Morpho, the 'killer app' for decentralised finance?

To decipher what Morpho is doing, you first need to understand what "DeFi" is, which is opposed to "centralised" finance, i.e. the so-called traditional system where you have to go through intermediaries, your bank for example, to borrow and save money.

Liquidity pools

In DeFi, there is no trusted third party, but "pools", piscines or bassins in good French. The idea behind these virtual pools is to allow lenders to pool their money (cryptocurrencies) so that borrowers can come in directly to help themselves in exchange for a certain rate.

A SIMPLE example to understand the mechanism: Gregory puts 2 ethers (ETH) in a "pool" where the funds of thousands of other lenders are also present, and Raphaël comes to draw from the pooled pool because he needs cash.

The advantage of this system is that it allows anyone to deposit or borrow money without an intermediary; no need to send an application to the bank. It all happens in a matter of minutes.

The downside, and this is what makes most DeFi apps work, is that you have to deposit a guarantee in cryptocurrencies to ensure that the loan will be covered even if the borrower defaults. 💡

Today, there are several DeFi protocols. The best known are called Aave or Coumpound and manage $6 billion and $3 billion respectively in their "pools". But however efficient they may be, these protocols do not offer users optimal rates. Why not? Because the community of lenders (Grégory and his friends) share the interest paid by a single borrower (Raphaël)...

It all depends on the operations, but lenders often benefit from fairly low rates of return - currently around 0.5% - when borrowers pay relatively dearly - around 3%! 🙃 Given that there is no banking intermediary, this difference is hard to justify. This system makes DeFi less attractive than the traditional system. And it is precisely this problem that Morpho intends to solve by bringing borrowers and lenders together via its protocol, to offer better rates...

But how? By using peer-to-peer in liquidity pools.

"Pools are very practical for providing liquidity, but they lack efficiency in redistributing it," explains Paul Frambot, who is still a student at Télécom Paris, one of France's leading engineering schools. "By using peer-to-peer pools, we enable a lender to match up directly with a borrower. It's much more efficient". In other words, the lender will be rewarded at a certain rate (e.g. 1%), while the borrower will repay at a slightly higher rate (1.2% in this example). Morpho recovers the difference between the rates, the "spread", to finance itself.

Morpho-Compound, Morpho-Aave...

To achieve this, Morpho Labs has created a solution that allows users to connect to the liquidity pools of popular protocols such as Compound, Aave or Curve. The company already launched Morpho-Compound in June. It is working on Morpho-Aave, which should be released in the coming weeks. "It's one of our priorities", explains Paul Frambot.

Other DeFi protocols should be integrated soon because the French project is capable of connecting to "any player", he adds.

Like most other DeFi players, Morpho has also created a token, MORPHO, which enables it to decentralise its governance. The token is also used to reward users of the protocol. The first MORPHO tokens will be unlocked in the coming days on the wallets of the most active users. But they will not be transferable, at least initially, in order to avoid mass sales. "Morpho is a long-term project," explains Paul Frambot. "We're building all the layers one by one."

Precisely how far could Morpho go? That's one of the big questions we can ask ourselves. Because the project, if it takes off, could potentially dry up a large part of the liquidity pools, like those at Aave or Compound. "It's a real risk," says one industry insider. "If DeFi users make a rational choice, they will use Morpho-Compound more than Compound," says Paul Frambot. In just a few weeks, Morpho has already raised several tens of millions of dollars.

A situation that does not worry the dominant players, such as Aave. "All Morpho users are currently Aave users," says Marc Zeller, head of developer relations for Aave. At least in the short term. Because in the medium to long term, Morpho intends to do without the liquidity pools of Aave and the others. In fact, that's the whole idea contained in its butterfly-shaped logo.

Morpho is only at the 1st stage of development of the project, of which there are three.

👉 Larva

👉 Chrysalis

👉 Butterfly

For the moment, the protocol is at the "larva" level and needs the "pools" of DeFi players to operate and offer liquidity to lenders and borrowers. Soon enough, however, Morpho will aim to move on to the second stage, that of the 'chrysalis', with the introduction of an order book system enabling different peer-to-peer rates within Morpho. According to our information, this stage is not expected before early 2023.

The final phase, the butterfly phase, corresponds to a system where Morpho would take off and no longer need liquidity pools to operate. Instead of pools, Morpho would use market makers in addition to an order book, i.e. market players who themselves supplement the transactions with their liquidity to take part of the spread. A system that is now widely used on the financial markets... classic.

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