State of Morpho Q1 2023

Key Insights

• Morpho’s matching engine efficiency reached an all-time high of 58% on February 7, surpassing $220 million in total value matched peer-to-peer.
• Morpho-AaveV2 has become the preferred destination for token incentives in Age 3, receiving 87% of the 9,999,999 MORPHO available.
• During the volatility surrounding the USDC depeg, Morpho generated the highest single-day interest for users matched peer-to-peer with $57,000 on March 11.
• Depositor APRs on Morpho, in some cases, outperformed underlying protocols Aave and Compound by more than 95 basis points.
• The first changes to the peer-to-peer index cursors have proven effective, increasing the matching efficiency for the adjusted markets.

Primer on Morpho

Morpho is a decentralized protocol that aims to enhance the lending experience on decentralized lending markets like Compound and Aave. It utilizes a peer-to-peer matching system to connect borrowers and lenders, which leads to better rates for all parties. It also avoids compromising on any of the standard features such as liquidity, liquidation guarantees, or risk parameters. By utilizing Morpho-Compound or Morpho-Aave, users can access the same liquidity available for borrowing or lending of the underlying protocol, but with the added potential of receiving an improved rate through P2P APR and additional MORPHO token incentives. In summary, Morpho offers an optimized way of accessing decentralized lending pools with improved rates while maintaining the level of security and liquidity offered by the underlying protocols.

Key Metrics

Performance Analysis

Protocol Overview

Total unique daily active users (DAUs) consistently grew, averaging 33 DAUs in Q1, marking a 13.2% QoQ increase. This steady growth reflects the protocol's growth within the DeFi community, and it also provides more peer-to-peer matching opportunities for the Morpho matching engine.

During the USDC depeg, user engagement experienced a significant increase, reaching a quarterly peak of 76 daily active users on March 11 as USDC traded over 10% below its $1.00 peg. This level of activity was only exceeded by the FTX collapse in November 2022, which registered 127 daily active users. With or without these events, the protocol consistently observes more unique daily suppliers than borrowers. At the end of Q1, 96% more total value was deposited than borrowed.

The USDC depeg events also demonstrated the protocol's resilience, as Morpho functioned as intended by adopting the underlying protocols' risk parameter recommendations. It's worth noting that when Aave and Compound paused some markets during the depeg, Morpho followed suit to prioritize user and protocol security. After the incident, Morpho reactivated its matching engine and markets, unpausing in tandem with Aave and Compound.

The overall total value in the system has persistently risen, with a 34.5% QoQ increase in the deposited value and a 28.3% increase in borrowed value. Morpho-AaveV2 significantly outperformed Morpho-Compound in terms of total value deposited and borrowed. Its performance can be attributed to the prevalent MORPHO incentives favoring the Morpho-AaveV2 market, as determined by tokenholder votes. The total value in the system peaked over $1 billion on March 2 before dropping 37% by March 13 due to the USDC depeg. The end-of-period total value deposited was $532 million, and the total value borrowed was $271 million.

In the first quarter since Morpho's inception, global matching efficiency averaged over 50%. This resulted in the highest interest generation from loans matched peer-to-peer, amounting to $2.3 million in P2P interest. Throughout Q1, there were 22 days when peer-to-peer interest surpassed the peer-to-pool interest generated by underlying protocols. The market volatility amid the USDC depeg events resulted in the highest peer-to-peer interest ever generated in Morpho's history, reaching $57,000 on March 11. Additionally, following the changes to the peer-to-peer index cursors, there was a notable difference in the interest generated from depositors and borrowers for the first time.

Matching Engine

Morpho-AaveV2 maintained its dramatic growth trajectory, ending the quarter with $715 million in total value. Its matching engine efficiency also improved, concluding the quarter with an efficiency of 48%. On the other hand, Morpho-Compound started to lag, holding only $90 million at quarter’s end. Additionally, Morpho-Compound's efficiency remained relatively stable at 13%. There is a significant correlation between the total value in an instance and the matching engine efficiency. As the value in the system increases, more peer-to-peer matching opportunities become available, and vice versa.

Since its inception, Morpho-Compound has been allocated 13.1 million MORPHO token incentives, while Morpho-AaveV2 has received 11.9 million MORPHO. It is important to note that the relatively close total emissions between the two instances are due to Morpho-AaveV2's later launch, resulting in certain ages where only Morpho-Compound received tokens. In the most recent age, Age 3, Morpho-AaveV2 was allocated 8.7 million MORPHO token incentives, while Morpho-Compound received a significantly lower amount of 1.3 million.

On February 7, Morpho's matching engine achieved a peak efficiency with 58% of the total value in the system matched peer-to-peer. The matching engine efficiency quantifies the overall value in the system that is paired peer-to-peer in comparison to the total value that is paired peer-to-pool. Q1’s daily average matching engine efficiency was 50%, while the end-of-period efficiency stood at 44%. Furthermore, the average matching engine efficiency for the total borrowed value in Q1 was 74%, whereas the average efficiency for the total deposited value was 37%.

This significant difference can primarily be attributed to the wETH market on Morpho-AaveV2. At the end of Q1, it had $120 million of wETH deposited and $170 million of wETH borrowed. Consequently, users depositing into the Morpho-AaveV2 market would be instantly matched peer-to-peer, receiving the more favorable Morpho APR, which was, on average, 67% better in Q1. Morpho continues to improve the matching engine efficiency through the peer-to-peer cursor index and MORPHO token incentives.

Morpho offers depositors and borrowers more efficient rates than those available through the underlying protocols, Aave and Compound, directly. As the table above shows, these peer-to-peer rates are significantly more efficient. For instance, wETH, Morpho's largest market, provided a Q1 P2P APR that was, on average, 67% more efficient for depositors and 30% more efficient for borrowers. For stablecoins such as USDT, USDC, and DAI, efficiency improvement averaged 30-48% for depositors and 22-39% for borrowers.

Most notably, the P2P rate for wBTC on both Morpho instances was substantially better than the underlying protocols. In Q1, wBTC depositors on Morpho-AaveV2 received an average APR that exceeded the underlying pool by 57 basis points, whereas those on Morpho-Compound benefited from an APR surpassing the pool by 95 basis points. Morpho's peer-to-peer APR significantly outperformed the markets of the underlying protocols, particularly in markets with low utilization rates on the underlying protocol, such as wBTC.

For the first time, Morpho adjusted its P2P index cursor for six different markets from the standard 50%. The index cursor represents the percentage of the spread where the peer-to-peer rate is located. Increasing the index cursor raises the P2P APR for depositors and lowers it for borrowers, while the opposite effect occurs when reducing the index cursor. By adjusting the P2P index cursor, Morpho gains greater control over incentivizing deposits or borrows to specific markets.

This relationship was exemplified by the substantial cursor changes for aDAI and aUSDT, set to 31.5% and 70.9%, respectively. Prior to the change, DAI had significantly more deposits than borrows, and USDT had significantly more borrows than deposits. When Morpho made the P2P index cursor adjustments, matching engine efficiency for both markets increased. For example, at the start of Q1, the matching engine efficiency for aDAI was 29%; at the time of the index cursor change, it was 48%; and by the end of the quarter, it rose to 72%. Monitoring the performance of these markets in the next quarter will reveal how much influence the P2P cursor has on matching engine efficiency.

MORPHO Incentives

In Age 3, wETH emerged as the most incentivized market, receiving 3.6 million MORPHO rewards, followed by wBTC with 2 million rewards. Stablecoins collectively garnered 3.4 million MORPHO rewards, distributed among USDC, USDT, and DAI. Overall, Morpho continues to strategically allocate MORPHO incentives towards markets demonstrating the highest value in terms of total value supplied and borrowed.

To date, four proposals concerning the distribution of MORPHO token incentives have been submitted. As MORPHO remains non-transferable and as the current goal is protocol decentralization, monitoring the community's governance actions is essential.

On average, there were 96 unique voters, a relatively strong number given the average number of daily users of the protocol for Q1 was 33.8. The gauge vote for Age 3 Epoch 3 garnered 17.7 million MORPHO votes, falling only 3.9 million short of the entire circulating supply of MORPHO. Overall, governance participation has been strong and is expected to continue as tokenholders direct the emissions of all future MORPHO tokens.

Qualitative Analysis

Morpho Security Measures

The Euler protocol recently experienced a $191 million exploit, making it one of the top 10 DeFi hacks. The vulnerability resulted from a lack of liquidity-checking in the donateToReserves() function, which was introduced after multiple audits had been completed. The exploit had far-reaching consequences for several protocols in the DeFi landscape, including Angle, Balancer, Idle Finance, and TempleDAO. Given the interconnected nature of DeFi protocols, there is a heightened need for even continual risk assessment and security audits.

Morpho has taken extensive measures to ensure the security and transparency of its protocol, recognizing that its additional layer of smart contract risk might deter users. The protocol has undergone 19 audits from top firms, including Trail of Bits, Pessimistic, Omnisicia, Spearbit, Securing, and Solidified. Morpho continues to receive bi-monthly audits from Spearbit and ensures new features are audited before release, addressing a key issue from the Euler exploit.

The team has also partnered with Certora for formal proving, which uses mathematical logic to verify program correctness under all circumstances. Morpho Labs conducts in-house unit testing, fuzz testing, and peer reviews regularly.

The Morpho Labs team prioritizes transparency, having recently released their Yellow Paper, which details key variables and invariant assumptions. The paper provides mathematical properties and proofs, emphasizing protocol correctness. It also highlights various aspects, such as balance integrity, covering borrow and supply, Morpho's positions integrity on the pool, and liquidity of positions.

Finally, Morpho has also achieved the highest score to date on its process quality review with DeFi Safety, receiving a 98% rating. The score showcases the team's commitment to maintaining a secure and transparent protocol.

MIP 8 - Governance and Snapshot Update #2

Q1 introduced three different MIPs (Morpho Improvement Proposals). The first was MIP 8, a governance and Snapshot update with five distinct changes.

• Timelock: A timelock is an additional security measure that delays the execution of a transaction for a specified period to prevent unauthorized or malicious transactions from occurring. In Morpho’s case, a 24-hour timelock was chosen.
• Reduced Voting Time: The voting time for MIPs was reduced from 96 to 72 hours to align with similar protocols.
• Snapshot Subspace for Gauges: With a clear distinction between general protocol proposals and gauges, the Morpho team introduced a subspace for gauge voting. The voting period for this subspace was set to 144 hours.
• Voting Rules Reduced From Five to Two: Five rules are currently used to calculate an address's voting power. Having so many rules has complicated the code logic of voting rules, which Morpho believes should remain simple. Therefore, the proposal has reduced the voting rules to two by enabling the claimability of vested tokens. This requires whitelisting three vesting contracts and allows Snapshot to use the rules of balance-of and delegation.
• Adding the HAL Plugin: A quality-of-life upgrade, the HAL plugin enables community members to be notified of new and ending proposals on Snapshot.

MIP 9 - Peer-to-Peer Index Cursors

While MIP 8 focused on governance, MIP 9 focused more on the efficiency of the protocol. It introduces changes to the peer-to-peer index cursor for every market where peer-to-peer is enabled. Until now, the Morpho P2P cursor has been set to exactly one-half of the spread. In other words, the improvement in the APY users received compared to the underlying pool APY has been the same for suppliers and borrowers. This update introduces a curve depending on the one-month average utilization of a market similar to the rate curve of Aave and Compound.

With the changes to the peer-to-peer index cursor, there were a number of instant rate changes induced by the proposal. For example, the P2P rates for aWBTC, aWETH, and aUSDT changed from 0.65%, 2.26%, and 3.21% to 0.60%, 2.21%, and 3.38%, respectively.

MIP 10 - Morpho, Lenses, and Vaults

Following recommendations made by Spearbit, upgrades were proposed for the Morpho, Lens, and Vaults contracts. The Morpho and Lens upgrades aimed to make the contracts more maintainable and resilient. The upgrades included actions like preventing the deprecation of a market if it hasn’t been paused earlier, removing pool rewards on Morpho-AaveV2 to save gas, and removing some now useless functions and code duplications.

The upgrades aimed to make the vaults more gas efficient and distribute rewards more securely. This was accomplished by setting some variables in the vaults to be immutable to avoid reading storage for every vault interaction. As such, the vault rewards distributor contract will no longer need to specify the amount or recipient of MORPHO rewards. Rather, the recipient of MORPHO rewards will be set at the time of construction. Now, MORPHO tokens held in a vault can be transferred to the rewards distributor through a public function triggered by any EOA, which should accelerate the distribution of rewards.

Key Updates

Morpho recently announced Morpho-AaveV3, a new version of the Morpho instances previously deployed on Compound V2 and Aave V2. It has been tailored to the new mechanisms introduced in Aave V3. The new features include an improved matching engine, efficiency mode (E-mode), gasless token approvals, and account management. It also features a mechanism to split supply into pure supply and collateral supply to overcome borrow and supply caps. The core contracts are complete and undergoing audits, after which governance will determine their deployment.

Additionally, Morpho has integrated with several DeFi platforms and services. Idle Finance, which algorithmically optimizes digital asset allocation, integrated Morpho to provide better total returns in two core offerings. Morpho also partnered with Octav, a DeFi data analytics platform, and Warden Finance, another DeFi analytics and risk platform, and it integrated with popular wallets Trust Wallet and XDEFI Wallet.

Morpho-AaveV2 also went live on DeFi Saver, a dashboard for managing DeFi positions, where users can leverage their strategies with Morpho's improved rates. A comprehensive list of Morpho's current partners and integrations can be found in its documentation.

Closing Summary

During Q1 2023, Morpho demonstrated significant growth and progress, experiencing a steady increase in total unique daily active users, total value deposited and borrowed, and matching engine efficiency. The Morpho-AaveV2 market outperformed Morpho-Compound, capturing most of the MORPHO token incentives, and became the preferred destination for token incentives in Age 3. The changes to the peer-to-peer index cursors proved to be effective in improving the matching efficiency in targeted markets.

Despite market volatility during the USDC depeg, Morpho generated record-high interest for users matched peer-to-peer. In addition to the strong performance metrics, Morpho's dedication to security and transparency was evident through its numerous audits, formal proving, and high DeFi Safety rating. Morpho’s user experience will continue to be enhanced with the introduction of Morpho-AaveV3 and its improved features.

Morpho's Q1 2023 performance highlights the protocol's potential to become a significant player in the DeFi space. Its competitive edge comes from offering users an optimized way to access decentralized lending pools with improved rates while maintaining the same risk parameters and liquidity as the underlying protocols. As the protocol continues to grow and evolve, its development and performance in the coming quarters could begin to have a long-term impact on the DeFi ecosystem.