Before we get started, this is not a recommendation or endorsement to buy any token mentioned.
For anyone who’s ever lent or borrowed on DeFi protocols like Aave or Compound, you may have noticed there’s normally a larger spread between the rate being earned by those supplying assets vs those borrowing assets. In other words, Aave and Compound are not as efficient.
This is due in part to the way shared liquidity pools are designed in DeFi, where lenders supply liquidity, but often fewer are borrowing the available liquidity. In DeFi money market liquidity pools, yields are socialized, meaning numerous lenders share the paid borrowing interest generated by the few borrowers. This is ultimately what creates a spread.
A newer DeFi protocol called Morpho aims to solve this problem. With Morpho, rewards are no longer socialized. Instead, the supplied liquidity is dynamically matched peer-to-peer with borrowers on a come-and-go-basis. The lending interest corresponds to the interests paid directly by the borrower(s) they are paired with, meaning DeFi lenders in Morpho no longer share in socialized interest yield.
See the lending Aave APYs vs Morpho P2P APYs
As lenders and borrowers are matched peer-to-peer, the lending and borrowing rates can be chosen by Morpho but must stay within the spread of the underlying protocol's pool (ie Aave), between the lending APY and borrowing APY to be profitable for both parties. Here’s exactly how it works under the hood:
- Morpho maintains an on-chain priority queue, sorting