We Need Morpho Vaults?
Traditional Morpho lending platforms have higher user requirements:
Need to understand complex risk factors
Users must assess themselves:
Collateral Assets
Liquidation Threshold
Oracle
Market Ceiling
Morpho Vaults address these issues by providing:
Simplified User Experience
Automated Risk Management
Flexible Risk Configuration
Shared Liquidity
First, we need to understand what a lending pool and isolated market are.
Lending Pool
A lending pool is, simply put, a 'pool' where various digital assets are centrally stored. Users can deposit their digital assets into this pool as collateral to borrow other digital assets. At the same time, other users can also deposit their digital assets into the pool for others to borrow.
The Implementation Principle of Lending Pools
Smart Contracts: The core of a lending pool is a smart contract. This contract defines the rules of lending, interest rates, collateral requirements, etc.
Collateral: The digital assets deposited by users as collateral to ensure the repayment of loans.
Debt Position: When a user borrows assets, a debt position is created. This debt position records the type, quantity of the assets borrowed, and the interest that needs to be repaid.
Liquidation Mechanism: If the value of the borrower's collateral falls below the value of the debt, the system will trigger the liquidation mechanism, forcing the sale of the borrower's collateral to repay the debt.
Advantages of Lending Pools
Good User Experience: Simple operations and user-friendly interface.
Liquidity Concentration: A large amount of assets concentrated in one pool, facilitating borrowing and lending for users.
Security: The immutability of smart contracts guarantees the safety of funds.
Isolated Markets
Isolated markets refer to each lending pair (e.g., ETH/DAI) having its own independent market. This means that each market only lends against specific two assets.
The Implementation Principle of Isolated Markets
Multiple Smart Contracts: Each isolated market requires an independent smart contract to manage.
Independent Order Book: Each market has its own order book, recording all unfulfilled borrowing orders.
Price Discovery: Through the buy and sell orders on the order book, the market can automatically discover the relative value of assets.
The Advantages of Isolated Markets
High Flexibility: Different parameters can be set for different asset pairs, such as interest rates and collateral ratios.
High Efficiency: Since each market is independent, it avoids interference between different markets.
Strong Scalability: New markets and assets can be easily added.
How to solve the problem of isolated markets
Problem: Isolated markets, while providing flexibility and customization, result in limited funds available for withdrawal due to dispersed liquidity, affecting lending efficiency.
Core Concepts
Isolated Markets: Each market operates independently, with capital flow relatively closed, leading to dispersed liquidity.
Morpho Vaults: By connecting multiple isolated markets, it concentrates the dispersed liquidity to form a larger liquidity pool.
Liquidity: The amount of assets users can immediately withdraw or borrow.
Liquidity Amplification: Because multiple Vaults share the same market liquidity, the overall liquidity exceeds the simple sum of individual Vaults.
Solution: Morpho Vaults solve this problem by:
Aggregated Liquidity: Pooling the liquidity of multiple isolated markets together to form a larger liquidity pool.
Shared Liquidity: Multiple Vaults can share liquidity from the same market, thus enhancing overall liquidity.
Amplified Liquidity: Due to shared liquidity, the available liquidity of each Vault increases, thereby achieving liquidity amplification.
Assume there are three isolated markets: A, B, and C.
Initial State: Each market has a supply of $100, with a utilization rate of 90%.
Introducing Morpho Vaults:
Vault1: Allocating funds to markets A and B.
Vault2: Allocating funds to markets B and C.
Liquidity Changes:
The total supply in market B increases, leading to an increase in liquidity in market B.
Due to the increased liquidity in market B, the available liquidity in both Vault1 and Vault2 has increased.
Why does liquidity amplification occur?
Imagine a pool, with each Vault being a pool. When multiple Vaults add water to the same market (pool), not only does the water level of that market rise (i.e., liquidity increases), but the water levels of other Vaults connected to that market also rise because they share the additional water.
Why is the liquidity of Morpho Vaults better than traditional lending pools?
Higher Liquidity: By aggregating and sharing liquidity, Morpho Vaults provide higher liquidity than individual lending pools.
Better User Experience: Users can choose different Vaults based on their risk preferences to gain a more flexible borrowing experience.
Higher Capital Efficiency: Due to liquidity amplification, the same funds can support more borrowing demand.
Overall Project
TVL Data
Currently, the capital capacity ranking of lending protocols is second in the DeFi track, a hot segment. The current ranking is:
It can be seen that Morpho's ranking is relatively high, with a significant gap to AAVE; AAVE basically accounts for 40-60, and in the future, the token value may benchmark against AAVE's percentage.
And his borrowed funds continue to increase, reaching $1.754 billion. Of course, it should not be ignored that the competition in this space is also quite fierce, with hundreds of players, and the competition may become even more intense later.
Development Stage
[Phase One: Optimizing AAVE and Compound]
Morpho's initial business goal was to enhance the capital utilization efficiency of decentralized lending protocols like Aave and Compound. These protocols adopt a 'fund pool' model, where all users' funds are pooled together. However, this model has a problem: there is often a lot of idle capital in the pool, causing depositors' earnings to be diluted while borrowers have to pay interest on the entire pool's funds.
Morpho solves this problem by introducing a peer-to-peer matching mechanism. It directly matches users' deposits with borrowing demands, reducing idle funds and improving capital utilization. This way, depositors can earn higher returns, and borrowers can pay lower interest.
[Transition from Applications to Decentralized Infrastructure]
Morpho's second phase positions itself as an open and customizable DeFi infrastructure. It is no longer just an optimization tool but provides a platform for developers to build various lending products.
Morpho's innovation lies in:
No Permission: Anyone can create their own lending market and set custom risk parameters.
Flexibly Customizable: Developers can create various types of lending products based on different needs.
Risk Isolation: Each lending market is independent, and risks do not transmit to each other.
Low Cost: Morpho's smart contracts are very simple, resulting in low operating costs.
The essence is still to create an ecosystem, transferring risks and reducing its own risk exposure. This model is also easier to operate stably and protects the safe development of the overall protocol.
Investment Relations
Morpho has raised tens of millions of dollars, mostly from well-known investment institutions such as a16z, Coinbase Ventures, etc.
Airdrop
Currently, one can only earn MORPHO through Earn or Borrow; for other methods, just go directly to base for swaps; it's difficult to earn without cost. This link has detailed operations:
https://cryptorank.io/drophunting/morpho-activity308
Personal Opinion
It greatly expands the possibilities of DeFi by allowing users to customize lending rules.
Each lending market operates independently, and risks do not transmit to one another, which reduces the overall platform risk.
By peer-to-peer matching, Morpho improves capital utilization efficiency.
User-customized lending markets may carry higher risks, necessitating strengthened risk controls.
However, it seems difficult to shake the leader's position; recent trends:
Reference
ERC4626
Official Documentation
