👉 News. French project Morpho just raised$18 million

👉 Background. While it has seen strong growth, DeFi is still far from being effective onrates

👉Why it matters. Morpho has developed a system that provides better rates for both lenders and borrowers.

Web3 is a huge ocean where many projects are developing. Some want to offer new services or improve an existing system. Others want to disrupt their industry. Morpho belongs to this second category.

Created in 2021, the French project, whose symbol is a butterfly (we'll come back to the importance of the symbol below) is still a little-known player in decentralized finance, more commonly known as "DeFi." But for how much longer?

The project, which has just raised $18 million from 90 investors, including the prestigious American fund Andreessen Horowitz (A16z), is not short of ambition. "Decentralized finance is something incredible, but it lacks efficiency, and our goal is to improve it," explains Paul Frambot, co-founder of Morpho Labs, the company that designs the Morpho protocol.

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

Liquidity pools

In DeFi, there is no trusted third party, but "pools", pools or basins in good French. The idea of these virtual pools is to allow lenders to pool their money (cryptocurrencies) for borrowers to come 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 Raphael comes to help himself in the common pool because he needs liquidity.

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

The trade-off, and this is what makes most DeFi apps work, is that you have to post collateral 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 respectively 6 and 3 billion dollars in their "pools". But as efficient as they are, these protocols do not offer optimal rates to users. Why? Because the community of lenders (Gregory and his friends) share the interest paid by a single borrower (Raphael)...

It all depends on the transaction, but lenders often enjoy fairly low rates of return - currently around 0.5% - when borrowers pay relatively high - around 3%! 🙃 Since there is no banking intermediary, this difference has a hard time being justified. 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 convenient for providing liquidity, but they lack efficiency in redistributing it," says Paul Frambot, who is still a student at Télécom Paris, one of France's top engineering schools. "By using peer-to-peer in pools, we allow a lender to match directly with a borrower. It's much more efficient. In other words, the lender will be rewarded at a certain rate (say, 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. "This is one of our priorities," explains Paul Frambot.

Other DeFi protocols should be integrated soon because the French project is able to connect to "any actor", he adds.

Like most other DeFi players, Morpho has also created a token, MORPHO, which allows it to decentralize 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 at first, notably to avoid mass sales. "Morpho is a long-term project," explains Paul Frambot. "We are building all the layers one by one."

Just how far could Morpho go? This is one of the big questions we can ask. If the project takes off, it could potentially dry up a large part of the liquidity pools, such as those of Aave and Compound. "That's a real risk," points out a good 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 doesn't worry dominant players like 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 Aave's liquidity pools and those of others. That's the whole idea behind its butterfly logo.

Morpho is only at the first stage of development of the three-stage project.

👉 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. However, Morpho will soon move on to the second stage, that of the "chrysalis", with the introduction of an order book system allowing for different peer-to-peer rates within Morpho. According to our information, this step is not expected before early 2023.

The last phase, that of the butterfly, corresponds to a system where Morpho would take flight and would no longer need liquidity pools to operate. Instead of pools, Morpho would use "market makers" in addition to an order book. These are market players who themselves complete the transactions with their liquidity to take part of the spread. This system is now widely used in the traditional financial markets.

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