Delphi: Modular lending is the next stage of the DeFi market

24-05-04 17:00

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Original source: Delphi Digital

Original translation: Luffy, Foresight News

The DeFi lending industry has been sluggish, mainly due to complex multi-asset lending pools and governance-driven project decisions. Our latest report explores the potential of a new type of lending product - modular lending, revealing its characteristics, design, and impact.

DeFi Lending Status

DeFi lending protocols are active again, with borrowing volume increasing by nearly 250% year-on-year, from $3.3 billion in the first quarter of 2023 to $11.5 billion in the first quarter of 2024.

At the same time, the demand for more long-tail assets to be included in the collateral whitelist is also increasing. However, adding new assets significantly increases the risk of the asset pool, which hinders the lending protocol from supporting more collateral assets.

To manage additional risks, lending protocols need to adopt risk management tools such as deposit/borrowing caps, conservative loan-to-value ratios (LTV), and high liquidation penalties. At the same time, isolated lending pools provide flexibility in asset selection, but suffer from liquidity fragmentation and capital inefficiency.

DeFi lending has recovered from innovation, moving from pure "permissionless" lending to "modular" lending. "Modular" lending caters to a wider asset base and allows customized risk exposure.

The core of a modular lending platform is:

· Base layer processing functions and logic

· Abstraction and aggregation layers ensure user-friendly access to protocol functions without adding complexity

The goal of a modular lending platform is: Base layer primitives with modular architecture, emphasizing flexibility, adaptability, and encouraging end-user-centric product innovation.

There are two main protocols to watch in the transition to modular lending: Morpho Labs and Euler Finance.

The following highlights the unique features of these two protocols. We dive into the trade-offs, all the unique features, improvements, and conditions required for modular lending to surpass DeFi money markets.

Morpho

Morpho originally launched as an improver of lending protocols and successfully became the third largest lending platform on Ethereum with over $1 billion in deposits.

Morpho’s solution for developing modular lending markets consists of two separate products: Morpho Blue and MetaMorpho.

Morpho’s Liquidity Amplification

Before Morpho Blue, liquidity fragmentation was a major criticism of siloed lending markets. But the Morpho team solved this challenge by aggregating at both the lending pool and vault levels.

Reaggregating Liquidity

Lending to siloed markets through the MetaMorpho Vault avoids liquidity fragmentation. Liquidity for each market is aggregated at the vault level, providing users with withdrawal liquidity comparable to multi-asset lending pools while keeping markets independent.

Shared Model Expands Liquidity Beyond Lending Pools

MetaMorpho Vaults enhance lenders’ liquidity profiles, making them superior to single lending pools. Each vault’s liquidity is pooled on Morpho Blue, benefiting anyone lending to the same market.

Vaults significantly enhance lenders’ liquidity. As deposits aggregate on Blue, subsequent users deposit funds into the same market, increasing withdrawal funds for users and their vaults, unlocking additional liquidity.

Euler

Euler V1 changed DeFi lending by supporting non-mainstream tokens and permissionless platforms. Euler V1 was phased out due to the 2023 flash loan attack that cost it over $195 million.

Euler V2 is a more adaptable, modular lending primitive that includes:

(1) Euler Vault Kit (EVK): allows permissionless deployment and customization of lending vaults.

(2) Ethereum Vault Connector (EVC): enables vaults to connect and interact, enhancing flexibility and functionality.

Euler V2 will be launched this year, and we are curious how long it will take for it to gain a foothold in the competitive DeFi lending market.

Below is an overview of Euler V2 use cases, highlighting the unique DeFi products that can be achieved using Euler V2’s modular architecture.

Morpho vs Euler

Comparing Morpho and Euler side by side reveals their main differences, which are the result of different design choices. Both projects have designed mechanisms to achieve similar end goals, namely lower liquidation penalties, easier reward distribution, and bad debt accounting.

Morpho's solution is limited to isolated lending markets, a single liquidation mechanism, and is mainly used for lending ERC-20 tokens.

In contrast, Euler V2 supports lending using multi-asset pools, allows for custom liquidation logic, and aims to become the base layer for all types of fungible and non-fungible token lending.