Recently completed a $50 million financing, can Morpho become a new giant in the DeFi lending sector?

Author: Tea House Assistant Chain Tea House

Just completed a $50 million funding round, Morpho is an innovative DeFi lending protocol.

According to DeFiLlama data, Morpho's total value locked (TVL) has reached $1.4 billion, with borrowed amounts exceeding $880 million, and total financing has reached $68 million.

So, what kind of project is Morpho that has achieved such accomplishments in the DeFi space? Let Chain Tea House take you on a journey to explore.

To understand Morpho, we first need to grasp the entire DeFi lending track.

The substantial funding Morpho has received is enough to prove that the decentralized lending market has become an important part of the DeFi sector. The capital capacity of decentralized lending consistently ranks among the top, and the current TVL has surpassed DEX (decentralized exchanges), becoming the largest track in terms of capital accommodation in the DeFi field.

In terms of its business model, the decentralized lending market has achieved PMF (product-market fit), meaning it has found a sustainable business model in a decentralized environment. Although the early market relied on high token incentives, it is now gradually evolving towards a healthier model that depends on organic demand rather than subsidies to maintain operations.

However, overall, the lending track has a high market concentration, with leading protocols occupying most of the market share. Major players like Aave and Compound have formed a significant moat due to their strong brand power and long-term security records.

Moreover, lending protocols need to find a balance between liquidity and security. While the peer-to-pool model offers high liquidity, it has lower capital efficiency; conversely, the peer-to-peer model has high capital efficiency but lacks liquidity.

Morpho provides a new solution by combining both models:

As a peer-to-peer (P2P) layer built on lending pools like Compound and Aave, Morpho introduces its unique interest rate mechanism: by matching P2P and peer-to-pool (P2Pool), users can borrow and lend at better rates, addressing the issues of high borrowing rates and low supply rates caused by low utilization of lending pools, thus improving capital efficiency. At the same time, Morpho maintains the same liquidity and liquidation guarantees as the underlying protocols, allowing 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) face the problem of high borrowing rates and low deposit rates due to low utilization of the capital pool. Morpho directly matches borrowers and lenders, providing higher deposit returns and lower borrowing costs, thus enhancing capital efficiency.

For example, Xiao Ming applies to borrow 1 ETH from Xiao Hong, who provides it to Morpho. They are matched through P2P, obtaining improved rates. The entire process is handled automatically by Morpho, requiring no additional transactions from the users.

Morpho's matching engine sorts users and matches borrowers and lenders, ensuring 100% utilization, maximizing economic efficiency, and minimizing gas costs.

More specifically, when suppliers and borrowers are matched peer-to-peer, Morpho's optimizer can freely choose P2P rates, but must select within the spread of the underlying protocol (between Lending APY and Borrowing APY) to ensure benefits for both parties.

For instance, when Xiao Hong becomes the first supplier for Morpho's optimizer, her funds are deposited into the underlying liquidity pool. When Xiao Ming enters as a borrower, the Morpho optimizer automatically withdraws Xiao Hong's funds from the pool and directly matches them to Xiao Ming, allowing both parties to obtain better rates.

Thus, whether users directly use Morpho or deposit the cTokens obtained from Compound into Morpho, they can normally earn lender APY. Similarly, once matched with a borrower, both parties will receive the improved P2P APY, which is higher than the lender APY and lower than the borrower APY, providing better incentives for both.

Regarding the matching mechanism, Morpho's optimizer uses a priority queue data structure to match based on the amount users wish to borrow or lend. The liquidity of new suppliers is first matched with the largest borrowers, and so on, until all supplied liquidity is matched or there are no more borrowers. Similarly, the demand of new borrowers will first match with the largest suppliers, and so on, until all borrowing needs are met or there are no more suppliers.

If matching fails, Morpho will utilize the liquidity pools of the underlying protocol as a fallback mechanism to ensure that the needs of both suppliers and borrowers are met. Morpho DAO selects P2P rates between the Lending APY and Borrowing APY of the underlying protocol through the p2pIndexCursor parameter.

The Morpho optimizer protocol will automatically accumulate rewards distributed by the underlying protocol on behalf of users, meaning users can receive rewards just like they would by directly using the underlying protocol. Additionally, the Morpho optimizer will also distribute its own Morpho rewards to further incentivize users.

Furthermore, Morpho seamlessly integrates with existing DeFi lending protocols (like Compound and Aave), maintaining the same liquidity and security features. This essentially means that Morpho's business acts as a capital buffer pool for Aave and Compound, providing interest rate optimization services for lending and borrowing users through matching. Users need not worry about liquidity issues and can conduct lending and borrowing operations at any time.

The Evolution of Morpho: Morpho Blue

Previously, Morpho's initial version, Morpho Optimizer, operated on Compound and Aave to enhance the efficiency of its interest rate model. However, this limited the growth of Morpho Optimizer due to the current design of underlying lending pools, which heavily relied on its DAO and trusted contractors to monitor and update hundreds of risk parameters or upgrade large smart contracts daily.

After the transformation, Morpho launched Morpho Blue.

Morpho Blue is a non-custodial lending protocol implemented for the Ethereum Virtual Machine (EVM). It provides a new trustless primitive with higher efficiency and flexibility compared to existing lending platforms.

It achieves the deployment of minimal and isolated lending markets by specifying a loan asset, a collateral asset, a liquidation loan-to-value ratio (LLTV), and an oracle. The protocol is trustless and designed to be more efficient and flexible than any other decentralized lending platform.

The lending market of Morpho Blue is independent. Unlike multi-asset pools, the liquidation parameters of each market can be set without considering the highest-risk assets in the basket. Therefore, suppliers can lend at higher LLTV while bearing the same market risks as when supplying to a multi-asset pool with lower LLTV.

Additionally, collateral assets are not lent to borrowers. This alleviates the liquidity requirements needed for normal liquidation operations in current lending platforms and allows Morpho Blue to offer higher capital utilization. Furthermore, Morpho Blue is fully autonomous, eliminating the need to introduce fees to pay for platform maintenance, risk managers, or code security experts.

Notably, Morpho Blue features permissionless asset listing capabilities. Markets can be created with any collateral and loan assets and any risk parameterization. The protocol also supports permissioned markets, enabling a broader range of use cases, including RWA and institutional markets.

Its permissionless risk management characteristics also shape Morpho Blue into a simple foundational building block, allowing for the addition of more logical layers on top. These layers can enhance core functionalities by handling risk management and compliance or simplify the user experience for passive lenders. For example, risk experts can establish non-custodial curated vaults that allow lenders to earn passive income. These vaults reconstruct the current multi-collateral loan pools but are built on a trustless and efficient protocol.

Meta Morpho is an open-source (GPL) protocol that allows for the creation of any lending experience with optimized rates and transparent risk management on top of Morpho Blue. Meta Morpho vaults accept passive capital and deposit it into the Morpho Blue market. Liquidity is rebalanced across various markets to manage risk and optimize returns.

MetaMorpho allows users to delegate risk management to risk experts managing the vaults, similar to what is done on Aave or Compound, thereby simplifying the lending process.

Each MetaMorpho vault can meet the needs of users with different risk profiles by depositing funds into markets with different collateral assets and parameters.

In other words, Meta Morpho supports the creation of any lending experience on a trustless and efficient primitive Morpho Blue, such as Aave, Compound, Spark, Flux, and all their forks.

MORPHO Token

Morpho Token (MORPHO) is the governance token of the Morpho protocol. Morpho DAO consists of holders and agents of MORPHO tokens, responsible for governing the Morpho protocol. The governance system uses a weighted voting system, where the number of MORPHO tokens held determines voting weight.

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

As of June 2024, the distribution of MORPHO 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%

As a non-transferable token, although Morpho tokens have been issued and are already applied in voting decisions and project incentives, they remain in a non-transferable state. Therefore, they do not have a secondary market price, and users and investors receiving the tokens can participate in governance voting but cannot sell them.

While most DeFi projects achieve token liquidity within weeks, Morph DAO believes that establishing a long-term and sustainable ecosystem may take years. Therefore, user allocation will not only occur during the Morpho Optimizer phase but will also continue in future protocols.

Morpho's token incentives are distributed in batches, determined quarterly or monthly, allowing the governance team to flexibly adjust the intensity and specific strategies of incentives based on market changes.

Although the tokens do not have market prices in the early stages, holders can still participate in governance decisions of the protocol. This sense of participation and governance rights itself holds intrinsic value, motivating users to hold and use the tokens.

Additionally, token holders can enjoy unique features and privileges within the protocol. For example, token holders may receive higher borrowing rates, lower fees, or priority participation in testing new features. These privileges and features enhance the practical use value of the tokens, providing real benefits to users even in the absence of market prices.

Future Outlook

Many have previously asked whether Morpho will be a potential competitor to Aave and whether it will become one of the three giants in DeFi lending.

The mere raising of these questions is enough to demonstrate Morpho's potential.

The launch of Morpho Blue could pose a threat to Aave: while Aave has a strong market share and user base, Morpho, with its flexible and efficient solutions, has the potential to attract more users to its platform. On the other hand, Aave also has the capability to build similar interest rate optimization features to meet user needs and maintain its market position.

Moreover, Morpho has already shown strong business growth momentum in the lending market, especially after the launch of Morpho Blue.

Morpho Blue opens the lending market, allowing anyone to create lending markets based on the protocol, selecting collateral, loan assets, oracles, loan-to-value ratios (LTV), and liquidation ratios (LLTV). This flexibility and efficiency provide users with richer market choices, aligning with the principles of a free market in decentralized finance (DeFi).

Additionally, Morpho has accumulated $1.4 billion in managed funds. While this is still far from Aave's $7 billion level, these funds are currently concentrated in the interest rate optimizer function, with many pathways to introduce them into new features.

Morpho's token budget is ample and flexible, capable of attracting users through subsidies in the early stages. Morpho's stable operational history and capital volume have built a certain level of security and brand trust among users.

In summary, as an innovative DeFi lending protocol, Morpho possesses sufficient market potential and technical advantages. However, to stand out in the competitive DeFi market, Morpho needs to continue innovating while focusing on user experience and market education, ensuring security and stability, and establishing effective governance mechanisms. Can Morpho secure a place in the future DeFi ecosystem? Let’s wait and see.